Leidos Holdings, Inc.
- Spruce Point Report Overview.
- We urge investors to download the full report, and review our key findings in Spruce Point’s to hold management accountable for answers to the following issues:
- We believe Leidos wasted $1 billion on the acquisition of L3Harris’ (NYSE: LHX) Security Detection & Automation (“SD&A”) business – and has potentially misled investors on its financial benefits. In early 2020, Leidos leveraged its balance sheet to acquire this business. While management claims the SD&A deal will help Leidos achieve double digit growth, 15% margins, $500 million in revenues and boost international sales from 10% to 13% of total revenues in 2020, Spruce Point believes none of these claims are possible. After conducting expert interviews, evaluating foreign financial filings and dissecting management’s claims, we are still unable to reconcile at least $100 million of total, and $355 million to $367 million of claimed, international sales. We find evidence that one foreign entity in the UAE tied to the automation business recently restated sales and net income lower by 68% and 98%, respectively. We also find unusual transactions with a Thailand distributor – M.I.T Solutions – that has been linked to a graft scandal that led to the imprisonment of a Thailand Transportation Minister. We believe Leidos should impair the value of the business, and that the Board of Directors (the “Board”) should immediately terminate Chief Executive Officer (“CEO”) Roger Krone, Chief Financial Officer (“CFO”) James Reagan and Chief Accounting Officer (“CAO”) Christopher Cage for abysmal due diligence failures.
- Evidence suggests that under CEO Roger Krone’s leadership, Leidos is concealing numerous product defects from investors, including faulty explosive detection systems at airports, ports and borders. Mr. Krone joined Leidos after a long career with Boeing (NYSE: BA), where he worked under Dennis Muilenburg, who eventually rose to CEO and was later ousted following the Boeing 737 MAX scandal. Federal reports detailed a “culture of concealment” at Boeing under Mr. Muilenberg’s leadership and noted that the desire to meet goals and expectations jeopardized the safety of the flying public. We believe this is troubling in context. Backed by import records, a distributor lawsuit alleging fraud and expert interviews, Spruce Point finds evidence that the Company is concealing numerous product defects – C-MobileTM, ClearScanTM and MV3DTM – and that the SD&A business has underinvested in the latest technology, resulting in market share loss. These challenges could present a “Material Adverse Effect” with tail risk financial liabilities to Leidos shareholders.
- Evidence indicates Leidos is deflecting growing competitive threats from Amazon (Nasdaq: AMZN) and Microsoft (Nasdaq: MSFT). As an outsourced IT service provider to federal agencies, Leidos participates in cloud modernization projects. Amazon has been investing heavily in this area and growing its presence in the Washington D.C. region. There is a growing risk, acknowledged to us by a former senior C-Suite Leidos executive, that the technology leaders could start doing direct deals vs. subcontracting. Booz Allen Hamilton (NYSE: BAH), a key competitor to Leidos, has already acknowledged the increasing competitive environment for hiring technology talent and recently disclosed recruitment challenges. Leidos has failed to acknowledge any risk to its business from these dynamics.
- We believe investors should be extremely concerned by the Company’s current and recently departed CAOs, each of whom have questionable track-records. Prior to joining Leidos, former CAO Ranjit Chadha worked at Computer Sciences Corp (“CSC”) in accounting and financial reporting roles during a period in which the SEC charged its executives with accounting fraud and noted unusual unbilled receivables. Curiously, we find Leidos’ unbilled receivables also rising without clear explanation. Mr. Chadha became Leidos’ SVP Corporate Financial Planning and Analysis in June 2019, and recently departed in March 2020. In his new role, he removed from his biography his CAO role at Leidos. Public filings show that Leidos’ current CAO and long-time SAIC (NYSE: SAIC) employee, Christopher Cage, has a legacy criminal record in California. We find it troublesome that the Company’s financial strains increased post-acquisitions and following the departure of Mr. Chadha.
- Unfavorable Risk/Reward Owning LDOS Shares: The current sell-side consensus price is $116.67 which is ~8% above the current price. Yet, there is no evidence that the sell-side understands the magnitude and gravity of the problems faced by the Security Detection & Automation business. Despite all of our concerns, including concrete evidence of defective products jeopardizing the safety of citizens across the globe, Leidos trades at a premium to peers despite having below average gross, EBITDA and OCF margins. Peers include: Northrop Grumman(NOC), General Dynamics (GF), Cognizant Technology (CTSH), CGI Group (GIB), Jacob’s Engineering (J), Booz Allen Hamilton (BAH), Aecom (ACM), SAIC, CACI International (CACI), Perspecta (PRSP), Maximus (MMS), Parsons (PSN), Mantech (MANT), ICF International (ICFI). Analysts’ are enamored with Leidos near-term organic sales growth prospects, despite the fact we have evidence that management has manipulated this figure to its benefit in the past.