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L-3 Communications Holdings (LLL)Stock (Security & Protection Services Industry, Services Industry)
Although the U.S. budget for national defense has more than doubled from 2001 to 2008, it is expected to decrease in the upcoming years.[1] Just like any defense company, L-3 relies on government spending for most of its earnings - in particular the U.S. Government (80% of revenue).[2] In order to keep its hands on Uncle Sam’s wallet, L-3 has diversified its portfolio through some risky acquisitions. Its growth-by-acquisition strategy has bolstered some of its business units and opened new markets, but has also caused it to acquire debt without any outstanding results. For example, acquiring Titan, a large employer of language translators, for more than $2.5 billion opened the door to linguistic contracts, but L-3 subsequently lost the $4.7 billion linguistic contract that was the primary incentive for the merger, making the acquisition more costly than intended.[3] Relying on others for sophisticated technological work, the U.S. Government has established a trend of outsourcing jobs to the private sector benefiting many private contractors; the number of private federal contractors has soared and is four times bigger than the federal civilian work force.[4] L-3 will continue to benefit from the outsourcing of jobs and, if they play their cards right, from their growth-by-acquisition strategy even if Uncle Sam decides to cut down military spending.
[edit] Business Overview [edit] Business FinancialsL-3s revenue in 2007 was nearly $14B, a record high, up 12 percent from the previous fiscal year.[5] This growth has continued onto the first half (1Q plus 2Q) of 2008, with sales increasing almost 8 percent compared to the first half of 2007, totaling at $7.2B.[6] Much of this growth was driven by the strong demand for network communication systems, security and detection systems, training and other technology products. In 2007, L-3s total earnings were $756M, a 43.7 percent increase from 2006.[5] The U.S. Department of Defense (DoD) is L-3s largest customer, accounting for 74% of revenue in 2007; the U.S. Government accounted for 80%.[2] 
In 2007, L-3 received a total of $14.7B funded orders, which is the full value of all contracts for which funds have been appropriated by the customer. In 2008, L-3 expects to record 77 percent of its $9.5B backlog (total funded orders minus orders which are recognized as sales) as sales.[7] [edit] Business Segments [edit] C3ISR (17% of sales,16% of operating income, fiscal 2007)[5]The Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) business specializes in secure, high data rate communication systems. It connects various airborne, space, ground and sea-based communication systems and ensures secure transmission of information. Customers include all branches of the military and other U.S. Government agencies, along with other foreign governments. L-3 will supply the communication systems for the Canberra-Class Landing Helicopter Docks to two new Australian amphibious ships, a contract worth $109M; the system will consist of IT Networks, Data Links, Broadcast and Alarm Systems for the Royal Australian Navy.[8] [edit] Government Services (31% of sales, 28% of operating income, fiscal 2007)[5]The Government Services business provides teaching and training services for aircrews and navigators along with information technology (IT) services. Providing services primarily to the Department of Defense, and other U.S. Government agencies it has landed number 8 on the Top 100 Government IT Contractors list.[9] Contracts are similar to the $326M Marine Corps contract, in which L-3 will provide a video training system allowing users to view sites under surveillance.[10] [edit] AM&M (18% of sales, 17% of operating inceome, fiscal 2007)[5]The Aircraft Modernization and Maintenance business does exactly as the name suggests, provides aircraft repair, overhaul, and upgrades. It supports platforms such as the P-3 (Orion), a maritime patrol aircraft, the C-130 (Hercules) and C-27J (Spartan), which are both military transport aircraft, as well as the Canadian Maritime Helicopter Project (MHP). L-3 provides these services to foreign governments as well, just like the $18M contract from the U.K. Ministry of Defense, Royal Air Force to perform outer wing replacements on three C-130K aircraft.[11] [edit] Specialized Products (34% of sales, 39% of operating income, fiscal 2007)[5]The Specialized Products business caters to military and commercial customers in several niche markets. Products include security and surveillance systems for aviation, port and border applications, including those for detection of explosives, concealed weapons, contraband and illegal narcotics. Additionally, L-3 provides airborne traffic and collision avoidance systems (TCAS), cockpit voice and flight data recorders, and rugged displays for military and commercial applications. The U.S. Army has ordered mine detection systems with highly sensitive metal detection abilities to identify lethal land mines, for a total of $26M[12] [edit] Trends and Forces[edit] The U.S. Government contributes 80 percent of L-3 sales Over $11B, 80 percent, of L-3s net sales came from Uncle Sam’s wallet. Relying on government contracts automatically makes L-3 vulnerable to a notoriously fickle budgeting process and budget cuts. Defense company’s wallets have enjoyed the upswing in government spending; national defense spending has more than doubled from 2001 to 2008. [1] A continued upswing is unlikely for being impractical and unsustainable; the U.S. Government expects a 13 percent decrease in 2009.[1] But L-3 continues to win important contracts such as the $2B C-27J program, a medium-sized military transport aircraft, with a potential backlog of $6B; it has a joint venture for the project with Alenia Aeronautica, the aircraft manufacturer, and Boeing.[13]
[edit] Outsourcing begets outsourcingWith a significant portion (50%) of the government’s technology workforce soon to retire[14], L-3 will benefit from the government increasingly outsourcing IT jobs to the private sector. As the government witnesses the capabilities of outsourcing and obtains experience in choosing qualified players, it will continue increasing the jobs it sends out to the private sector. It has been estimated that the federal government’s IT outsourcing will increase 55 percent to $17.4B in 2009, from $11.7B in 2004.[15] The government has caught the attention of private contractors with all the outsourcing it is doing increasing the number of the private federal workforce to 7.5M.[4] A primary reason for this outsourcing trend is concerns about overspending. Particularly when it comes to aircraft, instead of building new ones, the govenrment would rather have them modernized, meaning repaired and upgraded; this trend is not only seen within the U.S. government but with many others as well. L-3 stands as a prime federal contractor for modernizing defense aircraft, and just acquired a new contract of $18M from the UK to modernize three C-130K aircraft.[11] The U.S. Army also awarded L-3 a $36M contract for aircraft maintenace.[16] The Department of Defense has seen benefits from outsourcing training programs as well. The Army is not training all of its pilots - it has sent rotary-wing pilot training to the private sector.[17] And as many more jobs are sent to the private sector, L-3 is in position to benefit. [edit] Growth through acquisitions brings risksL-3s diverse portfolio capabilities are a consequence of its growth-by-acquisition strategy. It has acquired over 20 companies in the past three years, spending more than $4.5B.[3] L-3s acquisition strategy consists of buying out neglected businesses to strengthen its own business or to open doors in new market areas. During the 1Q of 2007, L-3 acquired Geneva Aerospace, Inc., a leading provider of unmanned aerial vehicles (UAV) technology, a new market for L-3.[3] Its most costly acquisition was Titan, the US Government’s leading suppliers of linguists and interpreters, acquired in 2005 for $2,736M. However, this acquisition turned out to be more costly than intended as L-3 ended up losing the $4.65B linguistic contract it expected to win by having Titan as a subsidiary.[18] L-3 continues its acquisition strategy, albeit more cautiously, spending less than $200M per company in order to bolster its different business markets. [edit] CompetitorsAlthough L-3 relies on Uncle Sam for most of its income, it does not rely on any single large platform or program like many defense contractors do. The company's competitors range from large defense contractors to smaller IT companies. Its broad capabilities and products lets it compete, either on its own or teaming up with other companies. L-3s capabilities rely on information technology (IT) and its biggest competitors in IT are Honeywell, Lockheed Martin, and Raytheon, companies which are also IT driven. L-3 was selected by the U.S. Air Force as a prime contractor to modify and repair weapon systems, a contract value of $6.9B.[19] In 2007, L-3 won 63 percent of new competitive contracts and 95 percent of the contracts it rebid on when they were the incumbent supplier.[20]
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