At the risk of repeating myself, Boeing
In a column several months ago, I posited that defense firms should, by and large, sell for a market capitalization equal to or greater than the amount of revenue they bring in in a year. So far, it seems Mr. Market is still disagreeing with me, but more and more, the smartest investors on the market are saying I'm right. Case in point: Lockheed Martin's
On Wednesday, Lockheed announced it's selling its Enterprise Integration (EI) consulting division to private equity shop Veritas Capital. Asking price: $815 million. Annual revenues: $626 million. No need to pick up your calculators; I'll do the math for you. Lockheed is getting 1.3 times annual sales for the unit.
Viewed in isolation, this would prove nothing. But when placed alongside other recent defense deals, and examined closely, I believe it proves conclusively that companies like Lockheed and Boeing are selling for far less than they are really worth. Consider:
- Last year, Northrop Grumman
(NYSE: NOC) sold its TASC government consulting division to General Atlantic and KKR for $1.65 billion, a price equivalent to one times sales, nearly to the decimal. - In January, Boeing bought Argon ST for $775 million -- 2.5 times sales.
- Two months later, Orbital Sciences anted up 1.1 times sales to take General Dynamics'
(NYSE: GD) satellite manufacturing division off its hands. - Two months ago, it was FLIR Systems
(Nasdaq: FLIR) stepping up to the cash register, and paying 1.5 times sales to acquire tiny ICx Technologies.
Anybody see a pattern here?
Everywhere you look these days, knowledgeable managements and professional investors are paying at least one times sales, and in some cases much, much more, to purchase profitable, growing defense businesses. What's more, in at least two instances, acquirers paid more than 1 times sales despite the fact that the sellers sitting across the table were extremely motivated to make a deal. (Citing conflicts of interest, Congress has basically ordered Northrop, Lockheed, and anyone else who sells weapons systems to the U.S. to exit any consulting business that advises the U.S. on what weapons systems it should buy.)
In light of these facts, I'd go so far as to say that not only are private equity firms and defense contractors validating my valuation argument on Boeing and its peers, they in fact seem to be suggesting I'm too conservative.
You see, Lockheed's EI division isn't just one in a long string of examples; it's a striking reminder that even the worst defense company may be worth significantly more than it's selling for today. Because as it turns out, the EI unit in question is part of Lockheed's Information Systems & Global Solutions division, which is both Lockheed's biggest business and the one that carries the worst profit margin.
IS&GS earned an operating profit margin of just 7.4% last year, versus the 9.1% operating margin for Lockheed as a whole. Yet if this single part of Lockheed's least profitable unit is worth 1.3 times sales, how much more should the company as a whole be worth? For that matter, how much more should other companies in the defense industry be selling for?
One word: "lots"
As in, lots more than the stocks cost today. And isn't that exactly what we're all looking for as investors -- the chance to buy low today, so that we may sell high tomorrow? If that's your goal, then I submit the following shopping list for your consideration:
|
Company |
Annual Revenues |
Market Cap |
Potential Profit at |
|---|---|---|---|
| Boeing | $65.4 billion | $52.1 billion | 26% |
| General Dynamics | $31.5 billion | $24.1 billion | 31% |
|
Textron |
$10.3 billion | $5.9 billion | 74% |
| Lockheed Martin | $45.8 billion | $25.5 billion | 80% |
|
L-3 Communications |
$15.6 billion | $8.1 billion | 92% |
Foolish final thought
Fools, I cannot say for certain that all of these stocks are worth precisely 1 times sales, and that they'll ultimately sell for the value of their annual revenue streams. Some may be worth more, like the 2.5 times sales Boeing paid for Argon, and others may be worth less, like Northrop's TASC. Personally, if I were in the market for a defense stock, I'd be much more comfortable owning a low-debt option like Boeing, General Dynamics, or Lockheed, than the heavily indebted Textron or mildly indebted L-3. One thing that is for certain, though, is that all of these stocks are worth more than they're selling for.
One more thing: These discounts won't last forever, and perhaps they won't last for long.
