ITT Corp. (NYSE: ITT) Agreed to Acquire
EDO Corp. (NYSE: EDO)
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involving government services
contractors. The analysis is written by
Stuart McCutchan, president and CEO of
InfoBase Publishers, Inc. on-line publisher
of the market-leading Defense/Aerospace
Competitive Intelligence Service (DACIS).
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New York, N.Y.-based EDO Corp. designs and
manufactures a diverse range of products for
aerospace and defense, intelligence, and
commercial markets. Major product groups
include: defense electronics, communications,
aircraft armament systems, undersea warfare,
integrated composite structures, and
professional and engineering services. EDO
designs and develops advanced systems that
are at the center of the military's
transformation to lighter, faster, and
smarter defense capabilities. EDO has grown
revenues at a compound annual growth rate of
almost 16 percent over the last three years,
and is positioned to grow at approximately 60
percent in 2007 to its current-year forecast
of approximately $1.15 billion.
ITT chairman, president and CEO Steve
Loranger stated: "This combination is all
about growth and demonstrates our disciplined
approach to creating value for our
shareholders by expanding from our strong
core businesses and entering attractive
adjacent markets. ITT's continued strong
overall performance this year gives us the
capability to make this key acquisition,
which will be a powerful addition to our
existing business. EDO's extremely talented
people, complementary technologies, and
customer relationships, when joined with
ITT's strong defense team, will enable us to
reach new heights in meeting the changing
needs of our military and civil customers."
EDO CEO James M. Smith stated: "We believe
this is an excellent strategic fit and offers
shareholders tremendous value. It
substantially increases our business scale
and opens new opportunities in defense
markets. We expect employees and customers to
benefit substantially from the combination of
our technology-driven businesses."
EDO's attractive positions in defense
electronics add to ITT's well-established
sensing and surveillance capabilities. In
tactical communications, ITT's leading
position in battlefield communications is
complemented by EDO's expertise in mobile
networking and integration, interference
cancellation and antennas. Both companies
offer engineering and professional services
to a diverse customer base, serving all
branches of the military and civil agencies.
ITT defense president Steve Gaffney stated:
"We're bringing together two successful
defense organizations into one team with one
mission: To meet the needs of our customers
in support of our nation and its allies. We
are confident in our plan to integrate our
businesses and unlock tremendous value,
creating opportunity for employees, customers
and shareholders."
The combination capitalizes on ITT's and
EDO's mutual strengths. By leveraging the
diversified portfolios of both companies, the
transaction positions ITT to play an
important role on some of the U.S. military's
vital transformational initiatives, such as
the Joint Strike Fighter, the Navy's Littoral
Combat Ship, counter improvised explosive
device (IED) programs, and the Coast Guard
Deepwater programs.
Gaffney added: "This transaction combines
ITT's and EDO's technology prowess, customer
relationships, and proven operational
capabilities to scale mission-critical
military programs and create new markets for
our technologies."
On September 17, 2007 ITT Corp. and EDO Corp.
announced they had reached a definitive
agreement for ITT to purchase all outstanding
shares of EDO for $56 per share in cash, or
approximately $1.4 billion. Including
approximately $120 million of net debt and
the anticipated conversion of convertible
notes, this transaction values EDO at $1.7
billion. The transaction is expected to be
neutral to ITT's earnings per share in 2008,
and accretive thereafter.
The transaction, which is subject to approval
by EDO's shareholders, as well as customary
closing and regulatory conditions, is
expected to close in early 2008.
EDO Corp. had revenues of $715 million in
2006. At the time of the acquisition, EDO had
approximately 4,000 employees.
In connection with the transaction, Lazard
LLC and UBS Investment Bank are acting as
financial advisors to ITT, and Simpson
Thacher & Bartlett LLP is legal counsel.
Citigroup is acting as financial advisor, and
Debevoise & Plimpton LLP is legal counsel to EDO.
Sometimes a deal seems to carry a meaning out
of proportion to its size, simply because of
the time at which it comes.
With ITT's acquisition of EDO, we have a deal
which follows a sudden summer drought brought
on by disarray in the private equity
community… and a deal which flies in
the face of a prospective wind-down of the
U.S. role in Iraq. Good buying weather? Not
hardly.
This acquisition serves as a reminder that
there still are forces which are reshaping
the defense industry, that there still are
enough industry buyers to keep the game
interesting, and there still is a compelling
national interest where Iraq is concerned.
So yes, this deal punches above its weight
— but at $1.7 billion, it hardly needs
to. Among pure defense plays only one other
deal (the sale of Armor Holdings to BAE
Systems) ranks larger for the year. Like the
Armor Holdings deal, this deal is driven to a
large extent by the Iraq war (of which more
below). And it serves as notice that
consolidation in the defense electronics
sector is not yet over, especially where
mid-tier suppliers like Curtiss-Wright, DRS
Technologies, Harris, ITT, Rockwell Collins,
and L-3 Communications are concerned. With
dealmaking for the year now running at more
than $40 billion (a threshold reached,
appropriately enough, with this transaction)
it's evident that the industry's
consolidation remains in high gear.
What ITT Is Getting?
ITT might have acquired EDO even if the Iraq
war wasn't taking place — but it's much
less likely. Without the war there would have
been no need to counter Improvised Explosive
Devices (IEDs), and without that need there
would have been no requirement to fit up to
1,100 U.S. military vehicles with JCREW 2.1
Radio-Controlled Improvised Explosive Device
(RCIED) Electronic Warfare (CREW) systems.
Earlier this year EDO was selected as the
sole producer of JCREW 2.1 systems — a
win which was doubly welcome since it came
after the company nearly was shut out of this
important business area, before instituting
technological changes which locked in its
predominance for years to come. And so it is
that sales of electronic force protection
products, which accounted for 22 percent of
sales in 2005 but slipped to just four
percent of sales in 2006, are primed for a
rebound in 2007 (these sales are a leading
contributor to the 60 percent surge in sales
which EDO expects for the year).
Interestingly, the JCREW 2.1 program comes
under the cognizance of the U.S. Navy (NAVSEA
specifically), to which it was recently
transferred from the Army
Communications-Electronics Life Cycle
Management Command (C-E LCMC) (Ft. Monmouth,
NJ). Also interestingly, the U.S. Navy has
been the service with which ITT has been the
most laggard as a contractor — during
FY06 ITT ranked 9th among Army contractors,
16th among Air Force contractors, and 27th
among Navy contractors. But when you add in
33rd-ranked Navy contractor EDO, ITT moves up
the rankings to 19th — and as the JCREW
2.1 program comes online, that ranking is
bound to climb higher. Perceptions of ITT as
an Army contractor may die hard, but deals
like this one point to a new reality: in
terms of its customer base, ITT is emerging
as a broadly-balanced firm.
EDO's Navy business points to another new
trend as well: a shift away from hardware and
towards services. In saying this, we realize
that perceptions of EDO as a hardware
provider are both long-standing and
well-deserved. But EDO's Professional and
Engineering Services business, built with
three acquisitions over a six-year period,
has opened some new doors for the company
— and nearly all those doors open to
the Navy. While the company is certainly
still a provider of equipment as varied as
minesweeping equipment and aircraft bomb
racks, the initiative to diversify beyond
hardware means that services accounted for 38
percent of the company's $159 million in
prime contract awards with the Navy in
FY2006. We note that EDO's Professional and
Engineering Services business stands to
receive 15 percent of the JCREW 2.1 program
as well — a percentage which is likely
to be of serious interest to ITT's Advanced
Engineering & Sciences Div. in Annapolis,
Md., which has a business of its own
supporting current-generation CREW systems.
How EDO Changes the Game for ITT
ITT had revenues of $7.8 billion in 2006 and
is projected $8.6 billion for 2007. EDO had
revenues of $715 million in 2006 and is
guiding for $1.05-$1.1 billion in 2007. So we
calculate that EDO will expand ITT's top line
by 12.5 percent for the current year.
The effect on ITT's defense business will be
more pronounced. ITT's Defense segment
accounted for 46.8 percent of its revenues in
2006. Add just over a billion dollars from
EDO, and you've got a defense business which
will top $5 billion in size for the first
time ever.
There's much to admire in the fit between the
companies. We've already discussed aspects of
the synergies in the Navy contracting arena.
But at the heart of the business is the fit
between ITT's battlefield communications
business and EDO's jammers business
(including JCREW 2.1). Viewed simply as
vehicle installations, the two have much in
common, both in terms of provisioning and
support. What's less clear is the outlook for
anti-IED technology beyond the 2009 year
(which is the first year ITT expects this
very-fully-valued acquisition to begin paying
off). Will President Bush's plans to bring
home up to 30,000 troops by mid-2008 begin a
long inexorable drawdown in demand for JCREW
systems? Or will the Pentagon's tendency to
prepare its forces to fight the previous war
sustain demand for the system even in peacetime?
What's Next?
Typically an out-of-the-blue deal like this
would tend to trigger a spike in the value of
companies similar to the company being
acquired. But on the day the deal was
announced the shares of all of EDO's
competitors declined — as did the
shares of ITT itself — while EDO
shareholders realized a comparatively modest
"pop" of about $3.50 (or 6.7 percent). But
EDO shareholders could be forgiven for
viewing that premium as anticlimactic after
seeing their shares increase 150 percent over
the past year. And therein lies the rub: when
companies are fully valued, paying a
significant premium requires a leap of faith
which not too many are willing to pay.
So we don't expect this deal to inspire many
others, but we do see continuing interest in
the technologies (body armor, vehicle armor,
detection systems, robotics, and counter-IED
work) which have risen to prominence in this
counterinsurgency effort. Investors (and
companies) may have some white-knuckle
moments in front of them, but we think that
time will bear out the wisdom of these
investments. For the past half-century the
United States has been using technology as a
force multiplier. Enemy efforts to negate
that advantage will necessarily be
short-lived. There will always be a high-tech
way to fight a low-tech war.
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