The Long Case for DRS Technologies

Jun.29.07 | About: DRS Technologies (DRS)

Attractive valuation coupled with attractive acquisition features makes DRS Technologies (DRS) a buy. As a mid-level defense contractor, with a diversified portfolio of government contracts, it is an attractive take out or acquisition target within the Aerospace / Defense Industry.

Investment Thesis
DRS Technologies’s well diversified portfolio of government contracts makes the company an attractive addition to any large aerospace / defense company. The most valuable asset is the Command, Control, Communications, Computers and Intelligence C4I line of business, since the segment offers exposure to both fighter platforms, as well as, naval combat ships. DRS’s $2B backlog would be a welcome addition to any contractor. Furthermore, DRS’s $2B – plus sales could make a reasonable impact with even the biggest contractors.

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Valuation
Table 1: Comparison of DRS Technologies to the Aerospace / Defense Industry

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The table above illustrates what DRS is worth from multiple valuation methodologies. These values are then compared to the Aerospace / Defense industry averages in order to see where DRS falls within the industry. Since our investment thesis argues that DRS is a take out candidate, Take Out Value seems to provide the most realistic near term valuation. The P/S value is especially telling since DRS’s P/S ratio is 0.82, considerably lower than its peers. Our Earnings Power Value calculation may be unreliable, since the calculation using Adjusted EBIT is nearly $180 higher than EPS / WACC. Nevertheless, the other calculations suggest that the $131 price is not far off the mark.

Financial Data
Table 2: Selected Financial Data for DRS Technologies, Inc. (DRS)

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Investors should pay close attention to the disappointing ROA and ROE. Less than stellar returns suggest that management is not as efficient as possible. Given the strong portfolio of defense projects, these metrics should be much higher. New management should easily be able to raise these metrics. Secondly, the company looks to be in a financial quagmire. The low Altman Z Score suggests that DRS could be headed for financial trouble, another reason that it could be acquired. Lastly, the Capitalization Rate and Earnings Yield are both low, but would probably increase with new management.

Business Prospects / Model
DRS Technologies is a provider of defense electronic products and systems, as well as, military support services. The largest business segment is C4I or Command, Control, Communications, Computers and Intelligence Group. Their program portfolio is well diversified amongst each branch of the U.S. Military. Some of their projects include: DDG – 51 Aegis destroyers, M1A2 Abrams Main Battle Tank, M2A3 Bradley Fighting Vehicles, OH – 58D Kiowa Warrior Helicopters, AH – 64 Apache Helicopters, F/A – 18 E/F Super Hornet and F – 16 Fighting Falcon jet fighters, F – 15 Eagle tactical fighters, C – 17 Globemaster II and C – 130 Hercules cargo aircraft, Ohio, Los Angeles, and Virginia class submarines, CVN – 78 next generation aircraft carrier, Littoral Combat Ship and Future Combat System. These projects gives DRS exposure to the big three Defense contractors: Boeing, General Dynamics, Lockheed Martin. While DRS provides systems to multiple fighter platforms, their exposure to combat ships as well as land vehicles offers the big three product diversification possibilities.

The main competitors of DRS are: BAE Systems PLC, Raytheon Company and L – 3 Communications. Investors should pay special attention to this list, since one can readily see which of the big three might be the strongest suitor. BAE and Raytheon are large rivals of Lockheed Martin, and L – 3 was spun off by Lockheed after its merger with Martin Marietta. Any historian will note, Lockheed spun off L – 3 because of management more so than product portfolio. For these aforementioned reasons, it seems that Lockheed Martin could be the strongest suitor if DRS is acquired by a defense contractor.

Special Circumstances
A strong product portfolio, coupled with decent revenue growth, makes the business an attractive addition to any integrated Aerospace / Defense contractor. DRS’s large C4I business segment proves to be the most attractive asset. Such technology would be beneficial to the likes of Lockheed Martin, General Dynamics, Boeing, or Raytheon. Changes in management and / or acquisition are the most likely candidates for unlocking the real value of the business.

Major Holders
The table below, taken from Yahoo!Finance shows that Institutional Investors hold nearly 57% of the shares outstanding. This is interesting, since the sophisticated investors already believe in the story.

Table 3: Top Share Holders of DRS Technologies

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Full Disclosure: The author holds no position either short or long in DRS Technologies. He currently owns: ChipMOS Taiwan (IMOS, Brasil Telecom Participacoes S.A. (NYSE:BRP), ConocoPhillips (NYSE:COP), Verigy, Ltd. (NASDAQ:VRGY), Agilent Technologies (NYSE:A), and Lockheed Martin (NYSE:LMT) in his 401(k), but will be selling within the coming week.

The author currently works at Lockheed Martin in Enterprise Operations Finance. Any theories or data concerning the Lockheed Martin Corporation is purely the thoughts and insights of the author. He has no exposure to the M&A department or transactions at LMT.