The Wall Street Transcript recently interviewed James McIlree, defense electronics analyst for Collins Stewart LLC. Key excerpts follow:
TWST: Are there any names you're pointing investors toward at this juncture?
Mr. McIlree: Yes. One of the names that we like very much right now is a company called GeoEye (NASDAQ:GEOY). GeoEye has three satellites in orbit and these satellites take pictures of the earth that are sold to mostly government customers. Their primary customer for these images is the National Geospatial-Intelligence Agency or NGA. NGA takes these images and fuses them with other data that it has and it creates information that is valuable to intelligence agencies as well as the warfighter.
For instance, let's say that the customer is interested in troop movements of the Russians in Georgia. The GeoEye satellites can take a picture and get that picture to the NGA which can get information to decision makers about what to do or not to do about the troop movements in Georgia. Certainly there is interest in Iraq and Afghanistan and Pakistan right now, but anywhere there is conflict, anywhere where there are natural disasters, the customer would like to have up-to-date images. We think that the government customer is going to be a pretty steady customer in 2009 and as a matter of fact, the government helped fund the construction and launch of the most recent GeoEye satellite. The leverage to the model comes from commercial customers. GeoEye takes the images it provides to its government customers and sells them to, for instance, Google, for Google Maps and Google Earth. GeoEye has just signed a distribution agreement with Telespazio for sale of the images in Europe and Africa. GEOY will sign other agreements with government as well as commercial entities for the sale of its images to those customers. We think it's a pretty good business model and the exciting thing is that the incremental cost of selling an extra picture is fairly close to zero. Once you take that picture, you can sell it over and over again, which is a powerful model.
We think the numbers are likely to go up next year; it's trading at a very modest multiple of EBITDA, around 3.5 times EBITDA, which is very cheap. The way we've built our model is we've assumed most of the revenue is from government customers. If commercial customers come in, that will be gravy. We think there is a strong interest by the government in imagery from the satellites and we don't need the economy to do too well in order for this company to hit their numbers. At least relative to our estimates GeoEye doesn't have a lot of risk associated with the economy and we like the stock a lot.
TWST: Do you have another?
Mr. McIlree: Another one that I have been focusing on isn't really a defense name. The company is RRSat (NASDAQ:RRST), which operates a few teleports, the primary one in Israel. RRSat's teleports receive television content, then manipulate that content and transmit the manipulated content to the end-user. For instance, the company might digitize the content. It might insert advertising into the show. It might subtitle the show or provide translation services. But they're going to manipulate that content in some way and then they're going to transmit it to a satellite and that satellite will then transmit the signal to the end-user or the viewer.
RRSat provides a key component in the distribution of content to consumers around the world. It clearly is a consumer play, but also TV is one of the most stable consumer purchases out there and this company has long-term contracts with customers who don't just arbitrarily turn off a channel in a downturn and then turn it back on. They typically last through a cycle better than most, so RRSat has very good visibility on their revenue stream. The company is very cost conscious and has a very high operating margin and strong free cash flow. It's a cheap stock, has good management, high barriers to entry and low pricing pressure.
We think the negative case on this would be growth maybe not as good as everyone's expecting. I've tried to build into my model some very conservative numbers that explicitly assume a recession and my numbers are kind of close to everybody else's, so I think that everybody else has either done the same explicitly or we've arrived at the same spot in different ways. This is another name where the valuation is very interesting, it's around 5 times EBITDA with, again, a strong position in the industry and pretty good visibility on revenues and cash flows.
TWST: Is there anything else we should touch on?
Mr. McIlree: There is one other that I think is kind of an interesting speculative name called Force Protection (NASDAQ:FRPT). They make blast-protected vehicles for the U.S. Army and U.S. Marine Corps. The number one cause of fatalities and injury in Iraq has been improvised explosive devices or IEDs. Blast-protected vehicles protect the occupants of the vehicles from IEDs. Force Protection won about 20% of the contract to supply the blast-protected vehicles to the Army and the Marine for Iraq. It looks like there are going to be another 2,000, or maybe more, vehicles purchased for deployment to Afghanistan. If Force Protection is able to get any of that, then it can be a very good stock and if they get none of it, then I still think there is probably some room for the stock to go higher.
They have a sole source contract to provide explosive ordnance disposal vehicles (the Buffalo) to the U.S. Army under a five-year contract, and that will continue for a while. They have about 4,000 vehicles in Iraq right now that need maintenance and spares and repairs and that will continue for some time. Even if we withdraw troops from Iraq, those vehicles are going to stay and still need to be sustained. So I think they've got a pretty visible revenue and earnings stream going forward and the kicker is, if they can do something above and beyond that core business or base business, then the stock can move higher. The stock had a huge run-up in 2007, and then it had a huge decline in the latter half of the year.
In the beginning of the year, they went from a small supplier of vehicles to one of the major suppliers under the MRAP contract, which was the highest priority contract for the DoD. The expectations became greater than the reality and as that set in, the stock pulled back a lot, but they've changed management over the past 12 months and they have a new strategy on how they're addressing the market. Investors have stayed away from this one for a long time because those things that were big ups and big downs sometimes never recover, but this one looks like it has a pretty good shot. I'd characterize this as a speculative investment, but it's one of those where if it works, you can have a really good stock even if the economy continues to stay weak.