Time to reshuffle your cards, defense investors.
Fresh off its victory on the $40 billion KC-X Tanker contract, No. 3 national defense contractor Northrop Grumman (NYSE: NOC) decided to shift its focus a bit yesterday, when it agreed to sell off its "Electro-Optical Systems" (EOS) unit to fellow contractor L-3 Communications (NYSE: LLL).
What is EOS, exactly? According to Northrop's website, it's a business built from integrating "the assets and resources of five premier night vision companies into one dynamic division, Northrop Grumman Electro-Optical Systems." EOS sold $190 million worth of such night-vision gear last year. Yet L-3 is getting the whole ball of wax for a mere $175 million.
Is that a steal of a deal, or a rip-off? Hard to say, without knowing precisely what margins Northrop has been reaping from the business. What I can tell you is that the price looks objectively fair if L-3 can extract its own usual profit margin from the Northrop unit. Right now, L-3 sells for just a little more than 0.9 times sales -- which, coincidentally, is exactly the price-to-sales ratio it's paying for the EOS unit.
Worst case, best case
The worst case, therefore, is that L-3 is paying a fair price for the EOS business and improving its ability to compete with the whole range of defense contractors that offer similar night-vision technology -- General Dynamics (NYSE: GD), Raytheon (NYSE: RTN), Silicon Graphics (Nasdaq: SGIC), and Microvision (Nasdaq: MVIS), to name just a few.
And the best case is that L-3 is robbing Northrop blind. You see, Northrop earns about a 9.4% operating margin across its many revenue streams. But within the electronics shop in particular, where EOS used to be housed, Northrop has been pulling down a hefty 11.8% margin.
The way I look at it, L-3 appears to be snagging one of Northrop's most profitable operations -- a business that routinely earns more than L-3's own 10.4% operating margin -- and is paying no more than an average price for it. I see a lot to like in this deal.
Make the Fool your source for all things investing generally and defense investing in particular. See also:
Closed for 15 months – opening 10 days only! Get notified ahead of time as our expert portfolio manager invests $1 MILLION in the best opportunities from across The Motley Fool’s premium investment services. This is the first open since August 2008, by invitation only. Enter email below.
Terms & Conditions
RSS Headlines
Fool UK