The Case for the Defence.
Written by Julian Wheeler – Partner and US Equity Specialist
Currently, it is impossible not to include the conflict in Iran in any investment conversation; yet attempting to call its duration and outcome is a gamble akin to putting money on a long shot at Cheltenham. So instead, I am going to concentrate on what is likely to happen after its conclusion, no matter what the short- or long-term result may be, nor how long it takes to reach that point.
At around $65b in market cap, L3 Harris (LHX) is the smallest of the large US defence sector companies known as the ‘defence primes’. However, thanks to a shrewd acquisition made three years ago, it has placed itself at the centre of everything to do with “missiles”, be they used for interception, attack or defence. The names of some of the different weapons (‘Cruise’ ‘Patriot’ ‘THAAD’ ‘SM-3’) may be familiar to some, but less well known is the fact that they all contain a similar solid rocket motor and that more of those are produced by LHX than any other company. Irrespective of whether the Iran conflict lasts another week, month or year, America is going to urgently need to replenish its much-depleted stockpiles of projectile weapons.
But how can I have such confidence that LHX will get more than their fair share of the purchase orders? Well, last summer I suggested, to anyone prepared to listen, that buying Intel was a good idea, because the US Government had just acquired 10% of the shares. My reasoning was simple: no matter if they were lagging rivals currently, the tide was likely to flow in their direction going forward. Intel stock doubled in a matter of months.
And now Uncle Sam has come knocking once again, cheque book in hand, this time on the door of LHX. While this investment is not on the same scale as, nor is L3 Harris struggling like, the venerable Semiconductor company, in January they nevertheless accepted $1bn from the Department of War. The structure of the investment is reminiscent of a venture capitalist, giving them some control over future decisions and the use of proceeds. The DoW was very specific in their requirements in return for this cash injection. They demanded that LHX should spin out this ‘missile solutions’ division into a separate company through an IPO to happen later this year, thus ensuring that the funds from the taxpayer are spent entirely on increasing the production of these rockets. It is not a stretch to conclude that the Pentagon would then agree to buy them and that some juicy orders might be forthcoming around the time of that IPO!
Furthermore, while assessing the production line of these missiles, it was also noted that there is at present only one company that supplies the special fuel that is needed to launch these missiles from a ship or fighter. Buying this from a monopolist has naturally come at a high cost for LHX up to now. But help is at hand; contained within this year’s Defence Production Act is a stipulation to create a second source of fuel, which is slated to be Northrop Grumman. They should be happy enough to oblige, given they are also a buyer of this fuel in their role as second supplier on the rocket motor programme.
But notably, Northrop Grumman refused the Government’s money, offered in the same way as to LHX, saying they were larger and had the wherewithal to increase production by themselves. I wonder who will get the lion’s share of future orders? Actually – I don’t.
Meanwhile, in other news, a very different type of defence is being conducted by Google and Meta Platforms (the parent of Facebook and Instagram). They are facing accusations that they “addict the brains of children” (in the words of the Prosecution’s closing arguments) by the cunning use of techniques such as ‘infinite scrolling’ and ‘autoplay videos’. Some countries have already passed their own judgement on this matter and simply banned social media for the under 16s, but in the USA both companies have been on trial for the last 6 weeks. The other smaller fry in this industry, such as Snap and Pinterest, were given (and took) the offer to settle this case in advance. As I write the jury is out making its deliberations. While not attempting to predict the outcome in any way, if they were to return a ‘Guilty’ verdict to the charge of “clinical addiction” then would it not put these two social media giants in a remarkably similar position to the tobacco companies of last century?
Defence: the very word means action taken in a strategy of protection against harm or attack. I have covered military and legal, but perhaps we should add the portfolio in there as well.
For more background on our U.S. market views, visit the Over the Pond archive.
Contact Us
For further information on any of our services, or if you would like to arrange a meeting with an investment manager to see how we can work with you, please get in touch.
Important information
Shard Capital Partners LLP is a limited liability partnership, registered in England with registration number OC360394. Shard Capital Partners LLP Registered office: Floor 3, 36-38 Cornhill, London, EC3V 3NG. Shard Capital Partners LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom, reference number 538762.
Disclaimer:
We try to ensure that the information provided is correct, but we do not give any express or implied warranty as to its accuracy. We do not accept any liability for errors or omissions. The content of this brochure is for guidance purposes only and does not constitute financial or professional advice.
This document is provided for information purposes only and is intend for confidential and sole use by the recipient. It is not to be reproduced, copied or made available to others. The information set out in this document does not constitute investment advice or a personal recommendation. The views expressed in this document are not intended as an offer or a solicitation, to purchase or sell any security or other financial instrument, credit or lending product or to engage in any investment activity.
Past performance is not a guide to future performance. It is important that you understand that with investments, your capital is at risk. The value of investments, as well as the income derived from them, can go down as well as up and investors may get back less than the original amount invested. It is your responsibility to ensure that you make an informed decision about whether to invest with us, based on your particular objectives. If you are still unsure if investing is right for you, please seek independent advice.
The information and opinions expressed within this document are the views of (the company) and are based on information we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information provided is given in good faith but is subject to change without notice.
No liability is accepted whatsoever by (the company) or its employees and associated companies for any direct or consequential loss arising from this document.