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Confident to the Point of Concern For Harris


Harris' quarterly report was the proverbial home run and its macro tailwinds are no big secret...

Harris Corp's (HRS) quarterly report was the proverbial home run. All the drivers we spotted back in May are kicking at full strength, and the lagging Broadcast division is slowly beginning to turn. For the latter group my sense is that management is intentionally setting the bar artificially. By the time the switch-over to all digital broadcast comes about in February of 2009, chances are this "ugly duckling" segment will have its moment in the sun.

But that's about the only area of HRS' business where you will hear restrain on the part of management. The conference call was an odd dance between sell-siders skeptical of the company's guidance and hyper- confidence, and management raising the stakes on itself at every opportunity, particularly regarding its prospects for the FY ending Jun '09.

So here are the two likely outcomes I see:
  • The company delivers the goods, and with current estimates woefully low, the stock is on its way to an eye-popping ramp; or...
  • The company's talk turns out to be misplaced hubris, and punishment will be swift and brutal.
Consider these basic valuations: if the company simply maintains its high 'teens multiple on FY '09 estimates of about $4, the stock will trade in the mid $70's within the next 6-9 months. That would equal to a 37% move for a company sporting a $7.5 bln market cap. If they keep beating and raising as they are right now, we could easily see the $80's; and if we were in a bull market, I bet we'd be talking "Par" within 2 years.

The macro tailwinds for HRS are no big secret. The process of transforming our military from fire-power heavy, to one networked, agile and capable of surgical strikes continues. Communication and logistics are the key to the transformation, and much like we saw in the explosion of digital content distribution once the broadband pipes came online, the same scenario is playing out in the military, with mobile broadband now available to field troops. Also analogous, you can fully expect that once the first generation of networked warfare technology rolls out, upgrades and improvements will follow in short order (kind of like the argument that YouTube is really cool, but at this point it really needs to be in HD). This kind of dynamic is what makes for major product cycles.

Nor should we expect anything less than enthusiasm on the part of government budget-heads when it comes to spending on relatively low price-tags / immediate impact items, instead of pouring hundreds of billions into arsenals of new weapons, planes, and ships that may not see daylight for many more years

So "what's the risk?" you may ask. For starters, there are always competitive risks. Bear in mind that the government has a vested interest in keeping happy multiple suppliers so that its supply chain doesn't risk running dry and so that prices are kept relatively "honest". Second, HRS is banking on continued meaningful "supplemental" appropriations in 2009, to support its expectations. I suppose HRS' Washington sources are giving them good info of what is the likelihood for such "supplementals", but there are inherent unknowns in a new administration and possibly a drastically different Congress. Third, HRS is discounting an economic slowdown, but not a nasty recession.

Finally, and perhaps most importantly, through observations from past conference calls and through conversations I have had with former HRS' employees, I consistently got the sense that HRS lacked initiative to drive new product lines. Rather, HRS built to specifications received by its customers. This was a "safe" approach because there was little likelihood the products would flop; but at the same time, the market for each product was often limited to the customer requesting it, plus or minus some tangential sales. More recently HRS has been going out of its way to underscore its new innovative spirit. Check out this passage from the conference call:
"Unlike many of our competitors, our business model is not focused on selling single purpose legacy radios developed with US government funding and selling those to a few customers. Quite simply, we believe we are faster to market than our competition with solutions that solve our customers' rapidly changing, mission critical communications requirements. We believe it's all about having a vision for the market, investing our own R&D dollars to develop new products that utilize new technologies and create new capabilities, and then delivering the most advanced communications products in the industry to a highly diverse market and customer base. Harris has led and will continue to lead the ongoing transformation of defense communications across global markets because we are able to deliver the radios of the future to those markets today." [Emphasis added]

In my humble opinion Minyans, this is a game changer for the company, and these kind of drastic variations to the business model do not come without significant risks. If HRS can deliver on this vision, its target markets have just expanded dramatically, and so will the multiple the stock deserves . If on the other hand their products fail to gain traction, HRS can just as quickly find itself beached like a dying whale.

Through these lenses then, it should be no surprise that the company's optimism and confidence are being cautiously discounted by investors and analysts with "show me" attitudes. For my money HRS remains one of my largest long positions, with the caveat that I'll be looking for strong days to back myself into some long dated puts, and buy myself time for this story to play out without losing too much sleep.
Position in HRS
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