Sector Watch: IT services
Of all the consumers of information technology services today, the federal government is America’s largest, with spending having increased every year since 1980. According to INPUT, a market research firm, federal government IT spending will grow to $80.5 billion by 2011 from $63.3 billion in 2005. The Department of Defense accounts for the majority of spending.
This rise in federal government IT spending is largely the result of expanded national defense and homeland security programs, a growing need for sophisticated intelligence gathering and increased outsourcing by government agencies due to the retirement of large numbers of government IT specialists.
Two small caps benefiting from increased government IT spending are Digimarc Corp. (Nasdaq: DMRC), which produces digitally watermarked driver licenses and identification cards, and ManTech International Corporation (Nasdaq: MANT), a provider of secure IT systems and infrastructure for national security programs.
ManTech’s customers include, among others, the U.S. intelligence community, the Departments of Defense, State, Homeland Security and Justice, and the NASA Space program. The company provides an array of services, ranging from systems engineering and integration, technology and software development, to enterprise security architecture, information assurance and network infrastructure protection. ManTech maintains the secure communications systems being used to fight the war in Iraq and also supports a secure database for tracking terrorists.
During this year’s June quarter, ManTech announced $330 million in contract awards, with nearly 60% representing new awards. Backlog rose to $3.57 billion and was up 66% from one year ago. During the six months ended June 30, 2007, ManTech’s revenues rose 14% year-over-year to $643 million from $563 million, net income grew 18% to $28.4 million from $24.0 million and per share earnings climbed 17% to $0.84 from $0.72. This company targets 23% to 26% revenue growth in 2007, including 13% to 15% organic growth. Analysts expect ManTech to produce 14% to 15% annual growth over the next five years. On Tuesday, ManTech shares closed at $37.10. Over the last 52 weeks, shares have ranged between $29.79 and $38.04. My $45 price target for ManTech (MANT) is 25% above the current price.
Like ManTech, Digimarc is also reaping rewards from federal government IT spending; specifically, the company is benefiting from new Homeland Security initiatives, including the passing of the REAL ID Act in May 2005. The legislation mandates improved security standards for all aspects of the driver license issuance process and calls for secure driver licenses that can’t be counterfeited. Costs associated with this program are estimated at around $11 billion over five years. Digimarc is already the incumbent supplier of driver licenses to 70% of the market and is producing digitally watermarked licenses that are REAL ID Act compliant. By year-end 2007, the company anticipates that one out of every two driver licenses issued in the United States will be digitally watermarked.
Approximately two-thirds of American states source their driver licenses from Digimarc, which produces a total of more than 60 million driver licenses and other secure person IDs per year. Additionally, foreign governments in Russia, Latvia, Mexico, Ghana and four Canadian provinces use Digimarc technology to produce secure IDs for their citizens.
Digimarc typically provides services to its government customers under five-year contracts and has also successfully propagated digital watermarking in music, movies, television and radio broadcasts to reduce pirating and counterfeiting losses.
While Digimarc’s revenues grew only 4% year-over-year to $54.2 million from $52.1 million in the first six months of 2007, the company’s net losses narrowed considerably to $1.5 million, or $0.07 per share this year, from $11.6 million, or $0.54 per share, last year. June quarter highlights included a $4.5 million contract to help Russia upgrade its driver license issuance system, a contract with Tanzania to provide secure ID cards for registered voters, and contract extensions with both Vermont and Maine for digitally watermarked driver licenses. Analysts expect Digimarc to turn profitable in 2008 and to generate growth averaging 28% annually over the next five years. Shares of Digimarc closed at $9.20 on Tuesday. Shares over the last 52 weeks have ranged between $8.05 and $12.43. My $18 price target for Digimarc (DMRC) is nearly twice the current share price.
