Terror May Be Your Portfolio's Security

Safety fears have billions flowing into the homeland defense industry. It may be a smart bet, but volatility makes it a tricky investment

By Eric Wahlgren

With security officials worried that terrorists may try to throw the U.S. Presidential election into chaos, companies in the business of helping thwart such attacks are in a sweet spot. Both the government and private corporations are doling out contracts like never before in a scramble to find ways to keep people safe. The homeland defense industry, a $4 billion market in 2000, the year before the September 11 attacks, is expected to balloon to more than $170 billion in 2006, according to market researchers Homeland Security Research Corp.

Despite all the dollars flowing there, homeland defense can be tricky for investors. Many outfits are still one-product companies whose fortunes can hinge on winning a single key contract. Others are working on technologies that, while promising, have yet to be proven. In this latter camp are scores of concerns like Miami-based DOR BioPharma (DOR ). Its share price has zigzagged between 36 cents and $1.58 in the past year as investors weigh its potential to develop vaccines against possible bioterrorism attacks involving toxins such as ricin and botulinum. BioPharma shares now trade at about 41 cents, near their 12-month low.


  Indeed, many homeland defense stocks are off highs reached in a three-month rally that began after the deadly Madrid train bombings by al Qaeda in March, says Dawn Van Zant, founder of investment portal www.homelanddefensestocks.com in Point Roberts, Wash. Adds Peter Cohan, an investment expert and management consultant in Marlborough, Mass.: "The problem with a lot of these stocks is that they're not yet big moneymakers. They seem to get a bounce on the day of a terror warning and the day after, and then they seem to go back down again."

The stocks, however, are due for another advance leading up to the November U.S. elections, Van Zant believes. "I hope nothing bad is going to happen," she says, "but unfortunately, the reality is people fear there could be a major event closer to the election." Though Van Zant's site doesn't dispense stock-picking advice, she suggests that investors note where the big government contracts are going when looking for investments in this field. "Companies that can generate ongoing contracts and adapt to technology trends will benefit long term," she says.

One player that has gotten a chunk of change from the feds recently is New York-based L-3 Communications (LLL ). The defense contractor is the No. 2 supplier of products like walk-through metal detectors and high-end bomb-detection systems for airports, says Peter Arment, an equity analyst with JSA Research in Newport, R.I. Its main rival, No. 1 supplier InVision Technologies (INVN ) is in the process of being acquired by General Electric (GE ).


  Arment has a buy rating on L-3 and a $71 target price, suggesting that its share price could appreciate 18% from current levels over the next 12 months. He likes L-3's market potential: Only eight U.S. airports out of hundreds have the company's latest automatic bomb-detection systems. What's more, the nation's ports present another big potential market for screening systems as only 1% of incoming cargo is now checked, according to Arment, who says "L-3 is very well positioned."

Another promising company is CACI International (CAI ), the Arlington (Va.) defense contractor that also works with Unlce Sam to collect intelligence information and build secure networks, among other tasks. "They help the government keep track of what's going on in the world and have a high level of clearance, so the barrier to entry [for competitors] is obviously very high," says Stephen Leeb, editor of The Complete Investor, a New York-based financial newsletter for institutional and retail clients.

CACI's stock is 32% off its 52-week highs after a lawsuit alleging that it was involved in the prisoner-abuse scandal at the Abu Ghraib prison in Baghdad. CACI denies the allegations. And on Aug. 10 it said it had gotten a $15.3 million four-month contract extension to help the U.S. Army with interrogations in Iraq.


  As for Van Zant, she says she has been watching DHB Industries (DHB ), which makes tactical body armor for law enforcement, federal agencies, and the military. Profits for the Westbury (N.Y.) company rose 88% in its most recent second quarter as demand for its products jumped. And the share price is up 250% over the past year. "The stock has had a great run," Van Zant says, "and they have been announcing a series of substantial contracts."

Longer term, Van Zant believes the government's $5.6 billion "Project Bioshield" initiative will be a boon for players involved in developing ways to protect against bioterrorism attacks involving anthrax, smallpox, and other toxins. RAE Systems (RAE ), which makes portable chemical- and radiation-detection devices, is one concern that could gain, Van Zant says. The Sunnyvale (Calif.) outfit's stock is up 71% in the past year. But it's a small fry, earning $2 million in profits on $31.3 million in revenues in 2003, so it has lots of room for growth.

Another company that Van Zant says could benefit from bioterrorism defense is Genencor International (GCOR ) in Palo Alto, Calif. It's working on enzymes that could neutralize sarin gas and other nerve agents, she says. The stock is off about 5% from its year-ago level. In 2003, Genencor earned $22 million on revenues of $383 million.


  Perhaps a less risky way to bet on the growing homeland defense market is by investing in some of the big names in related industries that are also picking up federal contracts. Though homeland defense represents a small part of what these players do, the contracts can give them a boost, says Greg Parker, a research analyst who covers this sector at AIG SunAmerica in Jersey City, N.J.

Among the big winners in the $10 billion "U.S. Visit" initiative to beef up border controls are business-services outfit Accenture (ACN ) and conglomerate Raytheon (RTN ), Parker says. They'll focus on systems integration and will farm out a lot of the other work to subcontractors, he says.

Also, defense giants Lockheed Martin (LMT ) and Northrop Grumman (NOC ) are carrying out an $11 billion project to help the U.S. Coast Guard upgrade its ships and aircraft with state-of-the-art surveillance and communications capabilities. "These are not pure plays on homeland defense, but homeland defense is a nice addition to what they do," Parker says.


  Cohan argues that the best way to terror-proof a portfolio is to boost holdings in defense, insurance, and gold. In defense, he likes Raytheon, citing its diverse product mix, including aircraft, radar, and missile systems. In the insurance business, his pick is Marsh & McClennan (MLC ). The parent of troubled mutual-fund firm Putnam Investments also does a lot of business as an insurance broker. "[Because it's] a broker, it doesn't hold any insurance risk," Cohan says. And in gold -- the ultimate sky-is-falling investment -- Cohan favors Placer Dome (PDG ). "Long-term, these types of companies are a good way to play the threat of terrorist attacks," Cohan says.

Hope persists for the day when terrorist attacks are no longer a concern. But with homeland defense clearly a necessity right now, it makes sense for investors to take a look at this growing, if highly volatile, industry.

Wahlgren is a reporter for BusinessWeek Online in Paris

Edited by Thane Peterson

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