This article was originally published on October 14, 2020, but we’re getting a lot of new questions about the “5G Arrow” pitch about this “small company” in recent days, so this is a re-post to answer some of those questions… and the stock teased is now back to roughly where it was when Jovine started teasing the name last Fall. What follows has NOT been updated since October of last year, and the ad still being circulated from Dylan Jovine likewise seems largely unchanged. And just FYI regarding two other companies noted below, Aerojet Rocketdyne agreed to be acquired by Lockheed Martin late last year.
Dylan Jovine is pitching his Behind The Markets newsletter with a teaser ad about a “5G Weapon” — as far as I can tell, he’s the only one using that particular term, or calling it a “5G Arrow,” but let’s look into what he’s teasing, and see if we can ID the company behind it.
This is the basic idea, from the top of the spiel…
“What makes this weapon so powerful is that it has the potential to make all of them worthless….
The weapon… will change warfare – and could literally shift the balance of power from us to China.
“That’s how dangerous it is.
“I’ve never been more certain of anything in almost thirty years as a professional investor.
“So what is this breakthrough that’s going to revolutionize warfare?
“This new 5G Arrow is part of a new class of weapons called Hypersonic Glide Missiles.”
OK, so that gets us back into the realm of things we’ve covered before — hypersonic missiles (and technologies to counter those missiles) have been important priorities for the defense folks for several years now, and some associated stocks have been teased by other newsletters from time to time.
And it also hints at where the “5G” comes from, perhaps — yes, it’s just a marketing term used to associate this idea with the fact that we’re all hearing “5G” trumpeted right and left and it sounds modern and exciting, but it might also be a reference to the fact that “hypersonic” generally means “faster than Mach 5” (that’s closing in on 4,000 miles per hour… if the terms are unfamiliar, Mach 1 to Mach 5 would be “supersonic,” like the Concord or the SR-71 Blackbird, Mach 5+ is “hypersonic” — we probably won’t see hypersonic passenger travel for another 20+ years, but missiles are in testing now around the world).
Most likely, that means the hypersonic glide missiles being tested now by the military — they basically launch on top of a standard rocket into the atmosphere, then have a hypersonic boost glide vehicle on top that can get well into hypersonic speed, sometimes up into the Mach-teens, as it “glides” to the target, and can be repositioned or otherwise mask its trajectory with lateral movement along the way, making defense much more challenging.
So this is obviously a nightmare for those who don’t want to be hit by missiles, and it has already led to a new arms race, with Russia and China also far along in the development of hypersonic weapons, but what is it that Dylan Jovine is hinting at as an investment in this area? Here’s some more from the ad:
“That’s why the New York Times reports that ‘no existing defenses can stop them.’
“A country that has these new weapons will have a real advantage over an enemy that doesn’t.
“That’s why 70 years of Mutually Assured Destruction (M.A.D.) is on the verge of going out the door….
“…and why our entire nuclear missile stockpile will likely be replaced with Hypersonic Missiles in coming years.
‘Gonna Open Up a Massive Market for Defense Industry.’
And Jovine says it’s all four branches of the military who are clamoring to spend on this…
“If Hypersonic Glide Missiles were just going into one branch of the military, the opportunity would be massive.
“General Dynamics investors turned every $1,000 investment into a $115,000 when the Navy started putting their Tomahawk missiles on all their ships.
“But remember, this opportunity is at least four times bigger.Are you getting our free Daily Update
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“It’s not about developing a weapon for one branch of the military. We need them for all four branches.
“As National Security Analyst Amanda Macias recently reported:
“‘What the Pentagon is trying to do now is equip all service branches — The Army, the Navy the Marine Corps and the Air Force — with these weapons.'”
That General Dynamics (GD) reference, by the way, is not specifically about their profits from Tomahawk missiles — it’s a reference to the fact that General Dynamics shares rose by 8,990% from 1990 to 2018. Which is true, though they’ve lost a third of their value since then and GD is (and was) much more than just a missile contractor — I’m sure they made a lot of money selling Tomahawks, but they’re a huge company… they also make the M1 Abrams Tank and Gulfstream business jets, among many other things.
So what’s our exciting new stock here? Let’s get into the specific clues:
“Today, the Pentagon’s “#1 Priority” is building these new 5G Arrows.
“It’s so urgent that they have 38 scientists from this small company working around the clock at Sandia National Laboratories in Albuquerque, New Mexico.”
We’re also told that they have been working with DARPA, which gives the technology some gloss of association… and that they have beat out some big contractors…
“Today’s company has not only won government contracts….
“They beat out Lockheed Martin, Boeing, Raytheon and the other big boys to win the contract to build the new 5G Arrow!”
‘The Smallest Company Won the Contract.’
– Flight Global
“And a remarkable – yet overlooked – company is at the forefront. This company is literally at the center of this revolution….
“… to get in on the action, you want to own the company that’s been hired by the US Government to build them…
“The company at the very forefront of this massive change….
“The company that beat out all the larger companies to win the contract!
“In the last few months, they’ve announced one contract with the Army and another one with the Navy to build these weapons.
“And even if a small part of the $50 billion spent over the next 10 years flows toward this small firm, the growth will be through the roof.”
Jovine says that the “biggest obstacle preventing this stock from returning 9,000% is that it gets acquired by one of the major defense contractors it beat out to win this contract” … so who is it?
Thinkolator sez this is a little firm that I haven’t looked at before called Dynetics… you can see that story from Flight Global here if you’re curious, and they are just getting their manufacturing facility in Huntsville ready to go for this hypersonic glide body contract… and their PR says they’re also involved in some other hypersonic work, with Lockheed Martin and other prime contractors.
But that’s where the story takes a little bit of a turn, investment-wise, because Dynetics is not really a “small defense contractor” that’s surprising the big fellas by winning contracts and might get bought out… its a small defense contractor that has already been taken over by a larger government contractor. Dynetics is owned by Leidos, one of the large public government contracting companies. Leidos used to be known as Science Applications International Corp (SAIC), and has been a major civilian contractor for the US Government for 50 years, but they spun off their technology consulting business as SAIC and renamed themselves Leidos a few years ago as they focused on building their defense, intelligence and health contracting businesses.
So yes, you can buy Dynetics — but only by buying its parent, Leidos (LDOS), which is a pretty big company ($13 billion market cap, $12 billion in revenue)… though, to be fair, it still looks kind of small next to defense giants like Lockheed Martin (LMT, $110 billion), Raytheon (RTX, $91 billion), Northrop Grumman (NOC, $52 billion) and General Dynamics (GD, $41 billion), and it’s true that being the lead contractor on this particular slice of the hypersonic glide missile program will be more meaningful to Dynetics and Leidos than it would to those other four biggies. And consolidation has been a popular sport in aerospace and defense for 100 years, and has heated up significantly in the government contracting business more generally in recent years, so who knows, maybe they will get taken over at some point.
Over the past five years, Leidos has clearly tracked along with the broader aerospace and defense segment, but has outgrown the average stock in that group by quite a bit — partly because of a big deal they made in 2016 to merge part of Lockheed Martin’s non-core IT Services business into Leidos, though for the past couple years they also benefitted just from being “not Boeing” (BA is the largest company in the sector, so it swings the ETF a bit more than most — and all the companies who are meaningfully exposed to commercial aerospace, including Raytheon, Honeywell and HEICO, among others, are also hurting more than their “defense only” compatriots). This is how LDOS has done compared to the Invesco Aerospace & Defense ETF (PPA), just for context:
Dynetics was acquired by Leidos quite recently, the deal closed on January 31 this year (here’s a Motley Fool article about that, if you want an optimistic take), and that has driven a substantial amount of the growth for Leidos’ Defense Solutions business — helping to make up for the fact that their revenues in the health business are way down this year, presumably thanks to COVID shutdowns. The fact that Leidos made the Dynetics deal with cash means that it was instantly accretive to revenue and earnings per share (they bought Dynetics for about $1.65 billion), but it also highlights the relative size. If you’re buying Leidos just for that Dynetics division and the hypersonic project (which is not the largest business even within Dynetics), you might end up owning something quite different than what you’re thinking — that’s roughly one tenth of the company (the enterprise value for Leidos, adding net debt to the market cap, is roughly $17 billion).
That doesn’t mean Leidos is a bad idea — it might work out great, and it is admittedly difficult to envision the government cutting any of its major spending programs in defense or health care over the next couple years — just that it’s not all about the hypersonic missile program. That program is meaningful and could certainly grow into bigger stuff in the future as well, but the total of those hypersonics programs over the three-year contract is about $400 million, so roughly $150 million a year… which, in turn, is less than 1.5% of the annual revenue for Leidos.
So get excited if you like, but don’t forget that context — this is a major government contractor you’d be buying shares of, not a little hypsersonic missile specialist, and it doesn’t “own” the idea of hypersonic travel or hypersonic missiles — or, on the flip side, depend overly much on them for their long-term growth. Leidos is also working on a $3 billion contract to manage the nuclear research facility at Hanford, has been involved with the massive health systems contracts for the military and is the largest third party healthcare IT integrator in the US, and is part of the DoD’s big aircraft logistics and maintenance contract (which could total $25 billion, but to lots of different contractors), and even won a $2.9 billion IT services contract with NASA recently. There are a lot of moving parts here, with most of them in long-term government contracts.
The big picture is pretty impressive, to be fair — Leidos is relatively inexpensive compared to some of the shinier and larger defense contractors who are a little more weapons-focused (LMT, GD, etc.), with a forward PE ratio of about 14 (on adjusted earnings) and analysts expect them to be growing earnings at about 12% a year, with pretty steady margins and a dividend that, while still small (about 1.5%) could grow if they wanted to prioritize that. The actual revenue and earnings will not necessarily be steady and predictable quarter to quarter, since these companies that rely on big government contracts often have lumpy revenue and can move sharply if there’s a big contract win or loss, but from my few minutes looking over the company I’d say they’re in pretty good shape and look rationally valued. I’m actually going to throw them onto my watchlist, I’m not drooling over it at the moment but my first impressions are good, so I’d like to check back in on this one later… hopefully at a time when the market is a bit more panicked.
But it’s not my money we’re talking about here, it’s yours — so you get to make the call. I don’t own any of the defense or “hypersonic” names at this point, but sadly it seems that spending on this stuff is likely to continue to, well, explode higher over time… have a favorite player in the defense or hypersonic space you’d like to share with us, or do you agree with Jovine that Leidos is the most compelling stock to buy? Let us know with a comment below.