Shareholders Approve The Merger Of Harris And L3

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About: Harris Corporation (HRS), LLL
by: Kurt Pollet
Summary

The shareholders of Harris Corporation and the shareholders of L3 Technologies have approved the merger.

Harris and L3 have similar market-caps and both companies are expected to produce earnings growth going forward.

Management of Harris and L3 both see the merger as creating value for their respective shareholders.

Harris and L3 have rallied strongly this year, but both companies are still reasonably priced.

Investors could buy either stock, as the merged company would produce the combined earnings growth of Harris and L3.

Harris and L3 Merging Together

Harris Corporation (NYSE:HRS) and L3 Technologies, Inc. (NYSE:LLL) will merge to form L3 Harris Technologies, Inc. The shareholders of both companies have approved the merger which is expected to be completed by the middle of 2019, subject to regulatory approvals. L3 shareholders will receive a fixed exchange ratio of 1.30 shares of Harris common stock for each share of L3 common stock. Harris shareholders will own approximately 54% and L3 shareholders will own approximately 46% of the merged company.

Management for Harris stated in their press release,

Today's vote clearly supports our view that this merger will unlock additional growth opportunities and generate value for our customers, employees and shareholders.

Management for L3 stated in their press release,

The increased scale of L3 Harris will allow us to deliver comprehensive mission-critical solutions to our customers, while creating value for all of our stakeholders.

Both companies see the merger as beneficial. The merger is expected to increase the operating efficiency of the combined company with costs expected to be reduced by $500 million per year. While $300 million of this is proposed to be returned to its customers by reducing prices, it still leaves $200 million in annual savings.

The merger seems to be more about creating one corporation to compete globally with other larger corporations, rather than from competition with each other, as there's little overlap in products from Harris and L3.

Harris specializes in communications systems and electronics for military and civilian use, including air traffic control and global positioning systems. Whereas L3's products include systems used in pilot training and safety, and aviation security.

The market-cap of Harris is currently $21 billion and L3's market-cap is currently $19 billion. The merged company would have a market-cap around $40 billion.

The merged company would make them the sixth largest defense contractor in the United States and the tenth globally. The merged company will be sixth behind Lockheed Martin, Boeing, Raytheon, Northrop Grumman and General Dynamics.

I think that the increased size of the merged company leads to another benefit and that's the ability to secure contracts. The merger will turn them into a large $40 billion market cap corporation and larger companies tend to have larger marketing budgets which help promote the company and this in turn gives them more market presence, helping to secure contracts. Also, larger companies can more readily afford to price cut in order to secure a contract.

Management of both companies feels that the merger is beneficial and I tend to agree. The next step is that I will have a look at the financials and stock charts of both companies.

Financials for Harris

Harris is a company with a history of slow revenue growth and its earnings have been volatile. However, the analysts are expecting solid growth going forwards. Due to the company's earnings volatility, its margins vary year to year. Over the last decade the company's profit margins have ranged from 1% to 12% and its return on equity has ranged from 2% to 29%.

Harris is financially sound with acceptable debt levels. The company's long-term debt is $3.4 billion which represents 35% of the value of its assets and its total liabilities is 63% of its assets value. The company's working capital is reasonable (with a current ratio of 1.4) meaning that the company's short-term assets (cash and deposits) covers its short-term obligations (such as bills). Harris' working capital has been fairly consistent over the last decade.

Harris' forward PE multiple is 21x with a stock price of $181. The company's trailing PE multiple is 30x and its book value multiple is 5.8x. These multiples imply that Harris may be a little expensive. Harris pays a dividend with a forward yield of 1.6% and a trailing yield of 1.4%. The dividend payout ratio is 35%.

The chart below visually shows Harris' revenue and earnings trend over the last decade along with the next two years of consensus forecasts.

Harris revenue and earnings history chart

Harris data from Annual Reports

As the above chart shows, Harris' revenue is higher now than it was a decade ago, but it did show a declining trend from the 2011/06 fiscal year until the 2015/06 fiscal year. Since then, the company's revenue has broadly trended upwards with the analysts expecting this trend to continue into the 2020/06 fiscal year.

While Harris' earnings are higher now, they have been quite volatile, but the company did book a profit each year. With some fiscal years the company only just make a profit. The general earnings trend is upwards and the analysts are expecting Harris' earnings to increase heading into the 2020/06 fiscal year.

Financials for L3 Technologies

L3 Technologies is a company whose revenue has marginally increased in recent years, but prior to 2015 had shown a declining trend. The company is generally profitable with reasonable profit margins and returns on equity. Over the last decade the company's profit margins have averaged around 6% and its return on equity has averaged around 14%.

L3 is financially sound with moderate debt levels. The company's long-term debt is $3.9 billion which represents 27% of the value of its assets and its total liabilities is 57% of its assets value. The company's working capital is reasonable (with a current ratio of 2.0) meaning that the company's short-term assets (cash and deposits) covers its short-term obligations (such as bills). L3's working capital has been fairly consistent over the last decade.

L3's forward PE multiple is 15x with a stock price of $234. The company's trailing PE multiple is 18x and its book value multiple is 3.1x. These multiples imply that L3 is reasonably priced. L3 pays a dividend with a forward yield of 1.6% and a trailing yield of 1.4%. The dividend payout ratio is 32%.

The chart below visually shows L3's revenue and earnings trend over the last decade along with the next two years of consensus forecasts.

L3 Technologies revenue and earnings history chart

L3 Technologies data from Annual Reports

As the above chart shows, L3's revenue trended downwards until 2015 and then started to trend upwards. The analysts are expecting L3's revenue to continue increasing into 2020. L3's earnings have broadly trended higher over the last decade, but did show weakness from 2012 to 2015 where it also booked a loss. The analysts are expecting L3's revenue to continue increasing into 2020.

Stock Charts

The stock charts for Harris and L3 are shown below.

Harris ten year stock chart

Harris chart by StockCharts.com

L3 Technologies ten year stock chart

L3 Technologies chart by StockCharts.com

Comparing the two stock charts, both companies have steadily increased their stock prices over the last decade. Both stocks pulled back in late 2018 along with the market pullback and then both rallied strongly this year as the market resumed its rally.

In fact, the two stocks have virtually mirrored each other. While their stock performance is typical of strong growth stocks, I don't consider either of them strong growth stocks. However, even after the strong stock performance (lately being fueled by the merger), both stocks are still reasonably priced on a PE basis.

Harris is a little expensive with a forward PE of 21x, but analysts are expecting solid growth going forwards, so I think that it's still reasonably priced. L3 has a forward PE of 15x even after the strong rally and the analysts are also expecting growth going forwards.

Both stocks have rallied strongly gaining around 40% so far this year. From a technical analysis point of view, both stocks look like they are overbought and are due for a pullback. However, both stocks are driven by the merger. It's the promise that the combined company will become a super company and hence its earnings will soar, thereby yielding strong stock price gains. It's a nice thought and it's why investors will probably keep biding the stock price higher for both companies - at least until the merger is approved and finalized.

The analysts are expecting the earnings for each company to increase and so I would expect that once the merger is completed, that the combined company's earnings would also increase.

Over the long-term, I would expect that the stock price of the combined company would continue higher in line with the expected earnings growth going forwards.

Conclusion

The shareholders of Harris and the shareholders of L3 have approved the merger. The merger is not about competition between Harris and L3 as there's little overlap in products, but the merger is expected to form a more efficient company with $500 million per year in cost savings. The merged company will be the sixth largest defense contractor in the United States and the tenth globally.

Harris and L3 have similar market-caps and the financials are similar. Both companies operate profitably with reasonable profit margins and returns on equity, even though Harris' margins tend to vary. The debt levels of both companies are reasonable. Management of Harris and L3 both see the merger as creating value for their respective shareholders.

Harris and L3 both pay a modest dividend and both are still reasonably priced, even after the strong 40% rally seen so far this year. As the merger is not expected to be completed until mid-year, investors can still buy either stock. I would expect the stock price of the merged company to continue higher. The analysts are excepting the earnings of each company to increase heading into 2020 and I would expect the earnings of the combined company to also increase.

In my opinion, investors could buy either stock now. I think that when they merge, the merged company would produce the combined earnings growth of both companies.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.