Giants Merge, Elbit Earns

Since Elbit was split three ways, the military division has doubled in worth and will shortly be floated on Wall Street. Why it succeeded, and why McDonnell Douglas and Boeing neednt panic.

In November 1996, Elbit was split into three divisions. The military division, Elbit Systems, has since doubled in value, and will shortly make its Wall Street IPO. Boaz Levitan, of Sahar Securities, believes the split was a positive bonus for the military division.

Levitan accorded Elbits shares a Buy recommendation, with a target price of $16.5-18 for the coming year. Elbits Wall Street price stood at $15.25 on Tuesday morning.

The Recipe for Success

  1. Niche specialisation

    One of Elbits advantages is precisely the fact that the company is not afflicted by megalomania and harbours no pretensions to building an air-to-air missile or an entire fighter plane. Elbit profits from the niches in which it has specialised, and which industrial giants such as Boeing, Lockheed Martin and Dassault find unworthwhile.

  2. The World Would Rather Upgrade

    Defence budgets world-wide tend to increase the portion designated for upgrading existing systems at the expense of that earmarked for acquiring new systems.

    According to Strategic Studies Centre data, world defence expenditure amounted, in 1996, to $811 billion, down 40% compared to 1986. The number of persons directly employed in the industry also fell in that period from 17.5 million to 11.1 million.

    Roughly speaking, the military division engages in two fields: platforms and electronic systems. The "platforms category includes "irons" (engines, explosives), while "electronics systems" includes the "filling" for the platforms. Over the years, the smart electronic systems have become more important than the platforms. It is universally acknowledged that good electronics can compensate for quantity or for lesser quality in platforms.

    Elbit Systems is also benefiting from the significantly higher prices of the new systems. The F-16, for example, which was designed in the seventies, now costs $30 million, while the F-22, presently in the planning stage, will cost $100 million. This rising price trend should be helpful to Elbit, since most of the worlds armies will be forced to upgrade and continue to use their existing systems.

  3. Giant Mergers

    Another trend prevailing in the industry is that of mergers between the major manufacturers (Lockheed-Northrop, Boeing-McDonnell Douglas), with fewer models being manufactured. If the United States used to produce a different aircraft model for each branch of the military, the JFS future model is supposed to serve all branches.

    Sahar estimates that the fewer platforms that are manufactured, the greater will be the importance of electronics systems, with the aid of which the platforms can be adapted to a wide range of needs.

  4. Israels Reputation

    Another advantage pointed out by Levitan is Elbits Israeli identity. One reason is the high volume of procurement on the domestic market (the Israeli government is the source of one third of Elbits revenues), constituting a stable revenue base. Another reason is personnel, consisting of IDF officers or employees drawn from other defence industries.

    Especially beneficial to Elbit is Israels reputation in the defence field. Just as Swiss companies play up the Swiss reputation in selling chocolate and watches, so does the Israeli defence industry make the most of the IDFs renown for the purpose of sales promotion.

  5. Weak Points

The weak points of Elbit Systems, Levitan notes, are related, for one thing, to the fact that it is dependent on a small number of projects. This is because the company has decided to focus on major projects. Also, it is small compared to the industrys giants, the entry of any one of which into the upgrading field is liable to edge Elbit right out.

The companys quarterly results tend to fluctuate quite wildly, due to its income recognition method, and it could well be adversely affected by the fact that the competition (Israel Aircraft Industries, for example), has manpower surpluses and could gain the award of projects at dumping prices, if only so as to keep its staff busy.

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