The Long Case for DynCorp

| About: DynCorp International (DCP)

For those who don't know DynCorp (DCP) here is a little info:

DynCorp is a military contracting company that does logistics, translations services, training of police and military forces, aviation maintenance and support, along with eradicating coco in Columbia and Poppy in Afghanistan (nobody's perfect).

I think DCP offers an interesting investment opportunity here due to a number of factors I will outline. DCP’s stock has been punished over the last few months in part due to the genius over at GS that said the stock was a sell because DCP would never end up getting a couple of contracts that could double or triple there current annual revenue of just over 2 billion. One of which is the 4.6 billion dollar GLS contract (providing translation services in Iraq) and the other is the 5 billion dollar LOGCAP IV contract (which has the option to be extended up to 10 years for a total of 50 billion).

Well hindsight makes it easy now that they have received both contracts, but I called him out on this mistake long ago. I do expect some analysts raising their price targets in the near future (Earnings out 5/29 should act as a catalyst). Now the GLS contract is 51% owned by DCP and an agreement was reached with LLL (the old holder of the contract) that they would get about 150 million a year for services that they will continue to perform leaving about 385 million a year in additional revenue for DCP.

Another part of the drop in DCP’s stock price, which went from the mid twenties to the mid to upper teens, was that on the last qtr’s call there were some significant payment problems with the department of state causing the typical 72 days to receive their money to now over 90 due to new payment system implemented last qtr. This affected all contractors and the money will still be paid in full. Much of the revenue shortfall from last qtr. can be contributed to this and the fact that they had to spend a bunch of money to keep people ready to go for the GLS and LOGCAP IV contracts. Now if they hadn’t gotten them it would have been a lot of expenses for nothing but as it turns out now, it was money well spent.

With just over 2 billion dollars in revenues, given the size of the contracts they have just received, these are “needle moving” events with the potential to more then double their revenue and profits over the next 18 months. Even if they don’t get any more contracts I believe the stock while appreciate at least 20% from here (recently trading at 17.50). The typical PE of their competitors is around 17. DCP is growing faster then they are due to DCP’s smaller size but to be conservative take that 17 PE by next years estimated income and you get 17 * 1.35 = 22.95. This amount minus the company’s debt gives you a number a little above where it is currently trading, so I think the company would be only slightly undervalued here, accept these huge new contracts are not in the estimates yet. I think a conservative view is 20% plus upside and that is if LOGCAP is very slow to develop over the next year.

One more thing to think about was at the end of the last conference call Herb [CEO] mentioned some new contracts in the works that he is not currently allowed to talk about. Another big contract on top of the two huge ones they have just been awarded would be yet another huge positive for the stock.

Now after all that hype we need to take a look at the risks to the company. One is that these military contractors get beaten down like red headed step children by Hilary Clinton every time she talks about the war. She loves to push her hard stance on military contractors to separate her from the other candidates. I think DCP’s stock will take a hit if it looks like Hilary may be the next president, so that is some political risk you must consider. Any Democrat winning the election will be a headwind for defense contractors as pulling out of Iraq will surely be a front line issue and is a big source of revenue for DCP.

Bad publicity flows out all the time about military contractors, presenting another risk. The biggest percentage usually involves BlackWater who has several contracts that involve more of the “offensive” type missions. DCP’s business only overlaps BlackWaters about 3% but yet when bad news comes out about any military contracting company the stocks of all usually suffer. If a military contracting company gets involved in any civilian causalities you can be sure Congress will be all over them.

Another issue is debt – DCP has about 970 million dollars in debt resulting in about negative 200 million of net tangible assets. The company has 57 million shares out so this comes out to negative $3.50 a share.

Also in regards to the LOGCAP contract it’s not like the government is just going to hand them 5 billion. They will need to work with KBR who currently has the contract to transition some of the work over to DCP. Included in this process is that DCP, KBR and FLR will have to bid for jobs. In the quest to better control costs the government has decided to divide up large contracts and let the companies bid against each other for work. In the case of LOGCAP IV this is 5 billion dollars upper limit per company per year. This process was discussed on KBR’s conference call just a few days ago gotten from Seeking Alpha.

Charles E. Schneider - Interim Vice President and Chief Financial Officer

“For government and infrastructure, the U.S. Army announced two weeks ago that KBR was once again selected as one of the executing contractors of the U.S. Army's LOGCAP IV contract. Although this brings the re-award base and protest to a close, the terms and timing of the transition from LOGCAP III to LOGCAP IV are still forthcoming. Until this transition occurs, we will continue to work under LOGCAP III, providing quality services to the U.S. Military... And clearly, now that we've gotten to the point of LogCap IV being announced, there is a transition period that we see, that will take… that will require timing before the consultant to the Army develops the packages that will be put out to bid and transitions get taken. So with respect to 2008, we're probably a little more confident about our volumes because we now have a greater certainty. And when we commented in December, we weren't sure when the LogCap IV would come. And so we kind of hedged our bets in case we had an award of LogCap IV.”

So this process will take some time to get the ball rolling but barring some dramatic shift in plans the business and therefore the money is coming.

Bottom line for me is that I will be adding to my DCP position under $18 and I believe the conference call at the end of the month should serve as positive catalyst from current prices. The biggest risk I see is the Presidential elections which you need to keep an eye on if you decide to invest in this company.

Disclosure: Long