Harris Corp. [HRS] on Friday said it has agreed to acquire defense and government contractor Exelis Inc. [XLS] in a $4.8 billion cash and stock deal that provides the communications and information technology company with more competitive scale and significantly expands its contracting work for the federal government.
The transaction, the largest every by Harris, must still be approved by Exelis’ shareholders and federal regulators, and is expected to close in June. Once complete, Harris will have about $8.2 billion in annual sales.
“With the acquisition of Exelis we’re increasing our scale, broadening our technology base, and expanding our customer set in markets where we have decades of successful performance,” William Brown, chairman, president and CEO of Harris, said on an investor call to discuss the acquisition and the company’s second quarter financial results. He added later in the call that the combination will also provide Harris with more balanced earnings.
Currently almost 60 percent of Harris’ roughly $5 billion in annual sales comes from international and commercial, and civil, state and local government customers, with the rest, just over 40 percent, from the Defense Department and intelligence community. Combined with Exelis, the DoD and intelligence community will make up 50 percent of the company, expansion occurring in work for the Air Force, Navy and Marines, Army and elsewhere, according to briefing slides Harris presented.
Harris said that Exelis will strengthen its four core franchises:
- In Space and Intelligence, Brown said that Harris will have about $1 billion in annual classified sales, with “significant growth potential,” adding that combining Exelis’ electro-optical and Harris’ radio frequency capabilities “we’ll be able to offer responsive, multi-mission solutions to the intelligence community.”
- In Air Traffic Management, he said Harris brings its communications programs and Exelis surveillance systems, with Harris having four key Federal Aviation NextGen air transportation programs.
- For Weather Systems Harris’ ground processing capabilities will be linked closely with Exelis’ satellite sensors, lowering costs, increasing performance, and improving time to market for new systems for customers. Brown said that Harris will be able to “accelerate its push into value added services and predictive analytics,” areas both companies have been working on.
- And for Tactical Communications, Brown said the deal will drive scale and efficiencies across supply chain and manufacturing operations.
Brown also highlighted other potential growth opportunities for Harris following the transaction, including leveraging complementary international channels and pairing Exelis’ night-vision products with its radios systems for international customers.
Brown doesn’t expect regulators to raise anti-trust concerns over the acquisition. Byron Callan, an aerospace and defense analyst with Capital Alpha Partners, said in a client note that he doesn’t expect the government to require any meaningful divestitures to seal the deal.
The pending acquisition is the second $5 billion deal announced in the aerospace and defense industry in the past year with the merger of the defense and space businesses of ATK [ATK] and Orbital Sciences [ORB] scheduled to close on Monday.
Callan said both deals strengthen the middle weight players in the defense industry.
“The combination represent the re-emergency of a stronger mid-tier defense sector and may entail more competition for primes in some defense segments,” Callan wrote.
Once the deal closes, Harris shareholders will own 15 percent of the company and Exelis shareholders the rest. Harris said it expects the deal to be slightly accretive to earnings in its fiscal year 2016 results and a more significant contributor thereafter, aided by annual savings of between $100 million to $120 million beginning in the third year following closure.
Harris will be saddled with Exelis’ $1.9 billion unfunded pension liability but Brown said this has been factored into its go-forward plans, adding that funding requirements are well understood.
Brown will be the CEO of Harris after the deal but the company didn’t say how the rest of its senior management ranks will be filled other than that executives from both companies will be part of the leadership.
The financial advisers on the deal were Morgan Stanley for Harris and J.P. Morgan for Exelis.
In its second quarter, Harris’ sales were flat at $1.2 billion with international business up 5 percent, accounting for 31 percent of the total. Income from continuing operations was $140 million, up 2 percent from a year ago, while per share earnings were $1.32. Free cash flow was $104 million.
For the year Harris still expects sales of $5 billion while per share earning are now expected to be between $4.95 and $5.05, up 20 cents on the low end of the range and a nickel on the high end versus previous guidance. The earnings guidance increased on the retroactive reinstatement of the federal research and development tax credit for 2014 and other favorable tax items.