Why L3Harris’ Latest Merger Gambit Will Pay Off for Investors

Why L3Harris' Latest Merger Gambit Will Pay Off for Investors

A unique defense powerhouse is being constructed by the company.
With its planned $4.7 billion acquisition of Aerojet Rocketdyne (AJRD 1.29 percent), defense contractor L3Harris Technologies (LHX -3.62%) is making a daring bet by paying up to win a bidding war for the manufacturer of rockets and other propulsion systems.

Even though this deal has some risks, especially in the short term, it is a good move for L3Harris and could be a big step toward the company’s goal of becoming one of the best defense contractors in the country. What investors in L3Harris need to know about the company’s most recent move is as follows.

Pain in the short term: Aerojet is worth about 12 times its expected earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2024. Apparently, L3Harris had to compete with General Electric and others for the prize, which led to the higher price. It is possible that it also comes at an unfavorable time for L3Harris because the company just announced that it would spend $2 billion to acquire Viasat’s government operations.

Although a buyer has no control over

when a seller holds an auction, L3Harris investors would have preferred the company spread out its dealmaking to avoid cash drain and management distractions.

As a result of a recent transaction, L3Harris ought to be able to utilize the merger integration abilities it utilized to successfully complete these deals. However, there is no avoiding the cash drain.

Expect L3Harris to slow down or stop all share repurchases in the near future as it focuses on paying for these deals without taking on too much debt. Over the course of two years, the deal, according to Cowen analysts, has an opportunity cost of approximately $0.50 per share in the form of lost buybacks.

Due to the short-term overhang, at least three analysts downgraded L3Harris from “buy” to “hold” on the news. Wall Street was dissatisfied with the transaction. On December 19, shortly after the announcement of the transaction, shares of L3Harris fell as much as 4%.

However, this deal has a lot to offer those who are willing to overlook the immediate cost.

Aerojet is a one-of-a-kind asset

because it is the only American manufacturer of rocket engines and the owner of important intellectual property and manufacturing capabilities. Orbital ATK, which is owned by Northrop Grumman, is the other rocket manufacturer. Boeing and other prime contractors have voiced their displeasure with the fact that it has been challenging for Northrop Grumman to obtain the necessary components from Orbital at prices that are comparable ever since it acquired Orbital. The government’s decision to oppose Lockheed’s proposed acquisition of Aerojet was motivated by the same concerns.

Since L3Harris is not directly competing with Boeing, Lockheed Martin, or Raytheon Technologies, it has a chance to establish a relationship with those primes and establish itself as a preferred supplier of rocket engines. The partnership that L3Harris already enjoys with Lockheed Martin may also be strengthened by the transaction. Chris Kubasik, CEO of L3Harris, is a former Lockheed president and chief operating officer. L3Harris is already a key supplier to the F-35 program of the company.

The conflict in Ukraine

has necessitated an immediate replenishment of the Pentagon’s munitions, likely resulting in an upcycle for these rocket engines. Between fiscal 2022 and 2027, according to Cowen’s forecast, the Department of Defense will spend more than twice as much on major weapons programs. According to L3Harris, the deal would raise its backlog of potential business by approximately 30%, bringing it up to $30 billion.

In addition, despite the fact that it is highly unlikely that L3Harris will ever be able to compete with Boeing, Lockheed, Raytheon, and Northrop at the program level, the company has been working hard to shift from being merely a component supplier to prime contracting. L3Harris is already a significant contractor in the space industry, primarily providing sensors and other accessories. L3Harris would have new opportunities to interact directly with the Pentagon as a prime contractor in crucial areas like missile defense, space exploration, and Aerojet.

The end result is well worth

the wait In an ideal world, Aerojet Rocketdyne would not have come to market this year. This would have given L3Harris more time to process the M&A it already had in the works and refresh its balance sheet before making another deal. What’s more, in the close to term, there could be unevenness as the organization manages the combinations.

L3Harris, on the other hand, is putting together a one-of-a-kind collection of defense and national security assets for markets with enormous growth tailwinds by combining with Aerojet. NASA’s budget request is up 8% from last year, and the Department of Defense has requested more than $40 billion for missiles and missile defense in fiscal 2023. L3Harris’ international reach was also expanded in 2022 when Aerojet received approval for sales of more than $10 billion to foreign military organizations.

Investors can purchase this premier franchise at a price that is close to its 52-week low and receive a dividend yield of more than 2% in exchange for waiting through any integration hiccups. It’s a great time to think about L3Harris for those who can look past the obstacles in the near future.