November 21, 2001
Dow Jones Newswires
TALES OF THE TAPE: L-3 Commun Rises On The Defense
By LINGLING WEI
Of DOW JONES NEWSWIRES
NEW YORK -- L-3 Communications Holding Inc.'s (LLL) bomb scanners have put the company on more investors' radar screens as security concerns mounted in the wake of Sept. 11.
But as promising as that technology is, it's just one reason people are bullish about the company's growth prospects.
Cai von Rumohr, an analyst with S.G. Cowen Securities Inc., says he expects sales to increase across L-3's product lines, except for its commercial aircraft business - which only represents less than 5% of its revenue.
Von Rumohr projects the stock will reach $110 in the next nine to 12 months. The target reflects about 27 times his 2002 earnings estimate of $4.10 a share.
That's certainly not cheap. But given its "20% plus" annual earnings growth rate excluding acquisitions, the analyst says, the stock should "get to a premium relative to others in the industry."
A Growing Niche Player
The defense industry, after going through a consolidation wave between 1986 and1996, has dwindled to a handful of resounding names like Lockheed Martin Corp. (LMT) and Raytheon Co. (RTN).
Compared with these major defense contractors, L-3 has emerged as what industry observers call a niche player, through acquiring security electronics-related companies. The New York company made five acquisitions from the beginning of 2000 through September, which brought in 15% more contracts in process to the company as of the end of third quarter.
L-3 financed all those deals with cash or through issuing convertible securities. Investors appear to have shrugged off the dilutive impact of the securities as they say the acquisitions are necessary for the company's future growth.
"The acquisitions have rounded out its product offering and expanded its customer base," says Andris Kalnins, an analyst with Moody's Investors Service. The credit-rating agency last month assigned a Ba3 rating to L-3's new $350 million senior subordinated convertible notes.
That creditworthiness, Kalnins says, recognizes L-3's track record in integrating acquired businesses since its spinoff from Lockheed Martin in 1997 and its improvement in free cash flow.
Free cash flow for the third quarter was about $41 million, a jump from $13.7 million a year ago. As of Sept. 30, the company had $98.5 million in cash, compared to $32.7 million at the end of last year. Debt, meanwhile, was reduced to $905 million by the end of September from $1.1 billion on Dec. 31, 2000.
Stock Reacts More To War Mood
L-3's shares have been bolstered mainly by the fact that it is one of only two companies certified by the Federal Aviation Administration to make the explosive-scanning machines - priced at about $1 million apiece - for the nation's airports. The other company is InVision Technologies Inc. (INVN), Newark, Calif., which is about 17 times smaller than L-3 in terms of market capitalization.
The bomb detecting machines are expected to bring in $30 million to L-3 this year, says SG Cowen's von Rumohr, tiny compared with expected 2001 revenue of $2.3 billion. Next year, revenue will rise to $2.6 billion, von Rumohr estimates.
L-3's product diversity explains why the stock's movement is less sensitive to single contract announcements than to the overall market sentiment toward the ongoing war against terrorism.
On Thursday, for example, L-3 announced that its joint venture with Telos Corp. (TLSRP) had received a defense contract from the U.S. Army with a potential value of more than $1.4 billion over 10 years. The joint venture will provide systems and software-engineering services to the army.
Its shares, however, closed the day down 7% at $79.39, as investors, bolstered by progress in the war in Afghanistan, rotated their money out of safe-haven stocks to the riskier technology names.
"Any selloff of this type of defense names - with high profitability and good earnings prospects - is a result of the psychology of war," says Mark Garfinkel, who manages the STI Classic Small Cap Growth Stock Flex, a fund with $550 million in assets.
"But the new round of defense spending hasn't even begun," Garfinkel adds, and "there is a high probability that L-3 will have upside earnings surprise in the next 12 to 16 months."
L-3 breaks its revenue down into two segments. Its security communications systems unit, aiming at government users, includes data links, airport security systems and equipment used in securing telephone and network communications. Sales from this segment rose 50.4% to $346.9 million in the third quarter.
The other segment features display systems, telemetry, space and other specialized communications products. Sales from this unit, though, fell 4.4% to $271.3 million in the quarter from a year earlier, due to the slowdown in broadband commercial communications markets. Management has said 2001 sales of its telemetry and space products are expected to be flat from 2000.
Many analysts say the expected jump in government orders in the wake of Sept. 11 will surely outweigh the softness in the commercial communications business. L-3 officials declined an interview for the article.
"Fundamentals are going to the company's way," says John Rutledge, manager of the $15 million Ever Green Technology Fund, and that makes the stock attractive even after its recent strong performance.
L-3 shares, among Rutledge's top three picks, now account for 7% of the fund. Rutledge says L-3's defensive nature - not economically sensitive - suits the fund's need to ride out the tough business environment where many companies couldn't even predict how much they will earn in the current quarter.
L-3's recent strong bounce has lured many investors to take profits, but some are quick to add that they only trimmed a portion of their L-3 holdings, instead of an outright sellout.
Steven Colton, who runs the $440 million Phoenix-Oakhurst Growth & Income fund, says he sold one third of his fund's holdings of L-3 shares in late September because at that point the stock went beyond the 30-times average trading multiple in the past four years.
Colton adds that the stock remains the fund's top holding in the defense industry because "its business prospects are very strong."
In recent market activity, L-3 fell 0.3%, or 22 cents, to $84.47. The stock hit a 52-week high of $98.07 on Oct. 8.
-By Lingling Wei, Dow Jones Newswires, 201-938-2089
Lingling.Wei@dowjones.com |
