The national debt will likely lead to more conservative federal budgets within a few years, and if spending on national security is going to continue trending upward beyond this year, then Congress is going to have to make hard choices that they’ve been unable to so far, according to Roger Krone, the chairman and CEO of federal IT services contractor Leidos [LDOS].
Demand for modernizing IT infrastructures is broad across the federal government, as seen in the recent fiscal year 2018 omnibus appropriations bill, which provides for substantial increases in spending for the Defense Department and federal civilian agencies, Krone said Monday afternoon at “Captains of Industry” discussion hosted by the Atlantic Council.
“Government IT is a hot place to be right now,” Krone said.
Krone said his is “reasonably confident” that fiscal 2019 budgets will be similar to the 2018 spending plans although he only gives even odds that Congress will pass and the president will sign authorization and appropriations bills before the mid-term elections in November.
But the outlook for federal spending beyond 2019 becomes murky because of the national debt and the pressure that will be brought to bear to rein in spending, Krone said.
Asked whether 2018 marks a “long up-cycle” in the company’s outlook, Krone replied, “Of course we always hope so, but I wouldn’t count on it.”
Without citing former Chairman of the Joint Chiefs of Staff Adm. Michael Mullen by name, Krone pointed out that the now retired Navy admiral said when he was the nation’s top military officer that the greatest threat to the nation was the “size of the national debt.” This year, Dan Coats, the director of National Intelligence, told Congress that the national debt is a serious concern for national security.
“And there is just a point in time where the size of the national debt drives up interest costs, absorbs capital in the world today, and that Venn Diagram once again overlaps with national security and the security of the nation and so there is some upper limit to how much we can borrow and how much we can spend,” Krone said. He sees fiscal conservatism creeping back in by the 2020 and 2021 period, which will require the possible tradeoffs between “guns” and “butter,” he said, referring to spending on defense and non-defense priorities.
“And so, the prognosis for that is less of an increase and in fact you could see probably flattening of budgets in ‘20, ‘21, ’22,” Krone said. He also noted that the Trump administration’s plans for fixing and modernizing infrastructure could also eventually put pressure on federal spending.
Byron Callan, a defense and security analyst with the strategic advisory firm Capital Alpha Partners, in a client note on Tuesday agreed with Krone’s “less bullish” assessment of out-year defense spending. Callan also said that he is “less optimistic” than Krone that fiscal 2019 federal spending bills will be agreed to before the start of the fiscal year in October.
On other issues, Krone said industry consolidation in the federal IT services space. Leidos is currently the largest provider of IT services and solutions to government customers due to its acquisition of a former Lockheed Martin [LMT] government services business two years ago. Running a close second is General Dynamics [GD], which closed its nearly $10 billion acquisition of CSRA Inc. on Tuesday. GD overcame an unsolicited bid by CACI International [CACI], which demonstrated that company is willing to swing for a big deal.
The acquisition of Lockheed Martin’s Information Solutions and Government Services business does allow for Leidos to reduce its overhead rates and be more cost competitive but Krone said that wasn’t the primary impetus for scaling up the size of the company. Larger drivers are the broader portfolio of capabilities and customer relationships, which also enables cross-selling opportunities, he said.
He said the deal also lessened risks by diversifying its budget, customer and regional exposures.
The larger company size also strengthens the Leidos brand and gives it greater potential to expand its spending around research and development, Krone said.
Krone also said that the rapid advancements in technology that have led to an increasingly connected world are driving his company’s government customers to modernize and become more efficient and more secure from cyber threats. He said the advancements are challenging for even large organizations to keep pace with.
“As a result, what customers want from companies like Leidos is changing,” he said. “Services are not enough. It’s not just labor as an extension of the customer. Our industry is changing to highly skilled labor solving customer problems and supporting customer mission.”