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Morningstar | L-3 is Merging With Harris to Create Another Major U.S. Defense Prime Contractor

On Oct. 14 2018, L-3 Technologies and Harris announced plans to merge, creating L3 Harris Technologies. This is an all-stock merger (1.3 Harris shares to 1 L-3 share) and management anticipates closing mid-2019. Although we think there are some regulatory hurdles (perhaps regarding night vision and data links), our sense is that the U.S. government will ultimately approve the deal. The merger makes sense: U.S. defense budgets are growing, and there is limited product overlap but significant cultural, end-market, and core technology overlap between L-3 and Harris.The combined entity has pro forma 2018 revenue of $16.4 billion with operating margins of 14.6% and free cash flow close to $2 billion. We think that by 2022 L-3 Harris Technologies should be at approximately $30 billion in revenue with operating margins of 17.2% including cost synergies but excluding increased amortization linked to the deal. Free cash flow should land at over $3 billion in our model by 2022.L-3 derives about 70% of sales from the U.S. government, with the remainder from international militaries and commercial customers. Harris Corporation has a similarly diversified customer base and we think the two companies complement each nicely in terms of end markets and distribution channels. It's not clear yet how the new L-3 Harris Technologies company will be organized. L-3 currently operates four segments: aerospace systems (26% of our 2017 estimated revenue), electronic systems (33%), communication systems (24%), and sensor systems (17%). Harris operates three segments: communication systems, electronic systems, and space and intelligence systems. Aerospace systems modifies, upgrades, and maintains aircraft for the U.S. Department of Defense, or DoD. L-3 generates one third of its revenue subcontracting to major U.S. defense contractors but wants to grow its direct contracts with the U.S. Department of Defense. This split will remain roughly the same following the merger with Harris.