As Obama Boosts Infrastructure Spending, This Specialized Communications Company Is Set to Profit With Its Digital Defense Technology

A Taipan Publishing Group Strategy Report
By Michael Robinson, Editor, BreakAway Investor

With all the attention President Obama’s stimulus package receives, the so-called experts seem to ignore the critical role defense spending plays in the American economy.

Although it ranks as less than 5% of Gross National Product, the defense budget nonetheless totals more than $515 billion a year. That doesn’t include the sprawling Department of Veterans Affairs or the “supplemental” funding for the wars in Iraq and Afghanistan.

For investors, the trick is to know which programs will prove profitable over the next four years, especially if defense spending stalls or gets cut to help pay for the social programs Democrats hold dear.

That’s why I’m recommending readers keep their eyes on these surefire bets, which are nearly immune to the cross currents of electoral politics and Pentagon budgets. I’m talking about information technology and defense electronics, particularly those that enable secure communications.

This Company Does Business With Every Branch of U.S. Military

Harris Corp. (HRS:NYSE), of Melbourne, Fla., is bound to profit from increased spending in both sectors and will do well even in a defense downturn. The Emmy winning assured communications company ranks as one of the top federal contractors and does business with every major branch of the U.S. military, the Department of Homeland Security and the intelligence community.

Among other things, it provides digital defense maps, has gear on the super-sleek F-22 Raptor stealth fighter, does work on the big IT grid known as the Warfighter Information Network, and enables fiber optic and wireless military communications. Soldiers rely on its leading edge, software-centric tactical radio, the Falcon III.

Recently priced at about $43, the stock trades at a multiple just over 13 times annual ‘08 earnings. While it’s not dirt cheap, the stock is a steady performer and represents an investment in America’s security.

Since the last recession in late 2001, Harris’ stock beat the S&P 500 every single month. Last September, the company actually became a member of the prestigious 500 Index.

With an annual dividend of 80 cents, the stock provides a 2% yield, less than half of the top rates for Certificates of Deposits (CD), but not shabby either considering many growth companies pay no dividends whatsoever.

Plus, CDs don’t grow at an annual rate approaching 15% or have a $1 billion backlog of funded orders. And they don’t protect our borders from bad guys.

But Harris can. It makes a Border Security Shelter, a self-contained, rugged and easily deployed surveillance and security solution for remote outposts and regional command centers. Talk about flexible: The device can stay fixed, be mobile, manned or unmanned.

That’s because it’s big enough to accommodate two sentries sitting at a monitoring station and small enough to be moved relatively easily by truck. Picture a squat, beige metal box more square than, say, the type of dumpster one sees at construction sites. Except for the small dome-shaped antenna and heating/AC systems visible from outside, the shelter defines unobtrusive.

But on the inside, it’s teeming with high-tech gear. The shelter contains a tactical radio network and situational awareness software. Throw in day and night imagery, ground radar, and remote intrusion detector data, and you have eyes and ears anywhere you need them.

Services the Government Needs

Harris also operates a thriving business selling IT services throughout the federal government, including a wide range of civilian agencies. In short, the company has products and services the government can’t live without.

After a tough couple of years in the late 1990s, the company reorganized, dumped two lackluster units, and rebounded with a steady stream of earnings increases. In fact, earnings more than doubled in fiscal year 2007 to $480.4 million from the year before.

However, last year’s earnings were down slightly, a 7.5% drop to $440 million when the company had costs associated with a majority-owned subsidiary. But cash flow improved — net cash from operating earnings jumped 25% to $550 million.

And earnings increased again in this year’s first fiscal quarter by 19% to $119 million, while diluted earnings per share jumped 20% from the year-ago period to 88 cents. For the second quarter, however, Harris had mixed results — revenue jumped 16% to $1.52 billion and non-GAAP income climbed 24% from the year ago period to $1.08 per share. But Harris registered a net loss of $38.6 million because it took a non-cash charge for impaired goodwill and other intangible assets at Harris Stratex Networks, in which it has an 56% ownership stake.

Harris Technology Turns Soldiers Into Mobile Information Grids

At the Pentagon, meanwhile, top planners sketched out a vision that helps companies like Harris. Force transformation depends on what the top brass call Net-Centric Warfare, defined as a “system of systems.”

Let’s boil it all down this way: In combat, the Pentagon will be able to communicate in real time with remote command centers that in turn get video, voice and data from secure links that are literally ubiquitous. Every soldier in this scenario is a mobile information grid with radios, sensors, night vision goggles and helmets equipped with video cameras.

And don’t forget that we’ll be firing cruise missiles, redirecting forces to meet enemy troop movements and giving pilots updated target data. All these systems mean we can fight a battle at night in a sandstorm or a blizzard and crush the enemy.

The sheer volume of information not only gives the U.S. military a force multiplier effect over the enemy but also threatens to overwhelm the DoD’s computers. That is, of course, unless the Pentagon continues investing heavily in its IT backbone.

Revenues Double in Five Years

No wonder Howard Lance, Harris’ CEO, seems to be smiling so widely these days. He joined the company in 2003 and more than doubled revenues of $2.5 billion in fiscal year 2004 to $5.3 billion in fiscal 2008. He’s made acquisitions and announced several large military contracts.

Lance is a strong-willed, driven CEO who is constantly pushing Harris to increase revenues with new product offerings and by expanding into overseas markets. He loves innovation and the profits they produce.

Roughly four years ago, new products accounted for about 15% of sales; today they make up more than 30%. R&D gets heavy emphasis under Lance.

Technology consulting firm Booz Allen Hamilton lauded Harris last year for the firm’s innovation and its strong financial return on research and development.

Using 2007 figures, Booz Allen named Harris a “High-Leverage Innovator” in a special report titled “The Customer Connection: The Global Innovation 1000.” Such companies “consistently reap the greatest financial reward for every dollar they spend on R&D,” Booz Allen said in placing Harris at No. 118 on the list.

During the period the consulting firm reviewed, Harris more than doubled its internal R&D. When combined with government funding in 2007 Harris invested some $924 million.

A New Kind of Digital Technology

At this year’s Consumer Electronics Show in Las Vegas in early January, Harris announced its ATSC Mobile digital TV (DTV) technology platform for broadcasters and consumer electronics manufacturers should be available by March.

Harris said the technology enables the first significant new over-the-air broadcast medium in decades. The device delivers a mix of broadcast-quality video and data to a range of mobile consumer devices. Strategic partners include LG, Samsung and Zenith Laboratories.

Although it grabbed headlines for the consumer applications, Harris is heavily involved in developing mobile computing for federal agencies. No estimates are yet available for the potential size of this market. But bear in mind that millions of federal employees in civilian agencies and at the DoD work either off-site or in remote locations domestically and abroad.

Those employees either need to communicate with a central office from the field or they need to gather data away from the office to be uploaded later or transmitted to the home office wirelessly.

Take the case of the U.S. Census Bureau. Every 10 years the agency fields a small army of workers for the national headcount. The effort also includes capturing all kinds of data about the populace entered manually on paper forms.

The devices feature GPS technology and biometric security to directly capture canvassing information. Designed to save taxpayers approximately $1 billion, the company says the program ranks as the largest mobile computing initiative ever.

Eventually, the Census Bureau downgraded plans to use the hand-held devices for the next headcount to focus on address canvassing rather than field data collection. Nevertheless, there is no doubting federal mobile computing will become more important, and Harris made a big splash in the emerging market.

Easing the Pain From Analog to Digital TV

Technical achievements remain important for the company for both bragging rights and profits. Lance recently accepted the company’s eighth Emmy Award (actually two in one night). Harris invented a device for “Combining Adjacent TV Channels for Transmission by a Common Antenna.”

Translation: It’s a method of “space combining” analog and digital TV signals on adjacent frequencies within a single antenna. By eliminating the need for separate, expensive antennas for analog and DTV channels, the product reduces broadcaster costs.

Nevertheless, the bulk of the Harris franchise still lies in defense communications and electronics and IT. The company is particularly well known for its tactical radios that have been deployed in both Iraq and Afghanistan.

To date, Harris has shipped more than 50,000 of its Falcon III AN/PRC-152(C) tactical radios. That makes it the most widely deployed handheld radio under the military’s Joint Tactical Radio System for next-generation communications.

Back in June of 2007, Harris signed a deal with the Navy valued at $2.7 billion to provide interim software defined, single-channel handheld tactical radios. The program includes options for four one-year extensions. For fiscal 2008, defense electronics constituted $2 billion, or about 38% of revenues. During the calendar year the company announced more than $570 million in radio-related orders.

Furthermore, Harris’ Defense program develops, supplies and integrates communications and information processing products, systems and networks for a diverse base of aerospace, terrestrial and maritime programs. You’ll find their technologies at all levels of the military’s Global Information Grid — space, theater and tactical levels, including air, ground and sea applications.

One-Stop Shopping for All Government Agencies

The program lays the foundation on which the Navy and Marines support their broad strategic information management objectives. Considered the largest IT outsourcing contract the U.S. government has ever issued it will provide voice, data and video communications to more than 500,000 personnel in those two branches of the military.

Meantime, Harris supports the National Reconnaissance and the Patriot program, an advanced surface-to-air guided missile defense system. Under the 10-year contract Harris could reap up to $1 billion in revenue.

Satellite support keeps Harris busy as well. The company maintains the communications functions for the U.S. Air Force’s 50th Space Wing Satellite Control Network, a continuously operated global network of ground stations and communications links.

Harris also has a game plan for federal health IT, a new and potentially lucrative market for the company. The government has 9.2 million active duty service personnel and millions more retirees who receive medical and dental care.

Last year, Harris received a $12 million award from the Army for dental care IT. Health and Human Services is paying Harris about $6 million to develop and integrate an open-source national high-tech gateway for patient information.

At the Federal Aviation Administration (FAA), a decision to upgrade the agency’s IT infrastructure could become highly profitable for Harris. The company serves as the prime contractor for a 15-year program worth up to $2.2 billion to develop a communications network linking 50,000 FAA employees at 4,000 sites around the country.

Thus, with so many ongoing, long-term contracts, this company will do well in an Obama administration almost no matter what happens with defense. Harris seems to have spun a high-tech web around the federal government that will prove difficult to cut.

Consider Harris Corp. (HRS:NYSE) for your portfolio at up to $52, when Harris’ P/E hits 16. In the next 18 months to two years, as Harris catches up with its sales backlog, the stock could hit $56, well below its 52-week high of $66.71 last June.

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Originally published June 11, 2009.

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