Ross Wilkers

ANALYSIS

Mercury the latest contractor to face activist investor

Mercury Systems on Wednesday found itself the target of activist investor group Spruce Point Capital Management in both a series of Twitter posts and a self-described “forensic research opinion” that questions the financial outlook of the defense contractor.

Spruce Point is skeptical of Mercury’s organic growth projection and believes the company is overstating it. Spruce Point estimates Mercury organic growth at 6.5 percent versus the company’s guidance of 9.5 percent.

Andover, Massachusetts-based Mercury has been among the busiest buyers in defense electronics over the past two years with $575 million spread over six acquisitions with the intent to make more deals to grow its electronic warfare and mission computing portfolios among others.

Pro forma organic sales for Mercury in the last calendar year totaled $418.4 million, Spruce Point founder and Chief Investment Officer Ben Axler told me via email. Axler added Spruce Point’s analysis does not factor in sales growth from the acquired Themis Computing business and excludes contributions from Richland, which Mercury did not disclose sales on.

Mercury also disclosed in its annual 10-K Securities and Exchange Filing that it expects to lose its small business status, which the company holds due to having less than 1,250 employees.

Officials from Mercury did not respond to requests for comment. Shares in Mercury were 1 percent lower in afternoon trading Wednesday and were down as much as 4 percent in the morning session.

However, a Wednesday research note by investment bank Drexel Hamilton says they see “little in the report to cause investor concern.” Analyst Brian Ruttenbur also pointed out in the note that Mercury has “beat and raised financial guidance over the last five years and made a dozen acquisitions without a misstep.”

Activist investors such as Spruce Point take equity stakes in corporations and put pressure on management to make changes of both financial and non-financial types.

“They look for opportunities or mispriced assets in the capital markets,” said Michael Misantone, managing director at investment bank KippsDeSanto & Co. “Some are purely financial analysts, others are more operationally focused and they want to more often than not invest to make sure the markets are properly evaluating these companies.”

Pure-play government contractors have largely been able to avoid activist investors over the past decade due to record stock prices, but diversified aerospace companies such as Honeywell and United Technologies Corp. have both reportedly been targeted by activist hedge fund Third Point.

Various media outlets have reported that UTC is considering a breakup of itself into separate independent companies.

That said, activist hedge fund Jana Partners has found success in entering federal market players over recent years. Jana took a 1.9-percent stake in Harris Corp. in August 2016 and both parties agreed on two new appointments to the board of directors.

Harris then sold off its commercial maritime business and the IT services unit now known as Peraton in separate deals over the following eight months as part of a portfolio reshaping. Jana has since exited its investment in Harris.

In another investment Jana built up a 5.9-percent stake in the former Computer Sciences Corp. by February 2015. The company spun off its U.S. public sector business 10 months later into what became CSRA, which was acquired by General Dynamics this year.

Mercury is not the only instance Spruce Point has scrutinized a defense company over the past year. On March 16, the group issued a report on Kratos Defense & Security Solutions that questioned the company’s acquisition strategy, detailed its settlements with government agencies and criticized accounting practices among other areas.

Spruce Point’s founder Ben Axler even debated Kratos’ business structure that same day on CNBC with Ken Herbert, a defense analyst at financial services firm Canaccord Genuity.

Shares in Kratos fell 11 percent to $9.28 on March 16 but have climbed 25 percent since, while the stock was up as high as 7 percent Wednesday after its team led by Dynetics won the Defense Advanced Research Projects Agency’s Grelmins program to build unmanned aerial drones.

About the Author

Ross Wilkers is a senior staff writer for Washington Technology. He can be reached at rwilkers@washingtontechnology.com. Follow him on Twitter: @rosswilkers. Also find and connect with him on LinkedIn.

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