Leidos [LDOS] on Tuesday morning said it has agreed to acquire the Security & Detection and automation business units of L3Harris Technologies [LHX] for $1 billion in cash, adding a host of products and capabilities used mainly in aviation security worldwide to complement its legacy suite of solutions for securing ports and borders.
Leidos also said the pending acquisition, which is expected to close before July, will help boost its international business, adding customers in 75 additional countries and increasing its international business by 3 percent to 13 percent of sales overall.
L3Harris’ Security & Detection and MacDonald Humfrey Automation businesses have about $500 million in annual sales, 1,200 employees and more than 20,000 of various systems deployed globally.
“L3Harris’ businesses have been successful in driving revenue outside of the United States, which is a key reason why we’re attracted to them and what we view as a significant opportunity to unlock value for Leidos,” Roger Krone, chairman and CEO of Leidos, said on an analyst call Tuesday morning. In addition to adding new international customers, Leidos will be able to cross-sell its existing portfolio of security products “more broadly internationally,” he added.
The combined suite of Leidos and L3Harris security products are deployed in about 120 countries, representing 60 percent of the world, Krone said. He also said that the new sales channels can be leveraged throughout Leidos.
Krone also said that Leidos has been looking for ways to add products to its business to help balance out the services portion of the company. In late January, Leidos closed on the $1.7 billion acquisition of Dynetics, which has capabilities in rapid prototyping, hypersonic weapons, small glide munitions, directed energy, space solutions, unmanned and counter unmanned aircraft systems, intelligence and electronic warfare, and radar.
Leidos has been public about wanting to be more diverse between services and products and the new acquisition builds on an existing product portfolio, Krone said. Leidos has “been thinking strategically about our security products business for a long time,” he said.
Leidos expects the L3Harris security business to grow in the low to mid-teen percentages over the next three years, driven by global demand to replace aging security and detection products, as well as the company’s plan to wring more service revenue from the installed product base. Airports in Europe are at the front end of an Explosive Detection System (EDS) replacement cycle driven by higher detection standards.
There is also more than half a billion dollars that the U.S. Department of Homeland Security has been appropriated to dramatically increase purchases of non-intrusive inspection (NII) systems to scan more cargo and vehicles entering the U.S. at land ports of entry.
The legacy suite of Leidos security products include the VACIS cargo inspection systems found at ports and borders in the U.S. and a number of other countries. The company also sells radiation portal monitors world wide that are used to scan cargo for the presence of potentially illicit radiological and nuclear materials.
Leidos is also in the aviation security market through its 2010 acquisition of the former Reveal Imaging. That deal provided the company with an EDS based on computed tomography (CT) technology for screening checked bags at small and regional airports worldwide and accounts for 15 percent of Leidos’ $225 million in annual security sales. The reduced size EDS is used where smaller numbers of bags are needed to be screened every hour.
The deal for L3Harris gives Leidos CT-based EDS systems used at medium and large airports worldwide where larger numbers of bags are screened, body scanners used at airport checkpoints worldwide, explosives trace detection systems used by the U.S. Transportation Security Administration and other international customers, automated security lane (ASL) technology that is being used at a number of aviation security checkpoints globally and in the U.S., and even cargo security products, a product line L3Harris hasn’t focused on.
L3Harris is also competing for emerging work with the TSA and airport authorities worldwide to bring CT scanners to aviation security checkpoints.
Combined with the L3Harris’ businesses, Leidos’ estimated 2020 sales for security products and services would be about $725 million, 40 percent from services, 25 percent from checkpoint security products, 20 percent with checked baggage products, 8 percent automation, and 7 percent border security.
Currently, 60 percent of Leidos’ security business is through services versus 30 percent for L3Harris.
Leidos plans to apply its “proprietary” service model to the combined security portfolio “in order to grow a longer tail of service revenue streams for the product lines that we’re acquiring,” James Reagan, the company’s chief financial officer, said on the investor call. He expects this to add growth and be more efficient for the company’s customers.
The security and detection, and automation space abounds with competition. Smiths Detection, which is based in Britain, won the first round of purchases last year with the TSA for checkpoint CT systems, beating L3Harris, Analogic and Integrated Defense & Security Solutions for the work. All these companies are competing for the next tranche of purchases, which will include integration with partial ASL systems. TSA is expected to select at least two vendors for the next round of checkpoint CT systems, but competitors were expecting multiple awards in the first buy. In the end, Smiths’ price was so low the agency went with a single vendor.
Smiths Detection also competes with L3Harris worldwide and in the U.S. to sell medium and large EDS systems to airports and California-based OSI Systems‘ [OSIS] Rapiscan division has had success overseas with a medium-size EDS system that it is also selling for air cargo security.
At least several companies provide ASLs: L3Harris’ United Kingdom-based MacDonald Humfrey, Netherlands-based Vanderlande, and Rapiscan.
Rapiscan also has a sizeable installed based of domestic and international NII systems to scan vehicles and cargo at ports and borders, including with CBP, and Smiths Detection also competes in this space. For ETD technology, Smiths Detection has sold its systems to TSA and Rapiscan also has an installed base of products. For body scanners, TSA is evaluating a system supplied by Germany’s Rohde & Schwarz, which is aiming to compete with L3Harris for TSA and other purchases worldwide.
China’s Nuctech, which has a comprehensive portfolio of security and detection products for airports, ports, borders and critical infrastructures, also sells worldwide.
All these companies, including Astrophysics, have X-ray scanners used at checkpoints to protect buildings, facilities and critical infrastructures.
Following the acquisition of the L3Harris businesses and closely on the heels of the Dynetics deal, Leidos plans to focus capital deployment on paying down its debt over share repurchases, Reagan said. However, the potential for smaller, tuck-in acquisitions remain on the table, he said. There won’t be any deals the size of the L3Harris security business for a while, he added.
Leidos said the acquisition will be immediately accretive to sales, adjusted earnings, and operating margin before interest, taxes, depreciation and amortization (EBITDA). Leidos expects to achieve $20 million in annual cost savings synergies by 2022.
The deal is expected to add about $75 million EBITDA in 2020 and Leidos said it expects to incur a one-time $23 million after-tax expense this year related to the acquisition.
Leidos is using a combination of cash on hand and debt to acquire the L3Harris security businesses.
The L3Harris businesses will report within Leidos’ Civil group.
L3Harris’ financial adviser on the transaction is Evercore and Leidos is being advised by Credit Suisse Securities.