Editor's Note: Jon D. Markman writes a weekly column for CNBC on MSN Money that is republished here on TheStreet.com.


Considering all the flak that President Bush has endured for ordering 20,000 more troops to Baghdad, it's a wonder that he didn't just pick up the phone and dial 1-800-MERCENARY.

That's what the Pentagon is likely to do anyway, as it has throughout the Iraq conflict. Thanks to loopholes in the law and budgeting process, upward of 20,000 private military contractors -- sadly, the term mercenary is passe -- are believed to be at work for the U.S. in the region, and their ranks are growing all the time.

We've outsourced airliner and parka manufacturing to foreigners, after all. Why not the messy job of fighting, not to mention translating and spying? Independent companies are now the third-largest contributor of forces to Iraq, after regular American and British troops.

This has meant big bucks for a handful of little-known companies with Defense Department contracts. The most well-known of the bunch is privately held Blackwater USA, a secretive outfit run by a former Navy Seal that hires commandos from as far away as Chile, Bosnia and the Philippines to fight our wars and protect our diplomats. When four of its men lost their lives in an unusually savage attack in the Sunni stronghold of Fallujah three years ago, a spotlight was cast on the nasty business of private security forces. But since then, the attention has receded, and these companies' influence has grown.

Outsourced War

As the number of U.S. military personnel has fallen to around 1.5 million lately from around 3 million in 1970, the amount of money spent by the Pentagon on military operations has risen at a 6% annual rate from less than $50 billion to a bit more than $150 billion, adjusted for inflation. Much of the differential is being spent on outsourced services, and that is why independent personnel contractors -- a handful of which are public -- have become more important than ever.

If this gives you a chill, look at the bright side. It gives you the opportunity to be an entirely new type of war profiteer. No longer must you make money merely in the bloodless tailwind of mega-cap equipment vendors such as Lockheed Martin ( LMT) and General Dynamics ( GD). You've now got a chance to make a few bucks off the men and women who actually shoot to kill. It's a capitalist version of 24, without the commercial breaks.

The most interesting and potentially lucrative of the bunch, in my opinion, has the deliciously bland name of DynCorp International ( DCP). Really, it's like giving the name Spot to a vicious Doberman, or meeting a mobster with the name John Smith.

DynCorp has been around for five decades, starting as a U.S. Air Force logistics and mission support provider in California and then progressing through a series of mergers into an international provider of defense and aerospace services. In 2003, the company was acquired by major Pentagon information technology provider Computer Services ( CSC), but then it was, in rapid succession, sold to the defense-focused private equity firm Veritas Capital and then spun out as a separate company in an initial public offering last May.

Back Where We Started

The market shot the IPO full of holes after an abrupt management change, and shares sank from $15 to around $8.75 in three months. Yet before executives had a chance to retaliate by sending a brigade of employees on a mission to fire back at Wall Street, DynCorp won a couple of large and lucrative contracts and rather quickly doubled in value to $16.50.

So now here we are again, basically at the IPO price. What do you get on the do-over?

Well, DynCorp is certainly a best-of-breed company as the leading provider of civilian police forces overseas -- sometimes known as peacekeepers -- under contracts with the Department of State. It has expanded to provide personal protective services, drug-eradication services and brute force not just for the U.S. government but also for foreign clients such as the United Arab Emirates, Australia, Nigeria and Afghanistan. And its oldest division continues to perform aircraft maintenance work at U.S. military bases worldwide. All told, it has 14,000 people working in 35 countries.

The new sizzle at the company has come not from its biceps but from its brains, as a joint venture in which it is the lead partner won a massive $4.6 billion contract to provide translation services in Iraq. Its new Global Linguists Solutions division, in conjunction with privately held McNeil Technologies, will add materially to fiscal 2008 earnings. The contract, renewable in 20 quarterly installments, calls for DynCorp to provide 6,000 translators in Iraq and up to 1,000 additional U.S. citizens who speak various Arab and Persian dialects to the U.S. Army and other government agencies.

Of course, there is some hair on the story. The linguistics contract was yanked from the Titan division of L-3 Communications ( LLL), which has lodged a protest. And DynCorp may not be able to fulfill the contract requirements, as Baghdad is not exactly a safe work environment: Titan has reportedly lost 216 employees in the war so far.

DynCorp also has quite a bit of debt left over from its private equity days and is dependent on a relatively small number of customers for the bulk of its income. And on the surface, the financials aren't all that hot, as the company earned just $3.9 million on $2.1 billion in sales over the past 12 months, posting a net profit margin of just 0.2%.

Yet if you look past 2007 results that were undercut by cost overruns on two projects and severance payments to a couple of ousted executives, you are now looking at a company with a large backlog that is likely to grow by at least 15% next year with margins of nearly 9%. With another couple of big contracts in the wings and a new CEO gaining the Street's confidence, I believe the business is fundamentally sound and the stock is cheap.

Considering that DynCorp will absolutely continue to benefit from the military outsourcing trend and win contracts that leverage its rock-solid back office, it's not hard to imagine that it will earn as much as $2 a share in 2010. Put a reasonable multiple of 16 times earnings on that, and you've got the prospects of a $32 stock in 24 months, or a double from here.

Armor-Clad Ambulances

Other choices? Sure, there are a few. Among highly speculative microcaps, I find Arotech ( ARTX) intriguing. The company is a leading supplier of armor to the Israeli Defense Forces and sells armored vehicles, including ambulances, for urban warfare around the globe.

As part of a well-rounded offering, Arotech also sells combat driving simulators and specialty zinc-air batteries to keep your electric motor running for a very long time. Among mid-caps, check out ManTech International ( MANT), which provides security services to the military in Iraq and elsewhere, as it has potential to rise to $47 from its current perch around $36 in the next 18 months

Among large-caps, the KBR ( KBR) unit of Halliburton ( HAL) is worth a quick look for its military services arm, though it seems pretty expensive at current levels.

Back in August 2006, I recommended that readers take careful aim at defense stocks when they were under the gun, and my top recommendation, Lockheed Martin, is up about 19% since, to the mid-$90s from around $80. DynCorp should do just as well, if not better.

At the time of publication, Jon Markman owned shares of Lockheed Martin.

Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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