In a historic agreement, Iran agreed last month to curtail its nuclear weapons program in exchange for the lifting of economic and arms embargoes against it. There are many twists and turns to this tale (and you can read more about them here). Today, we're going to focus on just two key points agreed upon by U.S. and Iranian negotiators:
- In just five years, Iran will be able to buy weapons from abroad again.
- And three years after that, Iran will be able to buy ballistic missiles.
Not everyone is thrilled with this.
...Specifically, Saudi Arabia
Take Saudi Arabia, for example. Years ago, former Saudi King Abdullah had famously suggested that rather than sign a deal with Iran, the U.S. should "cut the head off the snake" -- and bomb Iran instead.
More recently, former Saudi ambassador to the U.S. Prince Bandar bin Sultan warned that granting Iran unfettered access to the international arms market could "wreak havoc in the Middle East." In response to the nuclear deal, the Prince said,, "people in my region now are ... consolidating their local capabilities" to deal with an increased -- if only conventional -- military threat from Iran.
And they're wasting no time in doing so. Last week, in a seemingly routine "notification" to Congress, the U.S. Defense Security Cooperation Agency (or DSCA -- the agency charged with facilitating arms sales by U.S. defense contractors to foreign buyers) revealed that Saudi Arabia intends to buy 600 Patriot missiles to bolster its air defenses.
Valued at $5.4 billion, the arms sale should yield significant revenue for Raytheon (NYSE:RTN) and Lockheed Martin (NYSE:LMT), the two companies named as principal contractors on the deal. Raytheon builds the Patriot's fire control and radar systems; Lockheed Martin makes the actual missiles.
What you need to know
One crucial bit of information that investors want to know was left out of DSCA's notification. Namely, we do not know how the $5.4 billion in proceeds from this arms deal will be split up between these two companies. We do know, however, that both Raytheon and Lockheed Martin stand to profit handsomely from this arms deal.
Although its "Missile Systems" unit is its largest by revenues, and the one that sounds most likely to handle a deal to sell Patriot missiles, Raytheon's Integrated Defense Systems division is actually the business responsible for Patriot. With $6.1 billion in annual revenues (according to data from S&P Capital IQ), Raytheon IDS is the company's second-largest business. Earning operating profit margins of 16% on its products, IDS is also Raytheon's most profitable division. If the Saudi arms deal were to be split down the middle, revenue-wise, that would imply Raytheon earning as much as $432 million in profits on its share.
Lockheed Martin is somewhat more logical in grouping its Patriot revenue under its "Missiles and Fire Control" division. While smaller in size than Lockheed's other businesses (Aeronautics for example, which builds the F-35 stealth fighter), Lockheed Martin MFC yields nothing to its sister divisions in profitability. In fact, the company churns out profits at the rate of 16.9 cents per revenue dollar -- making it by far Lockheed's strongest profits generator.
On this particular deal, a 50% share of $5.4 billion in revenues, at 16.9% profit margins, could mean as much as $456 million in operating profit for Lockheed Martin.
What it means to investors
When considering how to play the Saudi arms deal (and perhaps future Patriot purchases by other Gulf States, soon to follow?), investors must bear this in mind: While Raytheon and Lockheed earn similar profit margins on Patriot missile sales, missiles make up just 17.5% of Lockheed Martin's annual revenue stream. At Raytheon, in contrast, 26.8% of the company is devoted to building and selling Integrated Defense Systems such as Patriot -- and a further 27.6% of revenues come from selling other forms of "missile systems."
Simply put, Raytheon has a lot more to gain from selling defensive missile systems to Iran's nervous neighbors than Lockheed Martin does. Invest accordingly.
Rich Smith owns shares of Raytheon Company. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 338 out of more than 75,000 rated members.
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