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L-3 Communications Gets TSA Contract

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L-3 Communications Holdings Inc. (LLL) announced that its Security and Detection Systems division has been awarded an indefinite-delivery/indefinite-quantity or ID/IQ contract by the Transportation Security Administration or TSA to supply medium-speed explosives detection systems. The five-year acquisition program has a revenue potential of $549.6 million for L-3.

Under this contract, L-3 will supply TSA with eXaminer 3DX and eXaminer 3DX-ES systems for use in checked bag screening at the nation's airports. More than 640 of these systems are currently in use by TSA.

L-3 Communications Holdings operates through its wholly owned subsidiary, L-3 Communications Corporation. L-3 Communications is a leading supplier of a broad range of products and services used on a number of aerospace and defense platforms. In addition, the company is a prime system contractor for aircraft modernization and maintenance; ISR collection platforms; simulation and training; and government systems support services.

Recently, in July 2012, L-3 Communications completed the spin-off of 100% of a new, independent, publicly traded government services company – Engility Holdings Inc. (EGL) – to L-3 shareholders. We believe that L-3 Communications has ample opportunity for growth and profit expansion after the favorable conclusion to the spin-off of its Government Services businesses. The company has retained its profitable Cyber, Intelligence, and Security Solutions business. The spin-off also removes a lot of uncertainty with respect to revenue and takes away some of the low margin businesses of the company. Over the longer run, we view the company as one of the best-positioned pure defense players based on its non-platform focus, broad diversification of programs and its focus on shareholder value.

L-3 Communications remains a key player within the defense segment and mainly competes with FLIR Systems Inc. (FLIR) and Raytheon Company (RTN). We believe it is one of the best-positioned pure defense plays by virtue of its non-platform focus and a broad diversification of programs.

L-3 Communications is strengthening itself by focusing on improvement of operational efficiencies, investing in research and development to provide affordable solutions, acquiring businesses that will add new capabilities, and expanding product lines and divesting businesses. Moreover, its broad diversification of programs would provide growth momentum. Going forward, we expect future growth to come from the company’s strong presence in the current focus areas of C3ISR equipment; precision-guided weapons; unmanned aerial vehicles (“UAVs”); and other electro-mechanical robotic capabilities.

Over the longer run, however, we maintain our Underperform recommendation on the stock. The stock is currently trading at a discount to both the peer group and the S&P 500 based on forward earnings estimates. The discounted valuation is mainly because of the company’s non-platform focus, resulting in shorter cycle contracts, and its prominent position as sub-contractor/supplier to other defense primes. This also results in contracts expiring faster than its peers, bringing in the need of new ones to replace them. However, with domestic contracts drying up fast, the company’s growth will be influenced by its ability to capture new contracts going forward. In the near term, the company is witnessing lower sales while higher competition has resulted in margin headwinds through re-competitions of existing businesses. Thus, we would advise investors to exit from the company for now until the ongoing macro headwinds abate. L-3 Communications currently retains a Zacks #4 Rank, which translates into a short-term Strong Sell rating.

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