Morningstar | Top-line growth, the Vertex divestment, and improved efficiency will drive L-3's margins higher.
L-3 Technologies was born out of the mergers and acquisitions wave that swept through the defense industry in the late 1990s. Frank Lanza, Robert LaPenta, and Lehman Brothers--hence L-3--formed the company in 1997 as part of a Lockheed spin-off that had $700 million in revenue at the time. Under Lanza, L-3 grew aggressively through M&A, conducting over 80 deals from 1997 to 2006. Michael Strianese took over as CEO in 2006.L-3 derives about 70% of sales from the U.S. government, with the remainder from international militaries and commercial customers. During the defense downturn, L-3 suffered disproportionately due to a drawdown in Iraq and Afghanistan, where it had significant exposure. In response, L-3 cleaned up its portfolio, exiting the lower-margin manpower business through a spin-off in 2012 and a divestment in 2015. L-3 operates four business segments: aerospace systems (26% of our 2017 estimated revenue), electronic systems (33%), communication systems (24%), and sensor systems (17%). Aerospace systems modifies, upgrades, and maintains aircraft for the U.S. Department of Defense, or DoD; L-3 divested its Vertex business (about $1 billion in revenue) from aerospace systems in the second quarter of 2018. In the other segments, L-3 manufactures components for systems, aircraft, and ships that enable surveillance, targeting, detection, and communications. L-3 generates roughly 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.We like the revamped L-3 portfolio and the appointment (slated for Jan. 1, 2018) of COO Chris Kubasik as the new CEO. Due to the divestment of the low-margin Vertex business, solid growth in the company's end markets, and an increased focus on efficiency measures, we think management will be able to raise consolidated operating margins to over 12% by 2020 up from 10.7% in 2017. We anticipate improved margins, a narrow moat, and divestment of lower margin businesses will enable L-3 to create value in 2017 and well into the future.L3 Technologies is a defense technology company. The company's segments include: Intelligence, Surveillance and Reconnaissance systems, which provides engineering, modernization and sustainment solutions for military and various government aircraft, ground support equipment and other platforms; Communications and Networked Systems, which provides network and communication systems, communications products, radio frequency components, satellite communication terminals and space, microwave and telemetry products; and Electronic Systems, which provides a range of products and services, including components, products, subsystems, systems and related services to military and commercial customers.
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