And so it begins...
That, in essence is the Wall Street Journal's take on yesterday's long-awaited announcement that Axsys Systems (NASDAQ:AXYS) has found itself a buyer. Three months after the high-tech optics firm first informed investors that it had put itself up for sale, defense stalwart General Dynamics (NYSE:GD) stepped up to the plate and delivered a humdinger of a bid.
$54 going once, $54 going twice, sold!
Multiply General D's per-share offer by the number of Axsys shares floating around out there in the markets, and the General's paying $643 million for its new toy. But if the mere 8% premium to what Axsys shares were fetching Wednesday doesn't wow you, consider that this is nearly twice the price those shares commanded three months ago before the company announced it was exploring "strategic buyers."
But there are even more informative numbers to consider here. For example, based on General Dynamics' sales estimate for Axsys, it's paying 2.5 times sales for the company, which is over three times the valuation the General's own shares fetch. Expensive? Sure, but consider that based on trailing results, Axsys is:
- 34% more profitable per revenue dollar than its acquirer, and more important still,
- growing more than twice as fast as General D
Add these two numbers into the equation, and the acquisition makes more sense. (Albeit, considering the anemic state of Axsys's free cash flow relative to General Dynamics' own cash profits, I have to say that I'm not a fan of the company, or the acquisition.) My advice to Axsys shareholders asked to approve the deal would therefore be: Take the money and run.
Foolish further thoughts
Of course, that's only half the significance of this week's news. As the Journal opines, the main takeaway here is the valuation that this deal implies for other potential acquisitions in the defense space. General D has effectively set the benchmark by which potential defense contracting targets can value their shares for acquisition, and it's time for the bidding to begin. But where?
Optics rival FLIR Systems (NASDAQ:FLIR), for example, was recently my top pick in the small defense contractor space. It's growing nearly as fast as Axsys, nearly twice as profitable in terms of net profit, yet commands a sales multiple valuation only about 34% higher than the firm General Dynamics decided to absorb. Seems to me that FLIR could be the next chip to fall, and considering how cheap it is today, remains my top choice for opportunistic defense investors.
Any other bright ideas?
Actually, yes. I'll sketch out a few for you:
- Force Protection (NASDAQ:FRPT), a small but leading player in the armored vehicle space, boasts much lower profit margins than FLIR or Axsys, but its growth rates are up to par and its price is awfully nice -- the P/S ratio here is a mere 0.6.
- Like Force, Beltway contracting powerhouse SAIC (NYSE:SAI) sports a low valuation. Unfortunately, its profit margin is even weaker than Force's, its growth rate leaves much to be desired, and its much larger market cap means that it's probably out of reach for many would-be acquirers. I suspect only the top two companies in the space -- Lockheed Martin (NYSE:LMT) or Boeing (NYSE:BA) -- could swing it. On the other hand, both of these defense majors are seeing their revenue streams threatened by Pentagon cuts, and might find the idea of acquiring a big chunk of defense market share in one swell swoop rather attractive.
- More easily digestible -- especially if taken a bite at a time -- would be erstwhile defense stalwart Textron (NYSE:TXT). Anemic of profit and slow of foot, the company nonetheless sports a valuation that's almost too low to resist -- just 0.2x sales. Here we're looking at a valuable military helicopter business, a leading force in the transition to unmanned aerial vehicles (Textron makes the Shadow, and is reportedly the subcontractor behind Honeywell's flying coffee can-UAV.) Also, Textron's already been in the acquisition rumor mill. Its shares surged in April after it was reported a UAE-Kuwaiti group was making a bid for the company, its defense assets would likely need to be sold off separately to domestic contractors to pass US regulators.
Foolish takeaway
Not all defense contractors are created equal, and some offer significantly more compelling buy theses -- and prices -- than others. But the real point to remember is that bargains do exist in this space. General Dynamics has sounded the bugle and led the charge, and if the Journal is right, further buyouts could follow.
Victory through superior defense investing:
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