3 Aerospace and Defense Stocks That Are Buyout Bait

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InvestorPlace
As the world economy continues its rebound, corporate executives are getting more confident.  The result has been an uptick in mergers & acquisitions.  After all, many large companies have huge amounts of cash and are trying to find ways to boost their top-lines. One sector that looks poised for much more dealmaking is the aerospace and defense industry.  Of course, thanks to strong defense spending there is a variety of cash-rich operators like General Dynamics (NYSE: GD ), Lockheed Martin (NYSE: LMT ), Northrop Grumman (NYSE: NOC ) and Raytheon (NYSE: RTN ). At the same time, the industry is facing some powerful trends that should lead to increased consolidation.  First of all, the major defense firms are experiencing lower backlogs of orders as well as more project cancellations.  This is likely to persist for five to ten years as the U.S. defense spending tightens. Keep in mind that the new Secretary of Defense is likely to be Leon Panetta.  He is a well-known budget hawk and was even the chief of the Office of Management and Budget during the Clinton years, when the US produced budget surpluses. Next, there will probably be force drawdowns in Iraq and Afghanistan over the next couple years.  The fact is that America is war-weary.  If anything, the killing of Osama bin Laden is likely to be a factor that will accelerate the process. To fight these trends, it will be temping for the major defense firms to acquire smaller companies.  These should provide access to growth markets and new technologies. So what are some of the potential buyout targets?  Here's a look a three candidates: AeroVironment (NASDAQ: AVAV ):  Roughly 85% of the company's revenue comes from advanced unmanned aircraft systems — known as “drones.”  As seen in the wars in Libya, Iraq and Afghanistan, these are becoming a critical part of the U.S. arsenal. No doubt, the drone business has been a big growth driver AeroVironment, which has a 40-year history of innovation.  From 2004 to 2010, revenue surged from $48 million to $250 million.  The operating margins are currently 19% — and are likely to increase over time. AeroVironment also develops charging systems for electric vehicle batteries.  This business has substantial long-term growth potential as well. However, if AeroVironment does sell to a major defense firm, the battery business is likely to be unloaded.  But in light of its traction – with Nissan as a customer – it could fetch a premium valuation. Alliant Techsystems (NYSE: ATK ):  The company has two main businesses.  One is for solid rocket propulsion systems.  Unfortunately, in light of the budget issues at NASA, this business is likely to diminish over time. But Alliant's other business, military ammunition, is a gem.  The focus is on affordable offerings, which have high-end capabilities.  It's the kind of thing that is likely to remain attractive to the Pentagon. Alliant has several ammunition plants.  For example, its Missouri facility has the capacity to produce 1.4 billion rounds of small-caliber ammunition per year. All in all, Alliant is trading a cheap valuation, in light of its assets and cash flows.  The stock is at only 5.6 times EBITDA.  And going forward, the company forecasts that free cash flow will be between $225 million to $250 million in 2011. FLIR Systems (NASDAQ: FLIR ):  Since the late 1970s, the company has been at the cutting-edge of infrared technologies.  Of course, they are crucial for the modern battlefield, such as with night vision.  But FLIR also has a strong footprint in other sectors, such as law enforcement, homeland security and border patrol. In fact, FLIR has made a variety of breakthroughs that should lead to large market opportunities.  These include innovations like gas detection, food inspection, predictive maintenance and building monitoring. FLIR has demonstrated a strong long-term track record of growth.  Over the past ten years, the average annual growth rate of revenue was 23%.  Yes, it's the kind of performance that would attract any large defense firm. Hilary Kramer is the editor of the GameChangers and Breakout Stocks Under $5 stock picking newsletters. As of this writing, she held no position in any of the stocks named here.