Defense contractor L3Harris Technologies (LHX 4.24%) is making a bold bet with its planned $4.7 billion acquisition of Aerojet Rocketdyne (AJRD), paying up to win a bidding war for the maker of rockets and other propulsion systems.

For L3Harris, the deal continues a flurry of M&A moves since the company's formation in 2019 following the merger of L3 Technologies and Harris Corp. L3Harris is paying a premium to what Aerojet was offered by Lockheed Martin just more than a year ago, despite Aerojet being viewed as a wounded company in need of a partner after that Lockheed deal fell apart due to regulatory concerns.

While there are risks to this transaction, especially in the near term, the deal is a solid move for L3Harris and can be an important step in the company's bid to establish itself among the nation's top defense contractors. Here's what L3Harris investors need to know about the company's latest move.

Short-term pain...

The deal isn't cheap, valuing Aerojet at about 12 times expected 2024 earnings before interest, taxes, depreciation, and amortization (EBITDA). L3Harris reportedly faced competition from General Electric and others for the prize, leading to the higher price. It arguably comes at an inopportune time for L3Harris as well, as the company is fresh off announcing a $2 billion acquisition of Viasat's government operations.

Ideally, L3Harris investors would have preferred the company space out its dealmaking to avoid cash drain and management distractions, but a buyer has no control over when a seller holds an auction.

L3Harris, as the product of a recent deal, should be able to deploy the merger integration skills it used to make that transaction work well to get these deals done. But the cash drain can't be avoided.

In the near term, expect L3Harris to slow or completely cease share repurchases as it focuses on paying for these deals and avoiding having to take on too much debt. Cowen analysts estimate the deal carries an opportunity cost of about $0.50 per share in lost buybacks over a two-year period.

Wall Street was unimpressed with the transaction, with at least three analysts downgrading L3Harris from "buy" to "hold" on the news due to the near-term overhang. Shares of L3Harris traded down as much as 4% on Dec. 19 after the deal was announced.

... for long-term gain

But for those willing to look past the near-term cost, there is a lot to like about this deal.

Aerojet is a unique asset, standing as one of only two rocket engine makers in the United States and the owner of key intellectual property and manufacturing capabilities. The other rocket maker is Northrop Grumman-owned Orbital ATK, and prime contractors including Boeing have complained that since Northrop acquired Orbital it has been difficult to source needed components from Orbital at competitive rates. Those same fears drove the government's decision to challenge Lockheed's proposed acquisition of Aerojet.

L3Harris is not a direct competitor to Boeing, Lockheed Martin, or Raytheon Technologies and has the opportunity to build a relationship with those primes as a preferred source of rocket engines. The deal could also help solidify L3Harris' already strong relationship with Lockheed Martin. L3Harris CEO Chris Kubasik is the former president and chief operating officer of Lockheed, and L3Harris is already a key supplier to the company's F-35 program.

The war in Ukraine has created an urgent need for the Pentagon to replenish its munitions, likely creating an upcycle for these rocket engines. Cowen forecasts that Department of Defense spending on major weapons programs will more than double between fiscal 2022 and 2027. L3Harris said the deal would increase its backlog of future business by about 30% to $30 billion.

And although L3Harris is unlikely to ever compete with Boeing, Lockheed, Raytheon, and Northrop at the program level, the company has been pushing to evolve away from being just a component supplier and toward prime contracting. L3Harris is already a major contractor in the space area, providing mostly sensors and other add-ons. The addition of Aerojet would open new opportunities for L3Harris to interact directly with the Pentagon as a prime contractor in important areas including missiles, missile defense, and space exploration.

The end product is worth the wait

In an ideal world it would have been better for L3Harris had Aerojet Rocketdyne not hit the market this year, giving the company added time to digest the M&A it already had in the works and get its balance sheet reloaded before doing another deal. And in the near term, there could be choppiness as the company works through the integrations.

But by combining with Aerojet, L3Harris is assembling a unique collection of defense and national security assets serving markets with massive growth tailwinds. The Department of Defense has requested more than $40 billion in fiscal 2023 for missile and missile defense, and NASA's budget request is up 8% from last year. Aerojet also had more than $10 billion in foreign military sales approved in 2022, expanding L3Harris' reach internationally.

Investors buying in today can own this premier franchise at a price near its 52-week low, and get paid a dividend yield of more than 2% to wait through whatever integration twists lie ahead. For those able to look past the near-term headwinds, it's a great time to consider L3Harris.