Force Protection's Shredded Storybook

Storybook stock Force Protection (NASDAQ:FRPT) suffered a ripped page last week when its supposed monopoly on producing the next generation of U.S. armored vehicles turned out to be a bit more competitive than anticipated.

The story
For those not familiar with the company, here's the story in a nutshell. For years, U.S. troops serving in Iraq have been killed by insidious IEDS -- improvised explosive devices. These little nasties are nothing more than homemade landmines, but they're taking a horrible toll on troops who travel the roads in vehicles only lightly armored, and sometimes entirely unarmored. Enter Force Protection with a brand-new way of building armored vehicles -- a V-shaped hull that deflects an IED's blast, yielding the much-trumpeted claim that not a single U.S. soldier has been killed while traveling in a Force Protection-produced Buffalo or Cougar armored vehicle.

As marketing campaigns go, it's hard to top this one -- perhaps a little too hard. Because, you see, the military likes the idea of keeping its soldiers alive so much that it can't wait to get more of these vehicles (known generically as mine resistant ambush protected vehicles, or MRAPs) in theater. And the best way to do that ... is to get more companies building them.

Enter Navistar
News reports put the total number of MRAPs desired or required by the military at somewhere between 7,700 and 18,000. In April, Force Protection won a contract to build the first tranche of MRAPs -- 1,000 units in all -- for $490 million. Last week, the contract for a larger tranche was awarded. But it didn't go to Force Protection. It went instead to a company that most analysts considered barely an also-ran in this competition: truckmaker Navistar International.

Why was Navistar not considered a real threat to Force Protection's burgeoning monopoly? Perhaps because the firm is two years out of date with its SEC filings, has been delisted by the NYSE, and now resides on the Pink Sheets. Yeah, I can see how that would raise doubts as to the company's viability. And yet, its "International MaxxPro" MRAP won the second tranche -- all 1,200 units and $623 million in revenues.

While good news for troops, this is turning out to be bad news for Force Protection, for three reasons.

Valuation
Let's start with the obvious: After more than tripling in price over the last 52 weeks, Force Protection is one extremely pricey stock. Compare it to a few of its defense industry peers, and you'll see what I mean.

Admittedly, not all of these companies compete directly with Force Protection, and the majority are much larger businesses. Yet, one characteristic they all share in common is strikingly similar valuations. For whatever reason, the investing universe appears to have come to an agreement that the proper valuation on a defense contractor is somewhere in the neighborhood of 20 times its annual profits, and perhaps a bit more than one times its annual sales. But what price does Force Protection command? Three times the usual earnings multiple. Six times the multiple to sales.

Growth
Of course Force Protection backers will respond that the price ratios don't tell the whole story. The real story is growth -- Force Protection's got it, and its rivals don't. Indeed, in projecting its long-term profits growth at 30% per year, analysts believe it will grow its profits twice as fast as the fastest-growing of its peers.

Competition
And this is where Navistar's good news spells bad news for Force Protection. As a "storybook stock," much of Force Protection's popularity is predicated on, well, the story. The story of a company that's doing what no one else is doing, saving lives, and growing exponentially in the process. That, plus profits growth more than twice the industry average, appears to justify a stock price three times the industry average, in investors' minds.

Or at least it did. Since the news of Navistar's win broke, Force Protection has lost 14% of its value. The theory, it would appear, is that if erstwhile also-ran Navistar can win a contract and take away business that Force Protection investors thought was theirs for the asking, then chances are good that other companies will do so too. The 18,000 sales that investors had priced into the stock have been ripped from the pages of this storybook story. How the story will end, is anyone's guess.

For further Foolish musings on investing in defense companies, read:

• Frogs in Space
• Boeing's Brinksmanship
• Typhoon in Saudi Arabia
• Typhoon Hits England

Fool contributor Rich Smith does not own shares of any company named above. The Fool's disclosure policy is fully armored.