Seth Klarman, founder of the Baupost Group in 1982 and its leader ever since, revealed the firm’s third-quarter holdings Nov. 14. Satellite maker ViaSat (NASDAQ:VSAT) was its third-largest holding with 10.5 million shares valued at $350 million. Klarman now owns 24.9% of ViaSat. One of the best value investors anywhere, Baupost first took a position in the second quarter of 2008. In the span of three years, it has increased this position tenfold. As hard as it is to bet against Klarman, I’m recommending investors sell ViaSat and buy rival communications and info-tech provider Harris Corp. (NYSE:HRS) in its place. Here’s why.
Good Company
I first wrote about ViaSat in July 2010. At the time, I concluded that the company, which sells satellite and wireless communications and secure networking systems, didn’t provide investors with growth at a reasonable price. However, because Klarman was its biggest investor, I reasoned that this genius sees an opportunity too big to be overly concerned about value.
ViaSat is a good company for sure, but since it’s trading at or near a 52-week high and with a P/E ratio of 57.4 times this year’s earnings, investors considering purchasing its stock at this time might want to think twice. Klarman is a billionaire and can afford to wait for the opportunity he sees to arrive. You likely can’t.
ViaSat’s revenues for the first two quarters of the year grew 7.2% to $418.1 million while operating income dropped 69.3% to $6.3 million. On a non-GAAP basis, it’s earnings declined 12.7% to 48 cents a share. Analysts estimate fiscal 2013 earnings of $1.43 a share. On a forward P/E basis, investors are paying 32 times earnings.
Those same analysts expect ViaSat to increase earnings over the next 5 years by 21% annually. Unfortunately, its track record for generating consistent growth just isn’t there. Since fiscal 2006, earnings have fluctuated between 80 cents and $1.20 per share, while revenues have doubled from $434 million to $802 million. It just seems like a steep price to pay for a company that’s shown little consistency delivering higher profits.
Government Services
ViaSat and Harris compete against each other for government contracts. In fiscal 2011, ViaSat’s revenue from federal contracts represented 48% of overall sales compared to 72% for Harris. Only two years ago, ViaSat’s revenue from government sources was 62%. A move into consumer satellite broadband lowered its reliance on the Department of Defense. However, it came at the expense of operating margins, which are lower than they’ve been in a decade.
Harris’ New CEO
Effective Nov. 1, Bill Brown took over the CEOs job at Harris after 14 years with United Technologies (NYSE:UTX) where most recently he served as senior vice president of corporate strategy and development, responsible for the conglomerate’s strategic planning and M&A activity. Without reading too much into Brown’s past responsibilities, it seems likely his hiring indicates acquisitions are probably in Harris’ future. That’s a good thing because profits, although strong, seem to have plateaued and are in need of a catalyst so it can resume double-digit growth.
Valuation
Harris’ first-quarter revenues and earnings were mediocre at best. Revenues grew 4% to $1.46 billion and non-GAAP earnings of $1.06 per share, down 16.5% from $1.27 a year earlier. The good news is future orders were $1.62 billion in the quarter, up 20% from the fourth quarter of fiscal 2011. While orders are never ironclad, it’s still a positive sign. The company estimates its non-GAAP earnings in 2012 will be $5.10 per share at the low end. At the Nov. 18 closing price of $36.53, it’s trading at 7.2 times 2012 earnings.
As I said previously, I really don’t think ViaSat is a value investment for Klarman because head-to-head comparisons between the two companies demonstrate by almost every financial metric that Harris is the better deal. For instance, ViaSat’s enterprise value is 17.1 times EBITDA compared with 5.4 times for Harris. In addition, Harris’ total debt is two times EBITDA compared to 3.3 times for ViaSat. Lastly, Harris’ price-earnings-to-growth ratio (PEG) is one-third ViaSat’s.
Bottom Line
In the past 52 weeks, ViaSat’s stock is up 10.6% compared to a 21.5% drop for Harris, which is trading at its lowest point since early 2009. Harris pays a $1.12 dividend compared to none for ViaSat. Unless you’re independently wealthy like Klarman, the opportunity cost of owning ViaSat over Harris is just too great.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.
