Harris Corp. and L3 Technologies Inc. are combining to become the sixth-largest U.S. defense contractor, continuing a trend in the industry to create bigger companies that can take advantage of President Donald Trump’s increased military spending.
The newly formed L3 Harris Technologies Inc. would be an entity with a total market value of US$33.5 billion. Each company is known for its capabilities in communications and electronics and gets more than two-thirds of its revenue from the U.S. government.
Greater scale will allow for a more competitive offering by the new entity, Robert Stallard, an analyst at Vertical Research Partners, wrote in a note after the announcement. The combination adds to a flurry of aerospace and defense deals amid increased military spending and a boom in jetliner sales. On Oct. 10, aircraft-parts maker TransDigm Group Inc. agreed to buy Esterline Technologies Corp. for US$3.6 billion. Boeing Co. closed its purchase of components distributor KLX Inc. a day before that. United Technologies Corp. is poised to complete its US$23 billion acquisition of Rockwell Collins Inc.
“This merger creates greater benefits and growth opportunities than either company could have achieved alone,” Christopher Kubasik, L3’s chairman, president and chief executive officer, said in the statement. Kubasik will serve as vice chairman while William Brown of Harris will be chairman and CEO. Kubasik will succeed Brown as CEO in the third year after the transaction. The headquarters will be in Melbourne, Florida.
Small Premium
The deal has been approved by both boards and will result in L3 holders getting 1.3 shares of Harris common stock, a small premium currently valued at about US$201.33, for each share of L3, the companies said in a joint statement Sunday. After the deal is complete, Harris shareholders will own about 54 per cent of the combined company.
Harris is paying about a 5 per cent premium to L3, said Vertical Research’s Stallard.
“As this merger effectively removes any remote chance of Harris being acquired, we think the initial reaction tomorrow could be modestly negative for Harris shares,” Stallard wrote.
New York-based L3 and Melbourne, Florida-based Harris described the transaction as a merger of equals, with a 12-member board that includes six directors from each company.
Adding to Earnings
The companies say the transaction will add to combined earnings per share in the first year after the close of the deal, and generate US$500 million in annual pretax cost savings and $3 billion in free cash flow by the third year. For calendar 2018, the company would have about US$16 billion in sales and earnings before interest and taxes of US$2.4 billion.
“The significant increase in scale should help make L3 a much more formidable challenger against the larger defense primes, something they have struggled with for some time,” said Doug Rothacker, an analyst at Bloomberg Intelligence. “This will be key to their efforts in securing more high-margin prime contractor roles, versus their historical position as a subcontractor.”
Share Performance
L3, with a market value of US$15.3 billion, slipped 1 per cent this year through the close of trading on Friday to US$195.78 compared with the 6.5 per cent advance of a Standard & Poor’s index of aerospace and defense companies. Harris gained 9.3 per cent over the same period, closing the week at US$154.87 for a market value of US$18.2 billion.
Vanguard Group Inc. is the largest shareholder of L3 and the second-largest for Harris, controlling more than 11 per cent of each company, according to data compiled by Bloomberg.
Harris makes communications systems for battlefield management, as well as for civilian uses such as air-traffic control and wireless network transmission, and was recently selected by Lockheed Martin Corp. to develop a next-generation computer processor for its most advanced jet, the F-35 Lightning II fighter.
L3 provides communications equipment such as surveillance gear and cockpit electronics. It also makes night-vision devices, sensor systems and satellite communications. The Department of Defense may have some concern about overlap in night-vision systems, analyst Stallard said.
In separate news releases, both companies reported financial results for the most recent quarter. Harris reported fiscal first-quarter revenue of US$1.54 billion, up about 9 per cent from the prior-year quarter, thanks to growth in tactical communications, public safety and night vision. L3 said third-quarter sales rose about 10 per cent to US$2.52 billion.
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