Michael Robinson’s teased “‘Politics Proof’ Defense-Tech Play”

Sniffing out the bargain-priced stock teased by Radical Technology Profits, also pitched as a "next generation of drones" play.

By Travis Johnson, Stock Gumshoe, November 13, 2012

Michael Robinson is teasing us with a stock that he thinks will benefit from defense technology spending … and that is at a bargain price.

And it sounds a little bit familiar, actually, like it might be a stock he mentioned a few years ago when he was flogging a different newsletter …

… but let’s sniff around and see if we can name the stock for you so we can be sure.

Here’s a bit of the pitch:

“I have found what I believe is today’s best ‘politics proof’ defense-tech play….

“I just told subscribers to my high-tech trading service Radical Technology Profits to buy this small-cap leader today – while it’s still selling at bargain-basement prices. And I want to offer you the same opportunity….

“I look at this as a way to turn the tables on Washington…

“Here’s the thing. In the post-Iraq era, the Pentagon has become home to a bunch of penny pinchers. But for my recommendation, that’s turned out to be a very good thing.

“Even in the face of wholesale Defense Department budget cuts, the Pentagon is unlikely to cancel the type of contracts that this company has on its books. Two reasons:

“This is equipment the Pentagon badly needs, including complex gear for satellite communications, spy drones, electronic warfare, surveillance systems, cyber security, jammers that blind the enemy’s radar, and ballistic missile defense, and other products that are “designed-in” to the nation’s key defense platforms; and

“Thanks to fees written into the contracts, it would actually cost the DoD more money to cancel the awards than to just stay the course. Indeed, that’s exactly what the CEO – who I interviewed last week – was counting on that when it decided to revamp three years ago.”

Robinson says that this emans the company is sitting on “hidden profits” … and that this firm has done well by identifying a niche where they can ramp up revenues even under that “penny pinching” Pentagon. Here’s a bit more:

“… back in 2009, the CEO saw that a big spending shift would occur. And he took bold action….

… it’s still a high-tech concern, but it’s focused on legacy systems… older weapons platforms the DoD intends to keep in its arsenal and upgrade along the way.

“Actually, this is the second time the CEO has changed the firm’s focus. When he joined the company back in 2003, it was a struggling supplier of Web infrastructure services. It was a ‘dot bomb’ victim that had zero defense sales.”

And a few more clues from the brief (thankfully) teaser ad:

“Just look at the numbers. The firm has a market cap of only about $250 million. But it has a pipeline of funded orders worth four times as much. We’re talking a backlog of contracts with various DOD agencies valued at over $1.1 billion – with pending bids for another $4 billion worth.”

He thinks they’ll get pretty much all that contract money — and that things are looking up because their bid “pipeline” has gone up from $4 billion to $5 billion.

Oh, and the stock sells for under $5. So who is it?

Well, those clues do all point us in the direction of that “sounded familiar” name — and indeed, the Thinkolator says that this must be … Kratos Defense and Security Solutions (KTOS).

Robinson first pitched KTOS back in the Fall of 2009, when he was working for a different arm of the Agora megaplex and teased Kratos as a way to lure subscribers for his American Wealth Underground newsletter, which at the time was still called BreakAway Investor (Don’t worry, there won’t be a test — no one can keep all these newsletters and publishers straight). Now he’s toiling for Money Map Press and putting out his Radical Technology Profits newsletter. At the time, the stock did do pretty well for a few months (and, frankly, gut a huge bump almost immediately from his ad campaign) — it was in recovery mode at that time, doing a 1:10 reverse stock split and trying to build through acquisitions in the defense contracting business.

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Over the next two years, the stock moved up and down from roughly $10-14 until mid-2011, when the stock went into almost free-fall down to the $5-6 range by the end of the year and stayed there, with some bounciness, up until now. They released earnings last week, and that bumped the shares down still further so they’re right around the all-time lows at about $4.30.

When Robinson first teased this stock it was a $100 million company — since then, it has grown revenues very nicely — almost tripling revenues from 2009 to 2012, as a matter of fact, so it makes sense that this is now a $250 million company. But the catch is that they’ve also sold gigantic busloads of new stock over those years, largely to fund acquisitions so that they could grow in new priority areas even as their core services business contracted. So there’s also … three times as much stock. Roughly. So that’s how a company can grow pretty well on the top line but still see its stock price fall hard, “per share” numbers matter a lot.

And it doesn’t help, of course, that they’re unprofitable. Kratos has a good story behind it, and I have some interest in it for that reason — but it also had a good story behind it three years ago, and they’ve only had one profitable year in the last five years (that was 2010, the year when their stock price was pretty buoyant).

The story is that they’re diversifying into single-source contracts by acquiring specialized companies, including their recent acquisition of CEI, a company that makes drone targets (aircraft that are meant to mimic aerial threats, presumably used for training, though it sounds like they’re getting into other drones as well). Kratos already had some electronic equipment in the CEI airframes, so presumably they knew the business and think it will grow well, and without a lot of competition. That was a $150 million-ish acquisition, so that’s a big part of the reason why KTOS’ share count almost doubled this year.

They are now reporting “pro forma” positive earnings, including 18 cents this past quarter, partly because they have big tax-loss carryforward benefits — partly from the acquisition of CEI, but they’ve been losing money for a while so I guess they’ve got plenty of tax losses to use. But there’s also a huge level of uncertainty with this company about what 2013 will bring, particularly for the next couple quarters — their “critical infrastructure security” division, which has about a third of its work in Metro NYC securing ports, railroads, subways, etc, now has a big chunk of work that’s apparently “on hold” as they wait until Hurricane Sandy recovery gets further along; and since the Department of Defense budget is pretty much completely unknown at this point, they can’t provide 2013 guidance. They may well have planned for and executed contracts that require them to be paid regardless of whether programs continue or get cut, but that doesn’t necessarily mean they’ll book the revenue they had hoped for in the first couple quarters of 2013, there is a lot of uncertainty out there.

Analysts, for what it’s worth (they’re guessing too, at this point — and they’ve frankly been quite terrible at guessing Kratos’ numbers in recent quarters), think that KTOS will earn 27 cents next year, so that’s a forward PE of 16, and those same analysts expect KTOS to grow earnings by 35% or so annually for the next five years. The range of guesses, though, indicates just how hard it is to forecast this stock — even in a regular year, but especially with the defense budget uncertainty and their ongoing acquisition-driven transformation for 2013 … the low analysts is guessing they’ll earn three cents next year, the high guess is 54 cents.

So … most of their revenue is guaranteed under long-term contract, but there is heavy uncertainty as well, particularly for new stuff and some big-ticket items — largely driven by the federal budget, with continuing resolutions and sequestration not providing the Department of Defense flexibility to do new procurement, so they have had a big program or two delayed just because it can’t be procured yet, and some business that appears to be of a generally recurring nature is also up in the air until there are budgets to work with. You can look at that as an opportunity, with new business to be gained, or you can look at it as delays to revenue that investors had been expecting to see hit the company’s books this quarter or next, I guess it depends on whether you’re an optimist or a pessimist. Likewise you can look at Hurricane Sandy as a three month delay to their revenue generation from infrastructure security work, or as an opportunity to make more sales as some of the existing security infrastructure (cameras, scanning systems, monitoring, etc.) will have to be replaced after the flooding.

In the end, though, it really comes down to whether or not they can effectively execute on this revised strategy to specialize in niche products for the military and security industries, and turn that into profitable revenue. The income statements are confusing and they still carry a lot of debt at $650 million — it’s not mature until 2017, but at a 10% coupon that’s about $65 million in interest payments they have to make each year, I don’t know what their debt covenants are but they would have to almost double their operating income to make it possible to post a profit once they cover that level of interest payment. They are generating free cash flow, thanks to depreciation and tax benefits, so there is the potential that they can turn their revenue growth into profits and maybe even profit growth in the next year or so.

It’s really hard to guess where a company like this, with revenue growth but no per-share growth in anything, becomes a value — right now it trades at far less than book value, but that’s because they’ve been acquiring companies like mad so their balance sheet is awash in goodwill. And they trade at low price/sales multiple, too, but that’s because they haven’t been able to turn sales into profits yet. So if you’re curious about this one, start with the latest earnings release and conference call transcript and start sniffing around … then let us know what you think. Will this serial acquirer make another run on this strategic transformation and become profitable for at least long enough to give the stock a boost, or even transform into a consistently profitable niche defense contractor? Or are they just growing revenue for the sake of growth, leaving investors to again be disappointed with the lack of profits?

I’m feeling pretty cautious, partly because I don’t like to see that long-term record of unprofitability in what I think should be a pretty high margin business … but I really don’t know, and times of large-scale jostling as we’re seeing now for the defense budget can certainly sometimes drive companies so low that they end up being obvious bargins in retrospect … I’m sure there are finer minds than mine at work on this, so if you’ve got an opinion please feel free to share your thoughts with a comment below.

P.S. That little sidebar box up above (it’s beige right now, that might change) is something new we’re trying out — it’s to give the Irregulars, our paying members, a bit of a quicker summary of what the teaser pick is and some of the key issues, and, when I have one, a bit more of my opinion, you’ll have to be logged in to see the info. Let me know if you find it worthwhile, this is to help the folks who just want to know the stock and don’t want to slog through my commentary (and, of course, to provide a wee bit of something extra special for those of you who are paid members, without shortchanging the free stuff we’re publishing for the world to see). If we stick with this for future articles I’m sure I’ll tinker some with how it looks and what that box contains. You can contact us or comment below if you have any feedback on that, thank you!


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