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How Raytheon Will Unlock The Value Of Its Cybersecurity Business For Shareholders

Raytheon CEO Thomas A. Kennedy is determined to make his company a global leader in commercial cybersecurity -- and obtain the high valuation for shareholders that comes from dominating a market with double-digit annual growth.
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Defense contractor Raytheon is flying high. Its stock is trading near an all-time high, up over 80% since Dr. Thomas A. Kennedy became Chairman & CEO in 2014. E.P.S. rose 21% year-over-year in the first quarter, and Wall Street is noticing. Argus Research says the company's business mix and growth outlook merit a premium valuation. Morningstar says Raytheon is poised "for some of the fastest growth in the defense industry," and despite the recent run-up in share price is "the least expensive pure-play defense name."

But Raytheon -- a contributor to my think tank -- isn't exactly a defense pure-play. Although its business consists mainly of selling military hardware and services to the federal government and overseas allies (30% of sales are foreign), it has also emerged as a major player in the commercial cybersecurity world. That aspect of its growth is led by Forcepoint, the world's second biggest private cybersecurity firm, which operates semi-autonomously within the Raytheon portfolio of businesses.

Forcepoint was formed in 2016 as a vehicle for selling defense-quality cybersecurity solutions into commercial markets. Following a model Raytheon pioneered when it bought appliance maker Amana to market microwave ovens using its radar technology, Forcepoint was conceived to combine the cutting-edge cyber skills of Raytheon's defense business with the cultural agility and low overhead of a commercial enterprise. It brought together over a dozen cyber businesses the parent company had created or acquired since 2007.

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Raytheon is best known for its military hardware, such as this Patriot air defense system deployed in Turkey. However, it is rapidly emerging as a global leader in cybersecurity for military, civil and commercial customers -- a natural adjacency since all of its military systems must be secured against cyber threats.

I sat down last week with Dr. Kennedy and Forcepoint CEO Matt Moynahan to discuss how Raytheon will leverage its cyber business to grow shareholder value in a commercial market that is expanding at several times the rate of Raytheon's traditional defense markets. Because the growth prospects in cyber are so imposing -- a trillion dollars has already been spent on trying to protect networks worldwide over the last decade -- Kennedy saw that space as a logical adjacency into which the world's biggest defense electronics enterprise might expand.

However, he also saw that shareholder value wasn't likely to be maximized by running a commercial business out of a defense company. Since his goal was to become a global leader in cybersecurity and thereby obtain valuation gains far exceeding what was feasible in the medium-growth defense space, he fashioned Forcepoint as a sort of hybrid business unit. It reports as an integral business unit of the parent company, but it exercises considerable independence in its operations, and its status may change if Kennedy thinks that will unlock value faster.

For instance, Raytheon might elect to IPO the Forcepoint business, with the parent company retaining a sizable ownership stake, if that would get the valuation of Raytheon's cyber franchises to the level currently seen in some Silicon Valley counterparts. Investors are always trying to get ahead of the news, and right now they are awarding outsized valuations to cyber startups that in many cases don't even make a profit (Forcepoint does). Kennedy's goal is to generate similar results from cyber for Raytheon shareholders while also securing his other business lines against cyber threats.

So Forcepoint pursues commercial customers and some federal business while the most sensitive national-security cyber work is ensconced in the parent company's Intelligence, Information & Services business headquartered outside Washington. The idea is to match the right operating culture to each segment of the market, recognizing that many of the cyber execs at commercial companies came out of government and already know Raytheon products from that setting.

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