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Case Studies

Peter A. Sokoloff & Co. regularly analyzes transactions which occur within the industries covered. An archive of these case studies is kept online as a courtesy to our colleagues. To receive by e-mail new case studies as they are prepared, please e-mail [email protected] with your contact information.

Archives > Transaction Case Study 54

Kratos and Henry Brothers Electronics, Inc.

On October 5, 2010, Henry Bros. Electronics (NASDAQ, HBE) announced that it had agreed to be acquired by Kratos Defense & Security Solutions Inc. (Nasdaq: KTOS) for a price of $7.00 per share in an all cash merger transaction. Then, following a 40 day "Go Shop" period, and some spirited sparring with alternative acquirer Diebold (NYSE DBD), the companies announced on November 13th that the purchase consideration had been set at $8.20.

The terms of the first offer from Kratos included a provision that allowed HBE to continue to shop the company in search of a higher bidder. This is not unusual. Established practice for public companies is to act in the best interests of their public shareholders; therefore they must continue to entertain other offers. The typical protection for the buyer is a "topping fee" which provides a consolation prize payment to the buyer if another company makes a higher, winning offer.

On November 9th, Diebold (NYSE, DBD) submitted a non-binding proposal to acquire all of the outstanding shares of HBE common stock for $8.00 per share in cash. Kratos prevailed, increasing its offer to $8.20. Diebold considered increasing its offer and then withdrew on November 26th.

The Enterprise Value for the transaction is approximately $54 million. Based on HBE's Trailing Twelve Month numbers through September 30th, this equates to a revenue multiple of .89x and an EBITDA multiple of 18.12x.

On the face of it, the transaction appears to be quite dilutive to KTOS. At the beginning of December, Kratos was trading at 1.02x revenue and 11.97x EBITDA (Enterprise Value). So, why is Kratos making the acquisition?

The answer lies within two areas. First, as of Q3, HBE's backlog was $53 million. With revenue in Q3 ramped up to $19.35 million, it is not a stretch to forecast $70-$75 million in 2011. HBE guidance for 2010 is $65 million. Second, the economies to be derived from combining the businesses suggests that KTOS may be able to pull 8% EBITDA out of the HBE business in 2011. Using this logic, the multiples against 2011 performance could come down to about .75x revenue and 9.3x EBITDA. And that would make the transaction accretive to KTOS, based on its December numbers.

As a comparison, in April 2008, Tyco's ADT unit acquired First Data Services for an estimated year-ahead multiple of .85x revenue and 11x EBITDA. (See Sokoloff & Co.'s case study on that transaction.)

While there is risk in realizing the expense reductions fully in 2011, which could drive the EBITDA multiple up, the transaction is strategic for Kratos, putting it squarely on the map as a Tier 1 security systems integrator with strong customer depth and homeland security focus.

Kratos' shareholders are taking a wait and see attitude. After the announcement of the first offer, Kratos stock moved up about 10%. It gave back these gains by the time the second offer was announced.

Selected Comments from the Press Announcement

Kratos is a US-based national and homeland security solutions provider of mission critical products,
solutions and services with headquartered in San Diego, California. HBE provides technology-based
integrated electronic security systems, services and emergency preparedness consultation to commercial enterprises and government agencies. HBE currently has its headquarters in Fair Lawn, New Jersey. HBE will become part of Kratos' Public Safety and Security division.

"This transaction combines two leaders in the defense and security solutions market, creating a great opportunity for our organization, customers and shareholders," stated Jim Henry, President and CEO of
HBE. "As a much larger organization, the combined company will be better able to establish a presence
in targeted markets with the potential for significant growth opportunities, as well as enhanced service
opportunities in certain key markets and industries."

Eric DeMarco, Kratos' President and CEO, said, "Henry Brothers is clearly one of the premier Homeland
and National Security Solution Providers and Command and Control Center Design Engineering and
Operators in the industry today. We see the opportunity for significant cross selling between the two
businesses, including for Henry Brothers' proprietary first responder communications products and
solutions. Additionally, we see the opportunity to cross sell into HBE's large and established customer
base which currently includes Kratos' NeuralStar and DopplerVue situational awareness, security network management, protection and cybersecurity software products."

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