Here's Why L3Harris' Latest Merger Gambit Will Pay Off for Investors

L3Harris Technologies, a defense contractor (LHX -3.62%) is making a bold wager with its $4.7 billion acquisition Aerojet Rocketdyne. (AJRD 1.29%) It will pay up to enter a bidding battle for the rocket maker.

L3Harris says the deal is the latest in a series of M&A deals since 2019, when Aerojet was acquired by Lockheed Martin. Aerojet was seen as a company that needs a partner, after the Lockheed deal collapsed due to regulatory concerns.

Although there are some risks, this deal is solid for L3Harris. It can also be a significant step in the company’s bid to become one of the top defense contractors in the country. This is what L3Harris investors should know about the latest move.

Short-term pain...

Aerojet's 2024 earnings before interest taxes, depreciation and amortization (EBITDA) are 12 times the value of the deal. L3Harris was reportedly in competition with General Electric and other companies for the prize, which led to the higher price. L3Harris may find it a poor time to buy the prize, especially since Viasat announced a $2 billion acquisition.

L3Harris investors would prefer that the company be allowed to dealmaking in order to avoid cash drains and management distractions. However, a buyer cannot control when an auction is held.

L3Harris as a result of a recent transaction should be able use the merger integration skills that it used to make this transaction work well to get these transactions done. The cash drain is not to be avoided.

L3Harris will likely slow down or stop all share repurchases in the near future. It will be focusing on these deals and not taking on any debt. Cowen analysts believe the deal has an opportunity cost of $0.50 per share in lost purchasebacks over a period of two years.

Wall Street wasn't impressed by the deal. At least three analysts downgraded L3Harris' stock from "buy" due to the short-term overhang. L3Harris shares fell as high as 4% after the announcement of the deal on December 19. ... long-term gains

This deal is great for anyone who can look beyond the immediate cost.

Aerojet is an exceptional asset. It is one of two American rocket engine manufacturers and also owns key intellectual property and manufacturing capabilities. Orbital ATK, owned by Northrop Grumman, is the other rocket maker. Prime contractors such as Boeing complain that it has been difficult for Orbital to source components at competitive prices since Northrop acquired Orbital. These same concerns prompted the government to contest Lockheed's proposal to acquire Aerojet.

L3Harris does not compete directly with Lockheed Martin, Boeing, Raytheon Technologies, or Lockheed Martin. However, it has the potential to establish a relationship as a preferred source for rocket engines with these primes. This deal will strengthen L3Harris already strong relationship to Lockheed Martin. Chris Kubasik, L3Harris CEO, is the former president of Lockheed and chief operating officer. L3Harris has been a key supplier for the F-35 program.

The Pentagon has an urgent need to replenish its ammunition in Ukraine. This will likely lead to an increase in rocket engine production. Cowen predicts that the Department of Defense's spending on major weapons programs will more then double between fiscal 2022-2027. L3Harris stated that the deal would increase the company's backlog by between 30% and $30 billion.

L3Harris will never be able to compete with Lockheed, Raytheon and Northrop at program level. However, the company has been working hard to move beyond being a component supplier to prime contracting. L3Harris, which provides sensors and other add-ons to the space sector, is already a major contractor. Aerojet would allow L3Harris new opportunities to interact with the Pentagon directly as a prime contractor in key areas such as missile defense and space exploration. It's worth waiting for the end result.

L3Harris would have preferred Aerojet Rocketdyne had it not been on the market in this year's market. This would have given the company more time to process the M&A and reload its balance sheet before it does another deal. The company's integrations will be slow and uncertain in the short term.

L3Harris has teamed up with Aerojet to create a unique portfolio of national security and defense assets that will serve markets with huge growth tailwinds. In fiscal 2023, the Department of Defense requested more than $40 Billion for missile and missile defense. NASA's budget request has increased by 8% over last year. Aerojet had also received approval for more than $10 million in foreign military sales in 2022, which expands L3Harris' international reach.

Investors who buy in today will be able to own the premier franchise at a near 52-week low and receive a dividend yield of over 2% while they wait for any integration twists. It's a great time for L3Harris investors who are able to see past the short-term headwinds.