By now you may have already heard the news: Raytheon (RTN), one of America's biggest defense companies, has shifted its business model to enter the wide world of Internet security -- by buying its way in.
Announcing the rather convoluted acquisition earlier this week, Raytheon confirmed that it would purchase an 80% stake in private equity-owned Websense for $1.6 billion. Raytheon will then add its own cybersecurity unit, Raytheon Cyber Products, to the new subsidiary. The remaining 20% of Websense will be owned by the private equity firm that is selling to Raytheon, Vista Equity Partners. Vista will also contribute $335 million to the jointly owned Raytheon subsidiary.
Oh, in addition, the Websense subsidiary will owe $600 million in "intercompany debt" to its parent company, Raytheon.
As you can see, a lot of money is moving around in this transaction. But when all is said and done, Raytheon describes its acquisition as being worth $2.3 billion in enterprise value. And Raytheon said it expects everything to be said and done within the next few months, positing a closing date sometime in the current "second quarter of 2015."
So this acquisition is on the fast track. But why? Isn't Raytheon overpaying for Websense?
As a matter of fact, it is.
Making sense of Websense
Raytheon asserted it is making the right move into cybersecurity, and at the right time, citing "sophisticated threats" to "industry and infrastructure" clients under attack by "well-funded, nation-state adversaries and criminal networks."
Leveraging its reputation as a heavyweight defense contractor to appeal to these private clients, Raytheon said its new joint venture (actually more of a subsidiary relationship, with Raytheon owning 80% of the business, and consolidating Websense's results with its own) will offer clients "advanced, defense-grade technology solutions needed to meet this evolving threat."
And yet, consider the numbers: At last report, just before Websense went private in mid-2013, online financial data provider S&P Capital IQ clocked the cybersecurity specialist at delivering roughly $360 million in annual revenue, but just $23 million in profit. Websense's free cash flow was stronger at about $43 million. But even so, Raytheon's $1.6 billion cash purchase price works out to a valuation of more than four times Websense's last-reported sales, 37 times 2013 free cash flow, and 70 times 2013 earnings. (And considering that Raytheon is acquiring only 80% of Websense, you'd probably need to jack these valuations up by about 25% to get a sense of how much Raytheon is really paying for the full business.)
Sure, things might have changed a bit, and these numbers grown a bit, while Websense was under Vista's private ownership. But as of 2013, Capital IQ noted that the company's revenue had grown at less than 10% annually over the preceding five years, while earnings growth was "not measurable."
What it all means to investors
This hardly sounds like a bargain acquisition. Raytheon itself -- by no means a cheap stock -- today sells for just 1.5 times trailing sales, 18 times free cash flow, and 15 times earnings. And Raytheon is projected to grow earnings at a healthy, if not speedy, pace of about 8% annually over the next five years.
Long story short, while I certainly understand the appeal of jumping into the hot-hot-hot cybersecurity sector, it appears Raytheon might be overpaying for its new prize. Given that, I'm not at all certain I want to own this stock anymore.