Harris Corp HRS S
May 03, 2011 - 3:58pm EST by
2011 2012
Price: 52.91 EPS $0.00 $0.00
Shares Out. (in M): 128 P/E 0.0x 0.0x
Market Cap (in $M): 6,766 P/FCF 0.0x 0.0x
Net Debt (in $M): 1,161 EBIT 0 0
TEV (in $M): 7,926 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

Sign up for free guest access to view investment idea with a 45 days delay.



  • Tactical Radio Business Benefit from Conflicts
    • Conflict Boosted Demand
      • Last decade of overseas conflicts have spurred the need for communication equipment (rise in number of boots on the ground)
      • Evolving battlefield requirements: prior to modern-day conflicts, Tactical Radios were more of shared resource than today when almost every soldier and vehicle carries some form of individual tactical communication equipment
      • JTRS program of record for advanced Tactical Radios still under development, Harris has essentially been the sole provider of advanced Tactical Radios
    • Leverage to Tactical Radios
      • Tactical Radio business sales and profitability have boomed over the last 8 years
      • Prior to FY03, the business represented c250m sales at c20% margins or c$50m EBIT
      • In FY10, Harris' Tactical Radio business represented almost $1.6bn of sales at c42% margins (mid-30%s boosted by higher c50% MRAP / M-ATV radios) or $660m of EBIT (represents over 70% of consolidated operating profits)
    • Thesis
      • There is significant downside risk to Harris' Tactical Radio business, and hence to overall profitability
      • Catalyst: market reaction to order intake, forward earnings and backlog guidance


  • Tactical Radio Orders / Sales
    • Normalized Market  
      • Normalized market for Tactical Radios is admittedly difficult to estimate due to volatility of orders (e.g. due to surge, MRAP / M-ATVs, volatile international orders)
      • Research shows that is not unreasonable to estimate that close to half (or $1.7bn) of FY10/11E combined c$3.3bn Tactical Radio sales were directly related to conflict (incl. the surge in Afghanistan) including
        • c$1bn orders for MRAPs / M-ATVs
        • c$300m manpack orders
        • Other conflict related-DoD orders and international orders (incl. indirect DoD funded), some due to interoperability requirements (e.g. NATO)
    • MRAP / M-ATV Orders
      • MRAP / M-ATV order carry significantly higher margins c50% (vs. mid-30%s for other Tactical Radios)
      • While difficult to predict with certainty, management does not currently expect future orders going forward
    • Ending Conflicts
      • Surge prompted build out of Tactical Radio capacity, current orders more reliant on troop deployment levels
      • Progress made in conflicts and eventual planned withdrawals suggests declining go-forward need for new equipment (large new Tactical Radio orders) as troops have been equipped and troop levels are expected to drop
    • Austerity / International Markets
      • US / other Western government austerity suggests minimization of unnecessary capital spending
      • Sales to non-allied countries are more difficult or in some cases even prohibited (e.g. China)
      • International competition: while not denying the potential for market share grabs, international markets are more highly competitive (Thales and ITT having significant penetration)
    • Order / Product Cycle
      • Due to the product-nature of the business, Tactical Radio orders have historically converted to revenue in a relatively short timeframe c7months (Backlog / NTM Sales c1.7x)
      • Currently Tactical Radio backlog stands at $1,060 one would expect the majority of these orders to be filled by year-end
      • Multi-year shelf life, long outside of conflict due to less wear and tear
    • Orders / Backlog Target Risk
      • YE11 backlog target was recently guided down from c$1.25bn (previously expected flat book-to-bill in FY11) to c$950m (midrange $900k - $1bn guidance)
      • Assuming 2Q11 guided c10% growth in RF Communications and slightly lower growth in their Public Safety and Professional Communications partially offset by stronger than expected Tactical Communications revenue, the company would need c$800m 2H11 orders (~$400m per quarter) to meet its c$950m YE11 midrange backlog target
      • Pre-surge, in FY09 non-MRAP orders came in at ~$290m/Q (~$260m/Q in 1H09)
      • Last quarter (2Q11), Tactical Radio orders came in at $300m of which $100m was booked as part of a large multi-year International order
      • While not impossible to reach, it would seem that there is more risk to downside than upside in meeting the YE11 backlog target
    • Future Orders
      • While it is difficult to forecast future Tactical Radio sales with precision, it would not be unreasonable to expect Tactical Radio orders to decline significantly on a go-forward basis
      • Recent order tailwinds could accentuate the near-term drop-off


  • Downside Scenario
    • Leverage to Tactical Radios
      • Because Tactical Radios account for a substantial portion of profitability (higher margin), the Company's EBIT / EPS are highly levered to their sales
        • $100m sales ~$35m EBIT or ~18c EPS
    • Other Business Segments
      • More Difficult to Analyze Bottom-Up
        • Not intending to contradict management, we piece FY11 / FY14 guidance (and street estimates) to build non-RF Communication segment estimates  
      • Public Safety and Professional Communications (Other RF Communications Business)
        • Lower (c10%% margin) business
        • Incumbent has dominant market share (Motorola >70% if not more)
        • Large portion of customers are state and local governments or authorities related to these, many facing budget constraints
      • Government Communication Systems
        • Government budget spend constraints to pressuring outlook
        • Increasingly indications of competitive environment highlighted by peers in recent earnings calls
      • Integrated Network Solutions (INS)
        • Segment is a blend of acquired businesses, recently realigned to highlight growth potential and diversify away from Tactical Radio exposure; paid healthy multiples for some of these growth businesses
        • Differentiating competitive advantages hard to identify for some of these businesses (e.g. Cyber Integrated Solutions: cloud hosting / services)
        • Broadcast: management has struggled to turn to profitability for years
    • Consensus Estimates
      • Bloomberg (3-May-2011) Consensus Estimates
        • FY12 EBITDA: $1,278 (c6.2x TEV/EBITDA)
          FY13 EBITDA: $1,389
        • FY12 EPS: $5.17 (10.3x P/E)
          FY13 EPS: $5.79
      • Seems to imply little downside to current elevated Tactical Radio sales levels
    • Downside Scenario
      • Assuming $1.2bn-1.4bn Tactical Radio sales, FY12 consolidated EBITDA should be closer to $1bn (c20-25% below consensus), and EPS closer to $3.70 (c25-30% below consensus) assuming a flat share count
      • Larger reversal in the near term (vs. more normalized medium / long-term) would not be surprising due to recent large orders
      • Without strong opinions about the current relative valuation levels vs. peers, one would estimate c25%-30% downside from these levels if the thesis plays out as expected


  • Risks
    • JTRS
      • Potential delays / cancelation: substantial risk around the future support of the JTRS program given recurring delays, lack of technical progress, cost overruns vs. Harris' strong product offerings
      • Would leave room for future modernization spend on non-program of record radios, in particular on Harris' products which are cost-effective and proven on the battlefield
      • Some form of dual-procurement is still possible due to the success of Harris products
    • Strategic Takeout
      • Some scarcity of midcap assets to acquire though Harris might be a little large given risks
      • Though large contractors pressured as trying to manage through period of shrinking defense spending, focusing on shareholder value, M&A could be badly received by investors; risk on future orders
        • Leverage to conflict spend
        • JTRS program of record progress
    • Conflicts
      • Prolonged involvement in current conflicts
      • New conflicts spurring additional tactical communications demand (e.g. Libya, Pakistan)
    • Betting Against Management
      • Betting against management with less visibility then they have
      • No indications of severe operational problems or fraud that would lead one to believe that the company is in serious jeopardy
    • Valuation / Macro Sentiment on Defense Space
      • Defense valuations are generally depressed and recovering from cyclical lows due to expectations of declining defense spending
      • Positive developments - including those related to political influences over US defense budget - could lead to general re-ratings of the space
    • Timing
      • Difficult to time the drop-off in orders
      • High-margin Tactical Radio sales translate to significant cash generation
      • In past, Harris applied cash towards M&A (seemingly expensive), could turn into a headwind if excess cash is applied to more shareholder friendly actions 



    show   sort by    
      Back to top