Force Protection Volatility Presents Unique Buying Opportunity

On June 27th, 2007, I wrote an article entitled, “What’s Causing Force Protection’s Price Volatility?, and presented the underlying thesis that FRPT’s business fundamentals were strong, and that the rapid decline in price from the $30s/share to the low $20s/share was entirely customer-driven (Department of Defense inability to provide MRAP orders).

Since that post, the price has continued to significantly decrease, to the mid-teens, reaching a low of just under $15/share. As recently as Tuesday, August 7, General Dynamics (GD) was notified by the Pentagon that they were receiving a significant MRAP order - $338.7 million – causing FRPT shares to decline by as much as 11%.

In the interest of getting to the point as quickly as possible, let me submit the following reasons why Force Protection represents an excellent buying opportunity, particularly as the market continues to suffer at the hands of sub-prime mortgage concerns, lack-luster hedge-fund performance, and general fears over the ability to finance debt:

1. Force Protection fundamentals continue to be extremely strong. This is supported by the consistent increase in production capacity, culminating with the addition of a nearly 430,000 ft2 facility in Roxboro, NC, for the exclusive production of the Cheetah. This will be further affirmed by the upcoming earnings release, which I believe Force Protection will meet (Average Estimate: $0.13/share).

2. Force Protection’s share value should not be based on the number of orders won by other MRAP manufacturers. Rather, FRPT should be exclusively valued on the growth rate of their production capacity and ability to sell every single vehicle they can produce. This is what will ultimately drive earnings and profits, and consequently, the price per share. MRAP funding, particularly when one considers the separate programs dedicated towards Hummvee replacement, offers an enormous market which under no circumstances was Force Protection ever expected to exclusively dominate. However, ask yourself, “Is this market big enough to fuel FRPT’s accelerated growth rate and sales, even if other competitors receive market share?” The answer is a resounding yes.

3. When you see the tremendous volatility we are seeing across the broader market, you need to take a step back, and strongly consider a sector analysis. Even if individual equities within a given sector have strong fundamentals that warrant increased valuations, if the sector is viewed negatively, then it’s likely to be the dominant force. Under these market conditions, I think the defense sector represents a spectacular buying opportunity.

Specifically, this is because:

a. Defense spending continues to increase aggressively, with concerns that Democrats taking control of the White house will lead to severely decreased military spending now being refuted. Democrats, voiced through the likes of Senator Joe Biden of Delaware, Chairman of the Foreign Relations Committee, acknowledge that immediately pulling out of Iraq is completely unrealistic. The best estimates conclude that even if the order is given to pull-out tomorrow, it will take a minimum of one year to remove all the forces. Furthermore, although there is military progress being made in Iraq, political progress continues to stagnate, meaning that it’s unlikely that US Commanders on the ground when they report to Congress in September will recommend any type of force reduction.

b. Defense spending, and in particular programs and discussions geared towards replacing the Hummvee, are not exclusively dictated by progress in Iraq or Afghanistan. Rather, this represents a long-term, cyclic commitment to upgrading a fundamental component of our over-all military readiness. With the performance of the Cheetah, the recent attention it has received from the Pentagon, and the expanding production capacity of FRPT, there is enormous potential for FRPT to dominate this multi-billion dollar market. Military readiness, on general terms, is very much a topic of discussion. In fact, the most recent issue of the Economist has an excellent article outlining the growing concern over China's increasing military readiness. With the expanding military readiness of both China and Russia, you can be assured that a fundamental component such as ground force transport and readiness will not be over-looked.

c. The defense sector is not sensitive to the present concerns over financing debt. In fact, defense companies, much like Proctor & Gamble (PG), manufacture products that are required in both slowing and growing economics, and therefore present a great hedge against the current volatility. As the market volatility continues you should see the defense titans, such as Boeing (BA) and Raytheon (RTN), continue to grow their valuations.

There is no question that I never expected FRPT price levels to drop has heavily as they have, and this was probably due to an underestimation of the short pressure. However, if you’re in this for the long-term, then this should simply be viewed as a sale on FRPT shares. If you’ve got a fundamentally strong company, driven by growth in earnings and profits, in a fundamentally strong sector, which is made even stronger by the steep decline in other sectors, then you’ve got a winning stock. My gut tells me that if you\\'ve got some liquidity consider purchasing FRPT ahead of earnings, and particularly prior to September.

September represents likely additional MRAP contracts being awarded, and, a critical report from US Commanders in Iraq which could set the stage both for military spending, but also dominate the news rooms. FRPT should run back into the high $20s on any bullish news. Best of luck to all investors and traders, and as always, discussion and comments are always welcomed.

In the interest of full disclosure, I am private, novice investor, that holds 2025 shares of FRPT at a price entry level of ~$16/share. I have bought, and sold FRPT since it was $2/share. I look forward to hearing everyone's comment, shorts and longs. Only through discussion can we perform better analysis.

FRPT 1-yr chart:

Comments

[Turley Muller:]

I can tell you why? You seen the short-interest last report increased to 15m from 9m the previous month. I started to take a look at FRPT after I saw it take a beating today and was thinking about writing about but I discovered you already had. I think this stock is probably overdone on the downside. I think two issues
1) Contracts going elsewhere
2) The 13m (i think) shares being registered that were done in a PIPE deal end of last year.

I address the last, first. People always short before they know that shares may temporarily flood the market. Occasionally some dirty bastards in the PIPE deal will go short and then cover with newly registered shares "Shorting against the box" not supposed to happen but it does. Not saying that's the case but I am always suspect. Also, disappointing news affecting the near-term adds shorting pressure.

FRPT originally was perceived as being the only game in town. They have such a superior solution, yet we come to find out their capacity is miniscule. Since somebody / people overlooked ordering proper equipment before our current vehicles got blown to shreds its been a major catch up game. So I think it's fair that contracts are getting spread around since what we need is no where close to what we can make quickly. FRPT is expanding their production, but that takes time.
According to Thomas Weisel analyst David Gremmels the contract loss will end up causing FRPT to have excess capacity. I think it will get filled one way or another.
Figures I have heard is that 80-85% of troop deaths are a result of IEDs. All we hear is roadside bomb, roadside bomb, roadside.....
After not having armor in Somilia and again showing up in Iraq with canvas doors looks real bad. I think the government will spend and over spend on these vehicles. For a long-time. The sand and heat in Iraq causes 5 years of wear in one year, that's just driving around NOT being shot at. Like with hurrican katrina, the govt bought tons more trailers/mobile homes & Ice etc that was needed to make up for the lack of what they needed when they needed it.
So, I think it's not a question of "WILL" yet "WHEN" FRPT will be given plenty of work.
It seems logical that the military will want to make keep FRPT in business so that they will have capacity to call upon in states of urgency. Like 4 years ago when there was minimal capacity. FRPT needs to get it together in terms of managing their expansion and production runs. That's tough given that the company was more of an R&D outfit not a scale manufacturer. The fact that FRPT has R&D savvy gives them another strong point .
So, I think this stock is cheap given its future revenue potential.

2007 Aug 08 08:33 PM

[Manny Otero:]

Hi Turley,

Thank you for the reply and your commentary. You've touched upon quite a few issues, and for the most part I agree. However, I do think that FRPT has been able to ramp up their manufacturing capacity quite nicely, and believe this ramp up continues. It's important to realize that not all MRAP vehicles are created equally, and the manufacturing of these vehicles is quite challenging based upon the specifications outlined. If FRPT is taking longer to produce a single vehicle, one needs to consider is this a question of manufacturing capacity, technique, or is the price you pay for a higher quality vehicle. I agree that speed of deployment of these vehicles is of the essence, particularly with the massive political pressure in Washington; however, I also have to hope that there is some push-back at the Pentagon to ensure that the right resources, with adequate quality-control, are procured.

As for PIPE deal, I agree that there was likely some significant negative pressure on the stock from the resulting short interest. However, do keep in mind that those involved in the PIPE deal are likely looking for a larger return that selling FRPT in the $15 range, which appears to be a decent support level. I think during August you'll continue to see pressure on the stock; however, this will be the result of traders and not investors. Investors, particularly institutions, I suspect are filling their stock orders and positioning themselves for 4Q07 and 2008, which look to be spectacular time frames for FRPT.

However, I also try to be objective. I am not very pleased with management's response to the recent price decline. I think they need to do a much better job of managing expectations, and although I realize their first priority is to ensure the strength of FRPT fundamentals (earnings, profits, growth, efficiency), I also believe that as officers of a publicly traded company they need to also manage their shareholders. I believe the public relations department of FRPT should have by now issued some press release in response to the contracts that have been awarded acknowledging that while they're disappointed they believe they have a formula for success, and describe that formula in detail. I also think they could do a much better job of pushing back on Congress and the Pentagon, and challenging them why they're not purchasing the best technically produced vehicle. Again, they shouldn't over-do it, but some concise and clear statements are warranted.

In any case, thank you for the response to my article.

Cheers,
Manny

2007 Aug 09 02:26 AM

[omooc:]

I wonder if funding problem might be a factor. omooc

2007 Aug 08 10:14 PM

[dms7001:]

Manny what's your update now with the stunning drop in FRPT?

Thanks..

2007 Dec 11 10:53 PM