Defense contracts and scandal seem to go hand-in-hand. Whether it's Boeing's (NYSE:BA) procurement and theft scandals, Halliburton's (NYSE:HAL) bribery scandal at its KBR subsidiary, or the corruption scandal involving Titan's (NYSE:TTN) alleged payoffs to a small African country, some defense contractors seem willing to skirt the law in order to get their hands on the hundreds of billions of dollars the U.S. Department of Defense doles out each year.
It's the shareholders, of course, who pay the price, since the controversies take a toll on revenues, profits, and share-price appreciation. But that doesn't mean investors shouldn't consider these companies for their portfolios.
For example, in the wake of Titan's revelation that it was deeply mired in the foreign bribery scandal, fellow defense contractor Lockheed Martin (NYSE:LMT) backed out of a $20-a-share, all-cash takeover bid (it had originally been a $22-a-share, cash-and-stock bid) which promptly caused the collapse of Titan's share price.
The intervening months, however, have been somewhat more kind to Titan's owners, particularly in light of the rumors of a new takeover bid. While they had recovered somewhat from the blow dealt by the Lockheed debacle, rumors that L-3 Communications (NYSE:LLL) would mount a new merger bid in the mid-$20-a-share range sent the stock soaring northward again.
Titan is a niche contractor in the fast-growing defense communications and computer services segment. With a market cap of only $1.9 billion, it's dwarfed by Lockheed at $29 billion and even L-3 at $8.3 billion. Fourth-quarter revenues rose 15%, to $551 million, though profits declined a penny to $0.22 a share. While the company has used acquisitions to help it grow in the past, its size, business, and even its troubles make it attractive to others. The L-3 deal, if completed, would seem to be a natural fit.
Among the top suppliers of electronics and communications equipment to the defense department, L-3 Communications leads the pack in using strategic acquisitions to expand its presence. It was created with the express purpose of rolling up smaller contractors and has set for itself targets of 20% growth. However, it's becoming more difficult to locate attractive companies. With electronics comprising approximately 40% of the department's $340 billion budget, players like Titan become more valuable to these larger corporations.
A similar deal also occurred when bomb detection technology company InVision was acquired by General Electric (NYSE:GE). Interestingly, InVision itself had been the subject of a scandal involving bribes to foreign officials.
When such news breaks, the market often overreacts and sends the shares tumbling. Careful investors can use the opportunity to pick up companies at bargain prices. The fallen shares also make the companies more attractive to other, larger companies. Due diligence is definitely required, but defense contractors aren't going away anytime soon. Their services and technologies are definitely needed, and the whiff of scandal may just provide investors with a chance to swoop in and buy low.
Where billions are at stake, it seems unscrupulous people will always try to take advantage of the situation. Once the smoke has cleared, though, investors can make some clean profits from the cleared decks.
- Boeing Taking Flight?
- When Rocket Men Go Bad
- Halliburton Charges Into Iraq
- Titan Shrugs Off Merger Mess
- Titan Tumbles
Fool contributor Rich Duprey does not own any of the stocks mentioned in the article. The Fool has a disclosure policy.
