Rising Star Buy: Integral Systems

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This article is part of our Rising Star Portfolios series.

In this market, it's difficult to find a company with massive market share, world-class technology, and huge growth potential that still trades for a compelling price. It's even rarer to find a good deal after a company announces that it's pursuing "strategic alternatives." But that's exactly what Integral Systems (Nasdaq: ISYS  ) offers us -- which is why I'll buy $1,000 worth of its shares tomorrow for my Rising Star portfolio.

Protecting satellite assets
Integral Systems makes equipment and software that controls satellites and identifies interference -- a feature that both protects those satellites and makes them more efficient. Because buying and launching a satellite into space can cost hundreds of millions of dollars, ensuring that it functions correctly is an overwhelming priority for government and commercial satellite operators. Integral Systems does this as well as anyone on the planet.

But I'm even more excited about the future applications of its world-class technology, which company is just beginning to exploit. From network and space management, to communications links for unmanned aerial vehicles, to cybersecurity, Integral Systems is developing impressive products in markets with large demand. Some of its products generate huge returns on investment for customers; remember, satellites are massive investments, and in many cases critical to national security, so small investment that improves their performance and reliability is a no-brainer. Integral Systems also has opportunities to expand its work with intelligence agencies, a large market segment that the company has thus far underserved.

Place your bids
There's just one hiccup in this promising story: Right now, the company is for sale. Even though the selling process has been announced, I expect a much higher price when a deal finally gets done -- if it does get done. This is a world-class asset with a strong presence and critical technology in growing markets. It's likely to get a lot of attention from possible buyers such as Harris (NYSE: HRS  ) and ViaSat (Nasdaq: VSAT  ) , and even bigger players such as General Dynamics (NYSE: GD  ) , Lockheed Martin (NYSE: LMT  ) , or Boeing (NYSE: BA  ) that seek growth in an era of flattish defense spending.

Consider that Integral Systems' current enterprise value is $243 million, 1.3 times its trailing-12-month sales.  I consider that valuation far too low for a company with its technology and market positions. Compare it to the $490 million Raytheon (NYSE: RTN  ) paid this year for Applied Signal, a company that generated $225 million in sales in its October 2010 fiscal year, for a 2.2 price-to-sales multiple. Applying even a sales multiple of 2 to Integral Systems gets you $20 per share. I think that 's the high end, but I see fair value for the company in a sale at $15-$20 per share, meaningfully higher than the $12 price currently on offer in the market.

If the sale doesn't go through, the share price could suffer from choppy operational results. But given that CEO Paul Casner, whom I respect and admire, will receive a $1 million payment if he stays through a change of control, the incentives are there to keep a strong hand at the wheel, which should reduce risk. Among other perils, about 40% of sales comprise two contracts with the Air Force, which come up for renewal in 2012 and 2013. You never know what can happen in a rebid, but considering Integral Systems' attention to customer requirements and long record of working with the Air Force, I'd be very surprised if it lost a recompete.

My Foolish final thoughts
This is a good opportunity in a difficult market. Integral Systems has world-class technology, plenty of growth potential, and a true worth far greater than its share price would suggest. It's certainly possible that a sale won't happen, or will happen at a lower price, but given the amount of companies I foresee taking an interest in Integral Systems, I think the downside is limited.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Andrew Sullivan, CFA owns shares of Integral Systems. The Motley Fool owns shares of General Dynamics, Lockheed Martin, and Raytheon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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