For more than a decade, defense hawks have touted the Strategic Defense
Initiative as not just a military system but an incubator for all manner of
technology. Whether you buy that argument or not, there's no disputing that
Titan Corp.(TTN), a San Diego-based defense contractor, has found an unlikely use
-- electronic pasteurization -- for one of its Star Wars technologies.
Titan's SureBeam division has transformed a linear accelerator, originally
developed to shoot missiles out of the sky, into a system for irradiating meats,
fruits and vegetables. And over the past 18 months, Wall Street has become
besotted with this and other opportunities, driving the company's stock up
from $5 to $60 in late 1999. Although it's come down from those lofty levels
in the past few months, it's still trading at 29 5/8, or 42 times consensus
estimates for 2000 earnings, a healthy premium to the market and, according
to the company's critics, it remains overvalued.
Indeed, it is the SureBeam
business, which Titan hopes to
eventually spin off to
shareholders, that analysts tend to
focus on when they talk up the
stock, contending that this one
small piece of the business, which
should produce about $31
million, or 3% of the company's
expected $912 million in revenues
this year, is worth $20 a share or
more. Titan's other, more
mundane, businesses include
defense contracting, systems and systems integration. Overall, the company is
expected to earn $40.5 million this year, or 71 cents a share.
Not everyone is so certain that SureBeam will be a hit, however. For starters,
Titan's critics -- mainly short-sellers -- say it's too early too say whether
consumers will adopt irradiated meats and vegetables as wholeheartedly as
the company's fans believe they will. And even if they do, it's not clear that
Titan's customers, mainly meat processors, will continue to sign long-term
service contracts -- and the recurring revenues from these contracts is the
linchpin in the bull case for SureBeam.
Investors who have examined the
business closely say that, instead of
re-upping their expensive service
contracts, customers are likely to
insist that the company sell them the
SureBeam hardware instead. That's
not necessarily a bad business, but
certainly not worth the $20 a share
that some analysts are putting on
SureBeam right now.
Titan developed the first small linear
accelerator for Star Wars in the early 1990s and quickly began looking for
commercial applications. "We figured out that we could use one of these small
accelerators to accelerate electrons into a beam and use that beam for
sterilization," says Titan Chief Executive Gene Ray. The company began
marketing its sterilization system to the medical industry in 1993, and this
segment now makes up about one-third of SureBeam's revenues.
A few years later, the company began work on a system that uses this same
technology to rid food of harmful microbes and bacteria, like E. coli. The
SureBeam unit, which is designed to sit at the end of an assembly line in a
packing plant, works like this: After the meat is cut up, processed and placed
in its final packaging, it passes through a microwave-like machine for a few
seconds before being shipped off to retailers.
In December 1997, the FDA approved the process, finding that irradiation of
meat, at its recommended doses, does not diminish the food's nutritional value
in any detectable way. In December 1999, the USDA issued regulations
setting forth guidelines for irradiation. SureBeam's system, it should be noted,
does not use nuclear radiation to treat meat, as some critics of the process --
as distinct from critics of the company -- have intimated.
SureBeam's strategy is not to sell its systems, but rather to sell its service to
customers for somewhere in the neighborhood of five cents for every pound
of meat that runs through the machine. Currently, SureBeam has a facility in
Sioux City, Iowa, where some of its major customers, including Cargill, IBP,
ConAgra and Tyson Foods, have agreed to run some of their products
through the facility and test market them to retailers like Wal-Mart and the
major grocery chains. So far, however, large distributors like IBP and Tyson
foods are still working on things like packaging and distribution before they
begin test marketing this product.
It's not hard to see why the bulls are so excited by SureBeam. Production of
beef, pork and poultry in the U.S. hit 75.4 billion pounds last year, according
to company data. And that has global aerospace and defense analyst Pierre
Chao at Credit Suisse First Boston figuring the business is worth $1.1 billion,
or $20 a share. That assumes that by 2004 SureBeam will have captured
roughly 50% of the nine billion-pound U.S. ground-beef market, 8% of the
35 billion-pound poultry market, 3% of the 25 billion-pound processed-meat
market and 0.4% of the 65 billion-pound fruit and vegetable market. At
service fees ranging from four cents a pound for poultry to 15 cents a pound
for processed meats, Chao comes up with $350 million in revenues and $116
million in earnings before interest, taxes, depreciation and amortization, or
EBITDA by 2004. Run that through a formula for deriving the discounted
value of future cash flow and Chao comes up with his valuation.
The problem with that logic is twofold: For one thing, the big meat processors
aren't likely to stand for SureBeam's per-pound charges. Indeed, Titan CEO
Gene Ray acknowledged in an interview with Barron's that one of its largest
customers successfully persuaded SureBeam to sell it a machine to put on its
own assembly line. And Kent Huisken, director of marketing at Huisken
Meats in Chandler, Minnesota, which is currently testing the service, thinks it's
inevitable that customers will insist on buying the systems. Says he: "At some
point, depending on volume, there will be that crossover point" where it
makes more sense to own a machine instead of paying the per-pound
fee-for-service. Company officials, however, insist they are committed to the
service model.
What will happen to the carefully constructed bull case if SureBeam has to
start selling its machines? At the company's current capacity it can produce 24
machines a year, according to company documents. Industry sources tell us
these machines could fetch $4 million or so each. That translates into revenues
of $96 million a year and estimated earnings of $12 million -- hardly the stuff
of a $1.1 billion valuation.
And that may be a best-case scenario. Consider the folks out there, like
Ralph Nader, who are adamantly opposed to irradiation. In a March 22
statement, Nader's Public Citizen group said: "The food industry and its allies
in the federal government are promoting the use of high levels of radiation to
'sterilize" the filth that contaminates our food. Rather than ensuring clean,
wholesome, high-quality food by cleaning up the food industry, the FDA and
the Department of Agriculture have legalized the irradiation of food, a
technological fix that hides the real cause of food-borne illness: filthy food
produced by factory farms and processed at slaughterhouses."
Though this view may sound laughably extreme, it's no laughing matter for the
folks at Titan. Just look at the way like-minded groups have put an absolute
halt to genetically-modified crops in Europe.
In other words, once you dig into the sexiest part of the Titan story, there may
be less here than meets the eye. And when investors who are paying 42 times
earnings for the company's shares start to understand that, Titan's $755
million defense business, which is growing at just 9.3% per year, is unlikely to
give much succor.
Barrons is the source.
Jim |
