LEIDOS: A FINANCIAL ANALYSIS
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Leidos: A Financial Analysis
Andrew D. Johnson
University of West Florida
Financial Management - FIN 6406
December 4, 2016
LEIDOS: A FINANCIAL ANALYSIS
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Table of Contents
Executive Summary ...................................................................................................................... 3
Introduction ................................................................................................................................... 4
Leidos Founding and Early History ................................................................................ 4
Leidos Current Position ................................................................................................... 4
Industry and Competition ............................................................................................................ 5
Leidos and its Business Units ........................................................................................... 5
Leidos Competitors ........................................................................................................... 5
Financial Statement Analysis ....................................................................................................... 6
Income Statement.............................................................................................................. 6
Balance Sheet..................................................................................................................... 7
Ratio Analysis .................................................................................................................... 9
Contract Type and Revenues ......................................................................................... 15
DuPont Analysis .............................................................................................................. 17
Beta Calculation and Risk Assessment ..................................................................................... 18
Risk and Risk Measures ................................................................................................. 18
Beta Calculation .............................................................................................................. 19
Leidos Risk Assessment .................................................................................................. 20
Weighted Average Cost of Capital ............................................................................................ 21
Overall Evaluation and Conclusions ......................................................................................... 22
References .................................................................................................................................... 25
LEIDOS: A FINANCIAL ANALYSIS
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Executive Summary
Leidos, Inc. is a large science, technology, and engineering firm in the aerospace
and defense industry, whose customers include the Department of Defense (DoD) and
numerous other government agencies, as well as some commercial customers. Leidos has
grown significantly from its original founding as Science Applications International in
1969 and is now the largest single provider of government IT solutions, due to its recent
merger with two business units of Lockheed Martin. Leidos’ financial position is
characterized by a mix of debt and equity financing that is characteristic of the industry,
and asset utilization and profitability ratios that are below industry benchmarks, but not
significantly different from some competitors. Leidos’ returns have a tendency to follow
the market, but are influenced by numerous other factors beyond the market, such as
defense budgets and the geopolitical situation. Leidos offers greater potential returns than
at least one competitor, but at greater risk. Overall, Leidos has great potential and faces
great risk, which it could mitigate, to an extent, by expanding into commercial segments
and reducing its dependence on defense budgets.
LEIDOS: A FINANCIAL ANALYSIS
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Introduction
Leidos, Inc., formerly known as Science Applications International Corporation, is a
science, technology, and engineering corporation whose primary customer is DoD. The
paragraphs that follow will provide an overview of Leidos’ history and its present position.
Leidos Founding and Early History
In 1969, a nuclear physicist named J. Robert Beyster, and former employee of General
Atomics, decided to start his own business. Within 3 short years, Dr. Beyster’s nascent company,
Science Applications International, grew to 156 employees and expanded into fields, including
the electromagnetic effects of nuclear weapons on the power grid and electronics as well as
NASA spacecraft design (Leidos, 2016a). SAIC continued its growth into new defense related
segments and had an initial public offering in 2006 (Leidos, 2016a). In 2013, management
determined that SAIC’s scope had become impractically broad, and decided to split into two
companies, with the original company changing its name to Leidos and providing engineering
and scientific services, while the new SAIC would specialize in computing related services
(SAIC, 2013). In 2016, Leidos acquired the IT business of Lockheed Martin, which agreed to the
merger because of its intent to focus on aircraft manufacturing, as well as a need for cash caused
by its previous purchase of Sikorsky (Cameron, 2016).
Leidos Current Position
As a result of the merger, which was finalized in August 2016, Leidos became the largest
provider of government IT solutions, while continuing to provide a variety of technical and
commercial services and solutions. Leidos is traded on the New York Stock exchange, where its
symbol is LDOS. Its market value, based on its market capitalization as of July 1, 2016 is $5.7
billion (Value Line, 2016). While post-merger integration issues and defense budget
LEIDOS: A FINANCIAL ANALYSIS
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uncertainties have the potential to dampen Leidos’ near future outlook, Leidos is poised to be a
leader in its segment.
Industry and Competition
While Leidos does not engage in large scale manufacturing, it does provide a variety of
scientific, engineering, and software development services. In the paragraphs that follow,
Leidos’ business units and some of its competitors will be discussed.
Leidos and its Business Units
Leidos is organized into three business units, each of which has a different focus.
Accounting for 71% of revenue in 2015, the largest is the National Security Solutions (NSS)
business unit, which provides services and systems for DoD the Department of Homeland
Security (DHS), and numerous intelligence organizations (Leidos, 2016b). Health and
Engineering Services (HES), which provides healthcare related systems and a variety of
environmental and engineering services, is the second largest business unit, accounting for 29%
of revenues (Leidos, 2016b). The third business unit, which is known as Corporate and Other,
consists of Leidos’ management infrastructure and accounts for less than 1% of revenues
(Leidos, 2016b).
Leidos Competitors
The modern aerospace and defense industry has evolved considerably since its
emergence in the 1940s, and through multiple waves of mergers and acquisitions has become
dominated by relatively few large corporations with specialized business units and complex
manufacturing supply chains (Hensel, 2010), (Tang & Zimmerman, 2009). Leidos is no
exception, and its competitors include business units of much larger firms such as Lockheed
Martin and Boeing, with capital intensive business units that manufacture aircraft and ships.
LEIDOS: A FINANCIAL ANALYSIS
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Since direct comparison with such firms poses difficulties, due to their manufacturing
orientation, inventories, and vast differences in size, Leidos will be compared to Man Tech
International, a competitor whose offerings and organization are more closely aligned with those
of Leidos.
Financial Statement Analysis
In the paragraphs that follow, financial statements and the ratios derived from them will
be presented and analyzed in order to provide a quantitative assessment of performance as well
as a comparison of performance between both a competitor and S&P aerospace and defense
benchmark data obtained from Intrinsic Research.
Income Statement
As Exhibit 1 shows, revenue dropped for both Leidos and Man Tech International, but
not the industry benchmark, whose leading firms produce aircraft under larger and longer term
contracts than Leidos and Man Tech International. Leidos’ operating income grew, with a sharp
rise from 2011 to 2012, followed by a significant drop in 2014 due primarily to $486 million of
goodwill impairment charges, ultimately caused by decreased HES revenues, and $81 million of
asset impairment charges, due to an acquisition and changes in fuel costs for a renewable energy
project (Leidos, 2016b). Man Tech International’s operating income declined due to a reduction
in the contract for Mine Resistant Ambush Protected (MRAP) armored vehicle and other system
support in Afghanistan and Iraq (Man Tech International, 2014). Industry benchmark operating
income increased, again due to the size and duration of industry leader contracts.
LEIDOS: A FINANCIAL ANALYSIS
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Exhibit 1
2015
2014
2013
2012
2011
LDOS Revenue $ 4,712
$ 5,063
$ 5,772
$ 11,173
$ 10,587
MANT Revenue $ 1,550
$ 1,774
$ 2,310
$ 2,582
$ 2,870
$ 32,071
$ 31,320
$ 30,655
$ 29,669
$ (214)
$ 164
$ 734
$ 311
$ 95
$ 22
$ 171
$ 227
$ 3,875
$ 3,548
$ 3,021
$ 3,061
$ (201)
$ 251
$ 753
$ 388
$ 85
$ 22
$ 171
$ 231
$ 3,875
$ 3,548
$ 3,021
$ 3,061
$ (323)
$ 164
$ 525
$ 59
$ 47
$ (6)
$ 95
$ 133
$ 2,595
$ 2,339
$ 1,870
$ 2,021
BM Revenue $ 31,546
LDOS Operating Income $ 320
MANT Operating Income $ 85
BM Operating Income $ 3,699
LDOS EBIT $ 407
MANT EBIT $ 87
BM EBIT $ 3,699
LDOS Net Income $ 242
MANT Net Income $ 51
BM Net Income $ 2,707
(Intrinsic Research, 2016), (Mergent)
Net income and EBIT for Leidos increased significantly from 2011 to 2012, due to
increases in revenue, prior to dropping dramatically in 2014, due to goodwill and assets
impairment charges as well as taxes and interest expenses (Leidos, 2015). Man Tech
International’s net income declined substantially due to the combined effects of lost revenue and
interest and tax expenses (Man Tech International, 2014).
Balance Sheet
As Exhibit 2 and the spreadsheet that accompanies this document show, Leidos’ current
assets and current liabilities showed a general declining trend. The consistent declines in current
assets were due to decreases in cash, net receivables, and the assets of discontinued operations,
the majority of which was due to the separation of Leidos and SAIC (Leidos, 2015). Further
decreases in cash were caused by the payment of dividends, stock repurchases, and the payment
of notes which were a part of the Plainfield Renewable Energy program (Leidos, 2016b).
LEIDOS: A FINANCIAL ANALYSIS
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Current liabilities decreased due to decreases in accounts payable, payroll expenses and benefits,
and a sharp decline in the current portion of notes payable, which were also consequences of the
separation (Leidos, 2015). Man Tech International’s current assets increased from 2011 to 2013,
after which there was a sharp drop, due to decreases in cash and equivalents, accounts receivable,
and contract inventory (Man Tech International, 2015). Man Tech International’s current
liabilities dropped, due to decreases in accounts payable and accrued liabilities (Man Tech
International, 2014), (Man Tech International, 2015).
Leidos’ total assets and average total assets decreased, due to the general decline in
current assets, intangible assets and goodwill, and declines in property, plant, and equipment due
to the sale of buildings and facilities (SAIC, 2013), (Leidos, 2015). Man Tech International’s
total assets and average total assets decreased, due primarily to the aforementioned decrease in
current assets (Man Tech International, 2014), (Man Tech International, 2015). Man Tech
International’s total liabilities decreased as well, with a significant decrease from 2013 to 2014,
which can be attributed to decreases in accounts payable, accrued expenses, and long term debt,
due to payment of expenses and the redemption of unsecured notes whose principal amount was
$207.3 million (Man Tech International, 2015).
Leidos’ total equity rose before falling to a low in 2014 and recovering slightly in 2015,
due largely to changes in retained earnings, which were largely influenced by the previously
discussed asset impairment charges and the payment of dividends. Man Tech International’s total
equity showed a general increase with no extreme changes.
LEIDOS: A FINANCIAL ANALYSIS
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Exhibit 2
LDOS Current Assets
MANT Current Assets
BM Current Assets
LDOS Total Assets
MANT Total Assets
BM Total Assets
LDOS Current Liabilities
MANT Current
Liabilities
BM Current Liabilities
LDOS Total Liabilities
MANT Total Liabilities
BM Total Liabilities
LDOS Equity
MANT Equity
BM Equity
2015
$ 1,793
$ 369
$ 16,153
$ 3,377
$ 1,506
$ 37,153
$ 1,040
2014
$ 1,618
$ 419
$ 16,714
$ 3,281
$ 1,487
$ 36,827
$ 951
2013
$ 1,794
$ 750
$ 16,440
$ 4,162
$ 1,723
$ 35,562
$ 1,009
2012
$ 3,079
$ 745
$ 15,050
$ 5,875
$ 1,842
$ 34,908
$ 1,793
2011
$ 4,205
$ 688
$ 13,862
$ 6,667
$ 1,760
$ 31,302
$ 3,025
$ 369
$ 12,633
$ 2,309
$ 323
$ 28,797
$ 1,068
$ 1,184
$ 8,355
$ 419
$ 12,729
$ 2,283
$ 333
$ 27,770
$ 998
$ 1,155
$ 9,057
$ 750
$ 11,931
$ 2,567
$ 590
$ 24,913
$ 1,595
$ 1,134
$ 10,649
$ 745
$ 11,394
$ 3,257
$ 677
$ 27,198
$ 2,618
$ 1,165
$ 7,710
$ 688
$ 10,457
$ 4,486
$ 671
$ 23,968
$ 2,181
$ ,089
$ 7,333
(Intrinsic Research, 2016), (Mergent)
Ratio Analysis
Based on the data presented in the previous section, financial ratios and a summary
analysis will be presented, with additional details available in the spreadsheet that accompanies
this document. The ratios include short and long term solvency, asset utilization, profitability,
market value, and industry specific ratios.
Solvency Ratios
Solvency ratios for Leidos, Man Tech International, and the industry as a whole as
shown in Exhibit 3. The particular combination of solvency ratios was chosen because they
provide an examination of debt’s effects on near and longer term solvency as well as an
examination of the interaction between debt and equity. Leidos and Man Tech International have
higher current ratios and lower debt to equity ratios and equity multipliers than the industry
LEIDOS: A FINANCIAL ANALYSIS
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benchmark, while the industry benchmark for debt ratio is between that of Leidos and Man Tech
International.
As Exhibit 3 shows, Leidos’ current ratio rose, prior to dropping to a low in 2014, while
Man Tech International’s increased to a peak, after which it decreased significantly. In both
cases, both current assets and current liabilities showed a decreasing trend due to the reasons
previously discussed. Changes in current ratio are therefore due to changes current assets and
current liabilities relative to each other. Overall, the current ratios show that both firms and the
industry benchmark have been had short term solvency.
Exhibit 3
Leidos and
Man Tech
Current Ratio
2011‐2015
Leidos
Man Tech
Man Tech
Leidos
Leidos
Benchmark
Benchmark
Man Tech
Man Tech
Benchmark
Benchmark
1
2
2011
2012
0
2013
0
2015
2014
2013
2012
2011
6
4
2
0
4
0.5
2015
0
Leidos and
Man Tech
Equity
Multiplier
2011‐2015
Leidos
2
1
Leidos and
Man Tech
Debt to
Equity Ratio
2011‐2015
2014
3
Leidos and
Man Tech Debt
Ratio 2011‐
2015
(Intrinsic Research, 2016), (Mergent)
Leidos’ debt ratio dropped to a low in 2012, after which it rose to a high in 2014 prior to
dropping slightly in 2015. Both total liabilities and total assets showed a general declining trend,
due to previously described factors. Man Tech International’s debt ratio was significantly lower
than Leidos’ and the industry benchmark’s, indicating that Man Tech International has
LEIDOS: A FINANCIAL ANALYSIS
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emphasized equity financing to a greater extent. Overall, the debt ratios show that the firms and
the industry benchmark carry varying amounts of debt and that the amounts of debt change over
time due to changes in assets and liabilities caused by a firm’s circumstances.
Leidos’ debt to equity ratio dropped significantly, due to a decrease in total liabilities and
an increase in revenues and net income, before rising in 2014 and then slightly declining. Man
Tech International’s debt to equity ratio showed a general declining trend, with a sharp decline in
2014, which was largely driven by a general decline in total liabilities, since total equity showed
only a slight increase during the period. Overall, the debt to equity ratios show that both Leidos
and Man Tech International rely on debt for financing less than the industry benchmark, and that
the degree of reliance on debt can vary significantly between firms in an industry.
Leidos’ equity multiplier dropped to a low in 2012, due to a decrease in total assets and
an increase in equity, before rising to a high in 2014, for reasons previously discussed. Man Tech
International’s equity multiplier declined at a relatively slow rate from 2011 to 2013, then
sharply from 2013 to 2014. The general declining rate was driven by a general decline in total
assets as well as a slight increase in equity, due to reasons previously described. As with the
equity ratio, the equity multiplier shows that both Leidos and Man Tech International are less
leveraged than the industry benchmark, and that leverage can vary significantly between firms.
Asset Utilization Ratios
Asset utilization ratios, as shown in Exhibit 4, show that Leidos and Man Tech
International exceed industry benchmarks for asset turnover, sometimes exceed them for
accounts receivable turnover, and never exceed them for return on assets or return on capital
employed. The particular combination of ratios was chosen because of the overall view of
LEIDOS: A FINANCIAL ANALYSIS
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efficiency they provide from the perspectives of efficiency in the use of assets, efficiency in
collection of payment from the government, and profitability of assets.
Leidos’ asset turnover ratio rose to a high in 2012 before dropping to a low in 2013, after
which it recovered before declining again in 2015, due to primarily to changes in revenue
discussed previously, while Man Tech International’s declined consistently, with no extreme
changes. In both cases, changes in the asset turnover were due primarily to changes in revenue.
As expected, the asset turnover ratios show that both Leidos and Man Tech International are
more efficient at using assets than the capital intensive industry benchmark, but have become
less so over time due to declining revenue.
Exhibit 4
Leidos and
Man Tech
Accounts
Receivable
Turnover
2011‐2015
Leidos
Leidos and
Man Tech
Return on
Assets 2011‐
2015
Leidos
Man Tech
Leidos
Man Tech
Benchmark
Man Tech
Benchmark
(Intrinsic Research, 2016), (Mergent)
‐10
2012
2013
‐5
2014
0
2011
0
2012
2011
2012
2013
2014
2015
0
5
2013
0.5
5
2014
1
10
2015
1.5
10
2015
Benchmark
2
2011
Leidos and
Man Tech
Asset
Turnover
2011‐2015
LEIDOS: A FINANCIAL ANALYSIS
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Leidos’ accounts receivable turnover increased to a high in 2012, before plummeting to a
low in 2013, after which it recovered and remained relatively stable, due to relative changes in
revenues and average accounts receivable. Man Tech International’s accounts receivable
turnover showed a very different trend, decreasing by more than half from 2011 to 2012, due to
an increase in average accounts receivable caused by increased contract activity (Man Tech
International, 2013). Overall, the accounts turnover ratios show that both Leidos and the industry
benchmark are significantly more efficient at collecting payments from the government.
Leidos’ return on assets rose to a high in 2012, and became negative in 2014, after which
it recovered, due primarily to changes in net income which changed significantly, as previously
discussed. Man Tech International’s return on assets showed a very different trend beginning
with a high point in 2011 and dropping to a negative low point in 2013, due again primarily to
changes in net income. Overall, the return on assets ratios show that the industry benchmark has
shown consistently more profitability from its assets, while both Leidos and Man Tech
International experienced extreme changes. Such a conclusion is to be expected based on the
manufacturing focus of the industry benchmark and its longer duration contracts.
Profitability Ratios
As Exhibit 5 shows, profitability ratios for Leidos and Man Tech International fell below
the industry benchmarks. Gross profit margin for Leidos rose to a peak in 2013 and remained
relatively stable until dropping in 2015 due to relative changes in the rate of decline of revenues
and cost of revenues. Man Tech International’s gross profit margin showed a different trend,
beginning at a high in 2011, dropping to a low in 2013, and recovering in 2015, again due to
relative changes in revenues and cost of revenues for the reasons previously discussed. Overall,
gross profit margins show that neither Leidos nor Man Tech International are as profitable as the
LEIDOS: A FINANCIAL ANALYSIS
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industry benchmark due to the more profitable nature of contracts for the production of airplanes
and ships that are the core of industry leaders’ business.
Exhibit 5
Leidos and Man
Tech Gross Profit
Margin 2011‐2015
Leidos and Man
Tech Operating
Profit Margin
2011‐2015
Leidos
Man Tech
Leidos
Leidos
Benchmark
Man Tech
Man Tech
Benchmark
Benchmark
25
20
15
10
15
10
5
10
5
0
Percent
Percent
Leidos and Man
Tech Net Profit
Margin 2011‐
2015
5
0
0
‐5
‐5
‐10
‐10
(Intrinsic Research, 2016), (Mergent)
Operating profit margin and net profit margin showed a very different trend with Leidos
rising to a high in 2012 and dropping to a low in 2014, due to previously described changes in
operating income. Man Tech International’s operating profit margin showed a slightly different
trend, dropping to a low in 2013 and recovering in 2014, due primarily to previously described
changes in operating income. While there were some differences in the trends, due to interest
expenses and taxes, the changes were not extreme. Overall, the operating profit margin and net
profit margin show that neither Leidos nor Man Tech International are as profitable as the
industry benchmark when all variable costs, interest expenses, and taxes are considered. As with
gross profit margin, the lower profitability is due, at least in part, to the relatively higher prices
associated with industry leaders’ contracts.
LEIDOS: A FINANCIAL ANALYSIS
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Market Value Ratios
In order to compare market value between Leidos, Man Tech International, and the
industry benchmark, the price to earnings ratio (P/E) and dividend yield were chosen because
together they provide an overall assessment of shareholder value, undervaluation, future growth,
and return on investment. As Exhibit 6 shows, Leidos’ P/E ratio was significantly less than that
of both Man Tech International and the industry benchmark, except during 2013 when it was
significantly higher, due to investor sentiment and other potential factors. Overall, the P/E ratios
indicate that Leidos may be potentially undervalued relative to Man Tech International and the
industry benchmark, or that Man Tech International and the industry benchmark may be
expected to have greater growth in the future. Dividend yields for both Leidos and Man Tech
International were well above the industry benchmark, with Leidos being highest. Overall,
Leidos’ relatively high dividend yield indicates that it offers investors a greater return on
investment, albeit at a greater risk.
Exhibit 6
Leidos P/E
Man Tech P/E
Benchmark P/E
Leidos Dividend Yield (%)
Man Tech Dividend Yield (%)
Dividend Yield (%)
2015
2014
2013
2012
2011
15.5
22.2
21.0
2.8
2.8
1.8
15.3
23
20.8
3.3
2.9
1.72
47.1
12.8
18.7
3.8
3.1
1.79
7.7
10.5
14.2
4.1
3.1
2.28
11
10.8
12.8
NA
2.1
2.37
(Intrinsic Research, 2016), (Mergent)
Contract Type and Revenues
In addition to the previously discussed ratios, a number of additional ratios may be used
to assess firms in the aerospace and defense industry. One such ratio describes the percentage of
revenues realized from different contract types, which include cost reimbursable, fixed price, and
LEIDOS: A FINANCIAL ANALYSIS
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time and materials. A cost reimbursable contract is one in which the government reimburses the
contractor for costs directly related to the performance of the contracted work, in addition to an
incentive fee that is based on program budget balance after completion of work or other metrics
determined by the government customer (Corridore, 2016). A fixed price contract is one in
which the budget is fixed and the contractor is permitted to keep any funds remaining after the
contract is completed (Corridore, 2016). Finally, a time and materials contract is one in which
the nature and duration of the tasks to be accomplished are less certain and for which the budget
is less certain. Incentives with such contracts vary between different government customers
(Corridore, 2016). Each contract type carries different degrees of both risk and profitability, with
fixed price contracts being the most profitable and carrying the most risk for the contractor. In all
possible cases, DoD seeks to use fixed price contracts, in order to ensure that the contractor
carries the risk of cost overruns. Since, however, the specifications and ultimate costs of
deliverables are difficult to accurately determine for most defense contracts, cost reimbursement
contracts are more common (Kim, Roberts, & Brown, 2016). While such contracts are not quite
as profitable as others, they are less risky for the vendor and therefore more favorable. As
Exhibit 7 shows the types of contracts and their contributions to Leidos’ revenue remained
relatively consistent from 2011 to 2015, with cost reimbursable contracts being the single
greatest contributor. Man Tech International, however, showed a dramatic increase in cost
reimbursable contract revenues accompanied by a dramatic decrease in time and materials
contracts.
LEIDOS: A FINANCIAL ANALYSIS
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Exhibit 7
LDOS Cost Reimbursable
MANT Cost Reimbursable
LDOS Fixed Price
MANT Fixed Price
LDOS Time and Materials
MANT Time and Materials
2015
2014
2013
2012
2011
51%
68%
27%
21%
22%
12%
48%
69%
27%
21%
25%
10%
47%
72%
27%
17%
26%
11%
42%
51%
29%
16%
29%
33%
46%
34%
27%
16%
27%
51%
(Leidos, 2016b), (SAIC, 2013), (Man Tech International, 2016), (Man Tech International, 2013)
DuPont Analysis
As Exhibit 8 shows, return on equity for both Leidos and Man Tech International was
significantly less than the industry benchmark. Leidos return on equity climbed from 2011 to
2012 and then declined to a low point in 2014, after which it recovered. Man Tech International
return on equity lagged below Leidos’ and showed a general declining trend, with a low point in
2013. Changes in Leidos’ net profit margin, due to previously described changes in net income,
were largely responsible for the extreme changes in Leidos’ return on equity, most notably the
low point in 2013. Man Tech International’s return on equity was significantly less than Leidos’
except in 2011 and 2013, again due to changes in net profit margin caused by changes in net
income.
Exhibit 7
Return on Equity
Leidos and Man Tech Return on Equity 2011‐2015
0.5
0
2015
2014
2013
2012
‐0.5
Leidos
Man Tech
Benchmark
2011
LEIDOS: A FINANCIAL ANALYSIS
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Beta Calculation and Risk Assessment
Investment decisions have two important dimensions: returns, which are a measure of the
value an investor receives, and risk, which is the probability of those returns being different than
expected. (Ross, Westerfield, & Jaffee, 2016). In this section, risk analysis will be discussed,
beginning with a discussion of risk concepts.
Risk and Risk Measures
While not always normally distributed, risk may be visualized as such a distribution in
which the mean and median are equal to each other and represent expected returns, and risk is
represented by the variance. Under such a distribution, the probability of extreme actual returns
is significantly less than the probability of returns that are closer to the expected returns, and
standard deviations can be used as a comparative risk measurement, while the coefficient of
variation can be used to quantify risk relative to returns.
As Exhibit 8 shows, Leidos had an expected return and standard deviation that were
higher than Man Tech International’s. As a result, Leidos has greater returns and a higher degree
of risk associated with those greater returns. One way to consider risk and returns for both firms
is to examine the coefficient of variation for each, which standardizes risk per unit of return. As
Exhibit 8 shows, Leidos has a significantly lower coefficient of variation, which indicates that
even though Leidos’ returns may have a higher standard deviation than Man Tech
International’s, Leidos can be considered to be less risky when the degree of risk is considered in
relation to the expected returns.
Exhibit 8
Firm
Leidos
Man Tech
Expected
Return
0.012702
0.006706
S.D.
0.086657
0.078392
C.V.
6.822127
11.68926
LEIDOS: A FINANCIAL ANALYSIS
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Beta Calculation
The return of a stock can considered in a manner similar to a regression model, in which
the dependent variable is the return and the independent variables include the expected rate of
return as well as factors, or risks, which are systematic or unsystematic (Ross, Westerfield, &
Jaffee, 2016). With use of such a model, the return of a stock is equal to the sum of the expected
return and the product of one or more factors and their respective beta coefficients, which
quantify the degree to which each factor contributes to the stock’s return (Ross, Westerfield, &
Jaffee, 2016).
While numerous economic, geopolitical, and budgetary risks could potentially affect
Leidos stock returns, for the purposes of this analysis the only independent variables, or factors,
used were market returns from the Rutledge 2000, NASDAQ, and S&P 500 indices. Beta, then,
for the purposes of this paper, encompasses monthly values for both Leidos and the 3 indices,
and provides an indication of the risk of Leidos stock relative to the marked indices.
In order to compute beta, monthly values were downloaded from Yahoo Finance and
copied into a Microsoft Excel 2013 spreadsheet. Returns for both Leidos stock value and index
value were computed by subtracting value x + 1 from value x and dividing by value x + 1. As
shown in the spreadsheet that accompanies tis document, the Analysis Toolpak regression
function was used, with X being equal to the index returns and Y being equal to Leidos returns.
As Exhibit 9 shows, beta values for both Leidos and Man Tech International were
positive and less than 1 for all indices, indicating that both firms show less risk than each of the
indices against which they were compared, but that their returns will follow market trends and
thus be higher or lower than expected when market returns are. Since Leidos’ beta values are
LEIDOS: A FINANCIAL ANALYSIS
20
consistently less than Man Tech International’s, Leidos’ returns will follow the industry
benchmarks less closely.
Exhibit 9
Firm/Index
RUT 2000
NASDAQ
S&P 500
Expected
Return
0.009706
0.012501
0.010224
S.D.
0.045861
0.040167
0.033529
C.V.
4.72507
3.213147
3.279527
Leidos β
0.325188
0.3087
0.245883
Man
Tech β
0.403952
0.317501
0.264582
Leidos Risk Assessment
As the spreadsheet that accompanies this document shows, the standard deviation of
Leidos’ returns fluctuated from 2012 to 2016, but showed a net significant increase that was
much larger than that of any of the market returns. Risk for Leidos has therefore increased
significantly over time, and much more so than any of the indices. When β values are considered
however, Leidos appears to be less volatile than the market indices since it is positive and less
than 1. The fact that β values for Leidos are positive and less than 1 indicates that Leidos’ returns
have some degree of correlation with those of the market, but that the correlation is not complete.
Therefore, there are other factors outside of the market that influence the risk associated with
Leidos’ returns. One such factor is the defense budget, which affects DoD outlays. As the
spreadsheet that accompanies this document shows, DoD outlays have shown a significant
declining trend in recent years. Additional factors include the risks that DoD may prematurely
cancel or reduce the scope of large contracts or delay or cancel programs that would require large
contracts (Leidos, 2016b).
Overall, Leidos shares many of the risks that the market shares, but there are additional
risks posed by changes in defense budgets, cancellation of programs, and changes in the
LEIDOS: A FINANCIAL ANALYSIS
21
geopolitical situation that have an influence as well. Risk for Leidos, therefore, depends upon
general market and economic risks as well as governmental and geopolitical risks.
Weighted Average Cost of Capital
Debt, preferred equity, and common equity have different costs associated with them.
Funding of a firm is typically accomplished through a mixture of debt, common equity, and
preferred equity, each of which has inherent costs. Weighted average cost of capital (WACC) is
a method by which the costs of a firm’s capital structure may be determined.
As the spreadsheet that accompanies this document shows, Leidos’ WACC was
computed by first determining the weights of each component and then the costs of each
component. Since Leidos had no outstanding preferred stock, its capital structure consisted of
debt and common equity. Debt component cost was determined by dividing long term interest by
long term debt to obtain the pre-tax cost of debt, which was subsequently multiplied by 1 – the
tax rate to obtain the after tax cost of debt. Common equity component cost was determined by
use of the Capital Asset Pricing Model (CAPM), in order to apply the previously computed beta
values. Common equity component costs were computed under the assumed validity of the risk
free rate of 1.98%, based on the treasury long term composite, and the expected return rate of
7.2%, based on the research of Dimson, Marsh, and Staunton. Since, in the course of performing
research for this paper, no evidence has been found warranting a rejection of these assumptions,
the author is confident in the computed WACC values.
As Exhibit 10 shows, WACC varied with each of the different component cost of
common equity values (ks), which were different based on the indices used for β computations.
The component cost of debt after taxes (kdAT), none of which was in the form of bonds, remained
constant. As expected, WACC was greatest where ks was greatest and least where it was least.
LEIDOS: A FINANCIAL ANALYSIS
22
Interestingly, ks was greater than kdAT when ks was determined using β values computed using
RUT and NASDAQ returns, but not when β was determined with S&P 500 returns. While the
difference may not seem significant, the fact that ks could be greater or less than kdAT based on
different indices used to compute β could be cause for concern if large capital decisions were to
be made. In such a case, management should carefully multiple indices and exercise caution in
relying on β values from just one.
Exhibit 10
Leidos Weighted Average Cost of Capital
WACC
0.036
0.036
0.034
=
wd
0.504
0.504
0.504
kdAT
0.035
0.035
0.035
+
ws
ks
Index
0.496 0.037 RUT 2000
0.496 0.036 NASDAQ
0.496 0.033 S&P 500
Overall Evaluation and Conclusions
As the analyses presented in this paper show, Leidos has had a tumultuous recent
financial history due to its split with SAIC, its merger with two business units of Lockheed
Martin, changes in the defense budget, and general economic conditions. An examination of
solvency ratios shows that Leidos relies debt to finance a significant amount of its assets, but that
its reliance is tempered by a use of equity financing as well. Asset utilization ratios shows that
Leidos efficiently generates revenue with its assets, but that its efficiency overall has been
declining, while its efficiency at collecting payment from its government customers has been
excellent. Asset utilization ratios also show that Leidos’ ability to use its assets to generate net
profit have varied wildly. Profitability ratios show that Leidos is less profitable than the industry
benchmark, due at least in part to the differences in contracts and prices. When compared to Man
Tech International, Leidos’ profitability ratios indicate that changes in costs, impairment charges,
LEIDOS: A FINANCIAL ANALYSIS
23
interest, and taxes have led to lower relative profitability. Market value ratios indicate that
Leidos may be undervalued and that it offers a good return on investment to potential investors.
An examination of risk shows that Leidos has less of a tendency to follow the market than Man
Tech International does and is riskier, but has the potential for greater returns. A DuPont analysis
shows that Leidos’ return on equity is consistently below the industry benchmark and has
fluctuated significantly in recent years, largely due to changes in net income. Leidos’ WACC
calculations indicate that the cost of equity varies with the index used for beta calculation,
causing it to be greater than or less than the cost of debt in some cases.
Leidos’ major strengths include the diverse nature of the capabilities and solutions its
business units can offer, its position as the largest provider of government IT solutions as a result
of its recent merger, and its solvency. Its major weaknesses are its lagging profitability, its risk,
and its vulnerability to changes in defense budgets, which are a category of government
discretionary spending. Many of the reasons for lagging profitability, such as government
contract type and the prices the government is willing to pay, are beyond Leidos’ control.
Similarly, many of the reasons for Leidos’ risk, such as unpredictable defense budgets and
changes in the geopolitical situation, are beyond its control.
In order to improve its position, Leidos must overcome its major weaknesses despite the
fact that many of them are caused by factors beyond Leidos’ control. In order to accomplish the
seemingly impossible, Leidos must consider expansion beyond the federal government and into
commercial segments. The most obvious way in which Leidos could accomplish such an
expansion would be to leverage its IT solutions capabilities. As the largest provider of
government IT solutions, which have stringent technical and security requirements, Leidos is
LEIDOS: A FINANCIAL ANALYSIS
24
well positioned to become a leading provider of commercial IT solutions for large businesses and
financial institutions.
In conclusion, Leidos’ position is one of great opportunity and great risk, due to its recent
merger, unpredictable defense budgets, an uncertain geopolitical situation, a new presidential
administration taking office, and a record setting national deficit. In order to make the most of its
opportunity and minimize its risk, Leidos must chart a path that allows it to leverage its
capabilities and expand into commercial segments, while remaining ready and able to serve new
and existing government customers.
LEIDOS: A FINANCIAL ANALYSIS
25
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