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06 March 2014

Harris Seeks to Maintain Leadership in Global Defense Communications Markets

Philip Finnegan, Director, Corporate Analysis

 Harris Seeks to Maintain Leadership in Global Defense Communications Markets
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Strategy
Harris is seeking to maintain its leadership in global defense communications markets while pursuing opportunities to grow in public safety communications. International markets are a particular priority.

Management recognized several years ago that the company's past explosive growth in defense is now longer feasible, leading it to unroll new growth initiatives in areas such as homeland security, healthcare, cybersecurity and energy. Harris also is working to move up the value chain in communications, doing higher level systems integration work.

The company stands out as a model in growth and profitability in recent years, enabling it to make the investments in research and acquisitions to make these growth initiatives work. The balance between government and commercial business gives the company the ability to combine stability and predictability with the potential for higher profits.

Strengths
Harris is well-managed. It has earned a reputation for quality work and returns above those of the vast majority of companies in the defense sector. The company has successfully achieved and exceeded long-term targets for organic revenue growth, earnings per share growth, operating income to sales and return on invested capital. It has a strong balance sheet with high returns for the defense industry.

The company has done a good job of building a diversified customer bases, with a balance between government-driven and commercially-driven programs. That balance provides the stability from government-financed programs with the growth and higher profit margins of commercially-driven programs.

Its RF Communications unit has been run on a commercial basis that has enabled it to compete effectively against rivals, moving quickly to develop products and gaining market share. The high profitability and rapid growth of RF Communications' software-defined radios also have enabled Harris to invest heavily in research and development to keep competitors off balance. Its Falcon III shows the success of this effort, enabling the company to lead the market rather than waiting for government funding.

RF Communications is now the largest player in global tactical radios with a 40% worldwide market share, according to 2012 figures. It has 68% of the US defense market. It is also number one in the international tactical radio market with a 28% market share.

It faces some difficult markets. The regional jet market, Embraer's largest market, is flat. The low end of the business jet market, where Embraer is focusing, remains depressed and is slowly recovering.

Opportunities
Improving collaboration between Government Communications and RF Communications may enable each to penetrate new markets.

The Falcon III software reprogrammable military radio has strong potential to build on the company's successful Falcon I and Falcon II programs. Falcon III is well-positioned across the services (Special Operations Command, Marine Corps, Navy, Air Force and Army).

Harris is proving that it can take on larger, more complicated systems integration contracts, such as its win of the Federal Aviation Administration's Voice Switching and Control Systems providing air-to-ground communications links for air controllers.

Harris' management estimates that the company's commercial businesses can continue to improve their profitability. At the same, time the company has sharpened its focus on core businesses by divesting non-core areas such as Harris Stratex Networks.

International markets offer tremendous potential. Harris went from 10% international sales in its fiscal 2010 to 26% last year. Management expects that it can achieve further increases, achieving 29% in fiscal 2014. The company sees strong potential in the Middle East (particularly Iraq, Saudi Arabia and the UAE) and in the Asia Pacific region (particularly Australia and Central Asia).

In addition, Harris sees considerable potential to introduce new technologies, including satellite communications on the move, security communications devices (both fixed and wireless) and public safety communications in multiband radio technology. In an effort to build up its technological edge, Harris is increasing company-funded research and development funding.

Mobile professional radio used for homeland security and other applications offers considerable opportunities. The market is moving to an open standard IP-based architecture, making it possible to break into a market that has been heavily dominated by Motorola. Moreover, that market is extremely profitable.

Threats
The biggest threats to the company lie in the very successful RF Communications sector. The wind down of operations in Iraq could has cut spending on RF Communications' radios, particularly since increased deployments to Afghanistan will not fully offset any Iraq cuts.

Budgetary pressures on defense spending will hurt, particularly in spending for radios. Much of that spending has come from emergency supplementals, which it is now planned will end. The company's high profit margins may also come under pressure as the Pentagon seeks to cut its procurement costs.

About the Author

Philip Finnegan

Philip Finnegan

Phil is Director of Corporate Analysis at Teal Group. He has provided strategic and market analysis for clients in commercial aerospace and defense, including major U.S. and European prime contractors, since joining Teal fifteen years ago.

He also writes and edits Teal's Defense and Aerospace Companies Briefing, which analyzes the performance, outlook and strategies of 50 aerospace and defense companies in the United States, Europe, Asia and South America. He is a co-author of the annual World Unmanned Aerial Vehicle Systems with responsibility for UAV companies.

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