Stock Mart: L-3 Communications

Since April 1997, L-3 has nearly doubled its quarterly revenue, thanks in part to its aggressive acquisition strategy.
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Forgive

L-3 Communications

(LLL) - Get Report

its indulgent shopping habits.

Since defense behemoth

Lockheed Martin

(LMT) - Get Report

set it loose in April 1997 as the industry consolidated, L-3 has nearly doubled its quarterly revenue and acquired a string of companies, including

SPD Technologies

,

Microdyne

and

Interstate Electronics

. And plenty of targets remain for CEO Frank Lanza, who was a top officer at another acquisitive company,

Loral

, itself acquired by Lockheed Martin.

But some investors have expressed concern about L-3's strategy, and its stock has suffered. It reported that second-quarter profits doubled and revenue grew 36%, but investors were more concerned that revenue excluding acquisitions was flat, thanks to delays in a few international contracts. Shares have slipped 16% since the company reported earnings July 19. They closed Friday at 40 1/4, up 1/2.

Some investors who unloaded found a buyer in Richard Freeman, manager of the

Smith Barney Aggressive Growth

fund. He has no quibbles with L-3's growth.

"I'm drawn to companies that can make accretive acquisitions," says Freeman, who since late 1998 has grown his stake to 400,000 shares, or 1% of his portfolio. Freeman says L-3's acquisition strategy reminds him of longtime holding

Tyco

(TYC)

, which has acquired more than 10 companies in the last two years. In the June quarter, Tyco grew operating profits 75% from one year earlier and expanded margins partly by absorbing newly acquired units.

L-3 now trades at 3.5 times book value, 28 times profits in the trailing four quarters and 1.1 times revenue. While some peers such as

Litton

(LIT) - Get Report

trade at lower multiples, analysts Will Chiewchanpanich and William Kidd with

C.E. Unterberg Towbin

point out that L-3's price-to-earnings multiple based on 1999 earnings of 24 is less than the 34% earnings growth they predict this year. Litton and others in the industry trade at higher P/Es than their expected growth rates. Unterberg Towbin has acted as banker for L-3.

New York-based L-3 makes instruments that range from spy antennae for

Apache

helicopters, to "black boxes" for airplanes, to power systems for Naval ships and submarines. L-3 also develops explosive detectors for airports.

Uncle Sam

accounts for roughly two-thirds of revenue these days; foreign governments and commercial customers such as

AT&T

(T) - Get Report

comprise the remainder.

L-3's heavy defense exposure is worrisome to some. For instance, when the

House of Representatives

voted to eliminate funding for the

F-22 Raptor

fighter jet, concerns arose among defense industry investors. But L-3 is filling its arsenal of smart weaponry, as evidenced by its $60 million purchase of Interstate Electronics from

Scott Technologies

(SCTT)

. Interstate furnishes the

Navy

with equipment such as missile tracking systems for its Trident submarines. And the military needs sharper eyes and ears.

L-3 is "benefiting from increased spending on tactical intelligence as opposed to dumb hardware," says Colin Morris, senior vice president with the investment firm

Arnhold & S. Bleichroeder

in New York. His firm's hedge fund, long active in the defense sector, snapped up shares of L-3 when they traded below 40 this week.

Analyst Pierre Chao with

Credit Suisse First Boston

still expects L-3's sales excluding acquisitions to grow 8% to 10% this year.

"Almost all

this year's projected growth is in current backlog and is a matter of timing and delivery, not winning new work," writes Chao in a recent report. L-3's backlog swelled to $952 million in the second quarter from $875 million in the first quarter and $856 million at year-end. Chao, whose firm has banked deals for L-3, rates the stock a buy and sets a 12-month price target of 57.

Meanwhile, expect no apologies for L-3's shopping binges. While the company is cagey with Wall Street about future targets, bullish investors and money managers alike believe L-3 will continue acquiring in a consolidating industry.