Martin Young serves as a managing director at Loughlin Management Partners + Company, a Manhattan-based management consulting firm, where he advises firms, senior lenders, unsecured creditors and equity sponsors.
The former U.S. Army Officer has helped lead more than $10 billion worth of debt restructurings while at the firm across more than 30 engagements.
Before joining Loughlin, Young was a senior manager at RCN Corporation, as part of an internal turnaround team.
In his interview with ExecutiveBiz, Young discusses how the current budget environment will affect small and large contractors, which small firms are acquisition targets and the Affordable Care Act.
ExecutiveBiz: You’ve mentioned that budget cuts are going to go down four to five times sequestration. Can you explain that?
Young: We are already off the fiscal cliff. And the reason we say that is you have to sort of frame this in a couple of different ways.
One is you have to understand there's a tremendous amount of overseas contingency operation spending that's been going on for years now. It was slightly over $180 billion in 2008, and in fiscal year '12, it was slightly over $120 billion. In the current fiscal year, it will essentially be half that because of the drawdown in Afghanistan as well as from Iraq.
When you think about sequestration and the impact on the Defense Department, it's about $50 billion a year. So, you're really seeing the drawing down is really three times what the number is on the table for sequestration. Then in addition to that, if you think about the cuts agreed to last summer as the down payment for fiscal year 2013, that is about $50 billion.
ExecutiveBiz: In which ways might the Small Business Administration favor small contractors and hurt large or medium-sized contractors?
Young: Over the last six years or the last seven years, 2006 through 2012, the government has missed its goal to appropriate contracting dollars in small businesses, both in terms of prime contractors as well as the contracting roles.
What's happening through congress and the senate and basically the politics is that the contracting goals have actually been raised so small business contracting goals have risen from 23 percent to 25 percent and then subcontracting relatively raised from 36 to 40 percent.
When you think about that and then you think about actually hitting those goals, you're talking about substantial amount of dollars potentially as many as 30 billion if the government started achieving those goals in terms of allocations to prime and subcontractors in the small business area.
ExecutiveBiz: Speaking of small companies, what types of small contractors do you see being snapped up by larger firms? [CM1]
Young: You would see consolidation among prime contractors, which would increase subcontracting to smaller businesses.
The nice thing about services is it's a bit easier to scale because you don't have to deal with all those start-up production costs and inventory costs that you have to do in the product business.
ExecutiveBiz: Will the Affordable Care Act, benefit I.T. providers and those segments of large companies?
Young: Yes, I think it's too early to tell. I think one of the things and actually we'll defer to one of my colleagues who is very familiar with what's going on in the Affordable Care Act but how those things is going to be implemented is a big question mark. We really haven't gotten to that point yet in terms of understanding the implementation of something that is so ambitious at some of the things in the Affordable Care Act.
You know, in my estimation though, it's why I move this back to sort of the Defense Department realm. The way I think about it is that, you know, 10 years ago ““ 10, 12 years ago, the military really doesn't have a military-wide e-mail system.
And so what happened was that, you know, various, you know, agencies, various commands, et cetera had ad hoc systems and in many cases, people are even using private e-mail accounts to sort of communicate with the government.
What happened really over the last 10 years with the war is these sort of ad hoc systems continue to be developed and invested in. And so what you had was really a very complex network.
And, you know, over the course of time, a lot of contractors is very well because, you know, they could develop a specific solution to deal with integration issue or security issue or some sort of, you know, communications issue and there are hundreds of these sort of niche companies thus in terms of products and services that are serving the government because basically it's sort of hodgepodge evolution of the last decade.
Over time, I would expect more migration into the cloud and as we move these systems really more into cloud environment, I would expect to see a lot of obsolescence and consolidation of I.T. services.
In short, you'll see the same thing you've been seeing in really corporate America last 10 years. The government is just like catching up with, you know, really a lot of large enterprise with the new ““ you know, their I.T., their systems, et cetera, et cetera.
ExecutiveBiz: Okay, so the industry sounds like it's moving very fast. Can you explain the environment for the restructuring and bankruptcies you mentioned?
Young: The interesting thing is whenever you look at really the last 50 to 100 years, every time the United States has transitioned from war to peace, there's been some sort of a peace dividend and that peace dividend has basically been produced through the draw downs of troops, as well as other services in a contracting-base that supports them.
Over the last few wars, World War II, Korea, Vietnam, the Cold War in 1989, and the end of the first Gulf war, you saw a draw down to solve base closures.
What's happened was a lot of those contractors essentially went through a series of mergers and acquisitions. Basically, the companies where there was dropping revenues ended up being purchased or acquired by other companies that continue to go to larger and larger platforms.
We expect to see the same things. There's a cycle. This history has got repeating itself. But what is different about this cycle and is now leveraged system meaning that company this time around have more debt on their balance sheet than previous cycles in this nation's history.
A lot of that is because of the general liquidity and many practices that we saw over the last five to 10 years and the credit market as a result of a number of people in the lending, private equity communities being very comfortable with this industry and the growth industry.
In fact, if you look at the 10 years post 9/11, the industry grew at a compounded annual growth rate of about 8 to 9 percent annually. So when you have an industry that grows for 10 years at 8 to 9 percent annually, there's a lot of comfort in putting not just higher and higher multiples on these companies which basically comes from growth but also leverage and that's what has happened. The leverage is what creates new liquidity problems and the leverage is what creates bankruptcy.
ExecutiveBiz: Is there anything you would like to add?
Young: Yes, what I would say is you're going to see a few things I think over the next 12 months. The first thing is sequestration. One of the big issues that will bring potential shock to the system. That potential shock creates a liquidity crisis for certain companies that are heavily dependent on revolvers or other forms of debt to basically fund their working capital. If there's a material factor that materializes the change in the businesses and industry you could see a liquidity crisis in the first quarter.
Beyond that, what we expect to see is that as these wars draw down, revenues will fall, leverage will creep up and as a result of that increasing leverage, you'll start to see companies in various default scenarios and that will be the next wave.
Beyond that, we're going to expect to see companies that will essentially start hitting maturity walls. Meaning, you'll have companies that have a lot of leverage on them that can continue to operate but they're debt is coming due and there isn't a refinancing solution in the marketplace. That's generally what we would expect to see which is also very common of a lot of restructuring cycle.