October 18, 2006, 12:40 pm

stacked ipo calendar here these two weeks....pre ipo analysis available on each offering at http://www.tradingipos.com

This week's free blog piece is another government contracting ipo. SAI was one of three strong ipos that debuted Friday. Tradingipos.com was quite high on both apkt/ehth. However each is now well above ipo price making a free blog posting of the pre-ipo analysis piece for each a bit late...pieces on each were available on the site to subscribers well ahead of ipo date. I will not post an analysis piece on the blog for free until after ipo date, usually at least 3-5 days after.

2006-10-08
SAI - SAIC Inc.

SAI, SAIC Inc plans on offering 89million shares (yes, that is 89 million) at a range of $13-$15, assuming over-allotment is exercised. Morgan Stanley and Bear Stearns are lead managing the offering, seven houses co-managing. Post-offering SAI will have a total of 401 million shares outstanding for a market cap of $5.8 billion on a $14 pricing.

SAI does not have a specific use for the offering proceeds. Note however that just prior to this offering SAI is utilizing all pre-IPO cash on hand to pay out a $1.6- $2.4 billion dividend to insiders. Post-offering then SAI will have roughly $1 billion in cash on hand and just over $1 billion in debt. SAI will have less cash on hand post-offering them pre-IPO.

Vanguard will own 38% of SAI outstanding shares post-offering.

From the S-1:

“We are a leading provider of scientific, engineering, systems integration and technical services and solutions to all branches of the U.S. military, agencies of the U.S. Department of Defense, the intelligence community, the U.S. Department of Homeland Security and other U.S. Government civil agencies, as well as to customers in selected commercial markets.”

A large Federal government IT contractor offering. SAI does not make weapons, they provide information technology services. SAI does most of their contracting with the Department of Defense. 89% of revenues are from the US government, 69% from the Department of Defense. SAI has over 43,000 employees and 9000 active contracts. 20,000+ Revenues from the Army account for 16% of revenues, Navy 14% and Air Force 11%.

SAI is ranked the #3 information technology (IT) Federal contractor behind Lockheed Martin and Northrop Grumman. Post 9/11, this has been a growth sector. Department of Defense budgets have increased annually and the creation of the Department of Homeland Security has also fueled government contractor growth. This area figures to continue robust spending regardless of the outcome of the 2006 or 2008 elections. SAI puts it quite well in the prospectus:

“Following the September 11, 2001 terrorist attacks, U.S. Government spending has increased in response to the global war on terror and efforts to transform the U.S. military. This increased spending has had a favorable impact on our business through fiscal 2005. Our results have also been favorably impacted by increased outsourcing of information technology (IT) and other technical services by the U.S. Government. However, these favorable trends have slowed in fiscal 2006 and 2007 as a result of the diversion of funding toward the ongoing military deployment in Iraq and Afghanistan.”

SAIs funded backlog has grown steadily the past 3 years due to acquisitions and Federal spending growth. Funded backlog was $3.65 billion in FY '05(ending 1/31/05), $3.89 billion in FY '06 and $4 billion through 7/31/06.

The defense contracting space has been consolidating rapidly the past few years. A number of defense contracting IPOs this decade have been scooped up by larger entities, General Dynamics recent purchase of Anteon being the latest. SAI has a long history of growth through acquisition and I would absolutely expect that to continue. Due to their size, SAI will definitely be an acquirer, not an acquiree. They've acquired over 70 companies in the last decade alone. My take is that SAI is coming public in order to be able to use their stock to make larger acquisitions.

Financials

SAI will have a little over $1 billion in cash and $1 billion in debt post-offering. SAI will not pay a dividend as public company, however as noted they will be giving insiders a pre-IPO payout of $1.6- $2.4 billion.

Revenues have grown steadily this decade, although the pace has slowed the past 18 months. Revenues for FY 2005 (ending 1/31/05) were $7.2 billion and for FY 2006 (ending 1/31/06) $7.8 billion an 8% increase. Through the first 6 months of FY '07, revenues appear to be on a pace for $8.1 billion, a 4% increase. Revenues have actually been quite flat the past 5 quarters. Again at this point I would expect SAI to attempt to grow through acquisitions going forward, most likely public companies in the Federal contracting space.

Operating margins are relatively slim in this sector. SAI has been in the 6.5%- 7% historically. Net margins have been in the 4% range. Based on these margins and FY'07's revenue run rate, I would anticipate SAI to earn $0.90- $1.00 a share this year. On a $14 pricing SAI would be trading 15 X's current year earnings.

Going forward I would expect slow organic growth, mostly due to the sheer size of SAI. I would expect future revenue growth to be driven by acquisition. Again due to SAIs size, I would anticipate they'll be in the market for public companies in their sector that can be immediately accretive to the bottom line.

SAIs closest pure play comparables are CAI/SRX/MANT. This has been a very good sector to be in this decade with a number of highly successful IPOs including MANT/ SRX/ SINT/ MTCT. Also a number of other IPOs in this sector have been bought out at hefty premiums including ANT/VNX. This is a sector I'm quite familiar with having owned all seven of these companies stocks as various times, CAI's back when it was on the nasdaq as CACI. A quick comparison of a few with SAI:

SAI (on a $14 pricing) - $5.8 billion market cap, trading 0.7 X's revenues and 15 X's earnings. Net margins in the 4% range, expected revenue growth in the 5% ballpark.

CAI- $1.75 billion market cap, trading 0.85 X's revenues and 19 X's earnings. Net margins in the 5% range, expected revenue growth in the 8% ballpark.

SRX- $1.6 billion market cap, trading 1.2 X's revenues and 24 X's earnings. Net margins in the 5% range, expected growth in the 12% ballpark.

MANT- $1.1 billion market cap trading 1 X's revenues and 21 X's earnings. Net margins in the 5% range, expected growth in the 12% range.

SAI is coming cheaper on a PE basis, but due to size, the expected growth rates are a bit slower then CAI/SRX/MANT.

Conclusion- I'm neutral on this deal. I suspect the sheer size of the offering will mute short and mid-term performance. However they appear to be pricing it at an attractive multiple to 1) get the deal done and 2) have an opportunity for longer term appreciation. My preference in this niche is for the smaller players that have a good chance to be swallowed up at a premium by the likes of SAI. However SAI is a big player in a sector that has done quite well this decade. The 89 million shares being floated are a bit much for my tastes; however SAI should be a solid longer term play in a sector that should continue to perform well. Expect numerous acquisitions by SAI over their first year public, most likely a number of them being stock based acquisitions.

A Large offering coming at an attractive enough multiple to get it done successfully in range