Booz Allen Hamilton (BAH) hit Wall Street on 17th of this month and has raised about $238 million with its initial public offering (IPO) of stock. Based in Virginia, Booz Allen primarily provides management and technology consulting to the U.S. government, with a focus on defence, intelligence and civil issues (98% of its revenue in FY10 was derived from the U.S. government). This IPO follows the recent trend of private equity firms taking their leveraged buyout companies to public over the last 2 quarters. A 16% gain in U.S. stocks since the end of June has helped PE firms sell shares in a dozen of their companies, with 10 trading above their IPO price, compared with less than half of those that went public in the first six months. In case of BAH, its majority stake owner Carlyle Group (which bought approximately 80% of stake in BAH in 2008) has diluted almost 9-10% of its stake in the company. In the filing, the company had stated that part of the proceeds will be used to pay off about $545.2 million in debt that has been added to its books at the time of its leveraged acquisition by Carlyle.
This IPO has again opened up a controversial topic: whether it is really worth for a consulting firm to go for public money by sacrificing its age-old partnership culture. Is it really worth it when you consider all the hassles of SEC reporting and Sarbox compliance issues for a listed company? Market experts have been speculating over the last two years (since its acquisition by Carlyle) that the firm is bound to go public at some point or the other, as the PE firm did not really have any other exit option. Due to conflict-of-interest rules, Carlyle could not shop the company, which provides advice to government agencies on technology acquisitions, to strategic investors or rivals. But this exit route, while favourable to Carlyle Group, may have detrimental impact on the unique work culture and business strategy of Booz Allen, as has been speculated by business columnist Steven Pearlstein in his Washington Post article. Carlyle had acquired almost 80% of BAH’s stake for a total pay-out of $2.54 billion, which included a cash pay-out of $1 billion. But as in the case of most leveraged buyouts, it has already recouped more than 50% of the cash investment in the form of a special dividend pay-out by the company in the last financial year to the tune of over $500 million. The filing showed that revenue increased 18% to $5.12 billion in the fiscal year, while the profit is only $25.4 million, a profit margin of 0.5% which is very low for a consulting firm. This shows the impact of the special dividend pay-out. A company with this profit level is not going to be an attractive investment in an IPO, which was reflected by the fact that most of the share subscription has been at the lower end of the price spectrum of $17-$19 as specified in the filing document. Having said that, Carlyle has still made an approximate return of 100% at the listing price of $17. Also the spin-off of Booz Allen’s slow growing private and international consulting arm from its highly profitable government consulting business has contributed towards augmenting Carlyle’s total return.
So the IPO seems to be an attractive business for Carlyle Group. What remains to be seen is whether it will benefit Booz Allen, its employees and its government customers. BAH has a strong corporate partnership-driven culture that stresses quality, collaboration and putting customer interests before its own. Its steady growth in sales and profits has been organic, the result of sustained investment in people and technology without resort to costly and culture-diluting acquisitions. Booz Allen chief executive Ralph Shrader has particularly stressed this point in his post-listing press conference that the culture, the management team or the core values would remain uncompromised even after the firm goes public. But sceptics are raising their concerns. It has happened once before in the past when in 1970 Booz Allen went public for a short span of time before becoming private again. At that time the company executives had realised that the public shareholders’ expectations and regulatory compliances are in opposition to its unique business model. So who can assure that history will not repeat itself? Once there is a slowdown in the government-contracting sector, the company could be forced to chase low-margin contracts or buy up mid-size competitors in order to meet analysts’ and investors’ expected double-digit earnings. This could seriously lead to an erosion of Booz Allen’s unique work culture and its competitive advantages. Whether this will happen in reality is still left to be seen. Meanwhile sceptics are not getting over-enthusiastic about this supposedly landmark IPO, which could very well lead to some other consulting firms going public.