3 Companies That Could Change the Defense Industry

By Markets Fool.com

Combat in this century certainly hasn't shaped up to be anything like that of the 20th. Massive ground wars involving hundreds of thousands of people have given way to sophisticated tactics for preventing terrorist attacks and cyber warfare. Bottom line: The defense industry of tomorrow will require less steel and more silicon.

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With this idea in mind, some of the Motley Fool's best and brightest got together and put forth their premier ideas for investing in an increasingly dynamic and advanced industry. Everything was on the table, from laser beams to drone warfare.

Interested in investing in the future of the United States defense industry? Read on to learn about three companies that could change it forever.

Rich Smith
Kratos Defense & Security just might be the most innovative defense stock you've never heard of. With less than $800 million in annual sales, and a market capitalization below $300 million, Kratos is a "small-cap" defense company in a large-cap world, but it's got big ambitions.

Kratos, as you may have heard, was the company tasked with building the U.S. Navy's Laser Weapon System, which made headlines when it was tested in live-fire drills in the Persian Gulf last year. Based on the results of those tests, it almost immediately was classified as an operational weapons system.

Laser cannons, capable of shooting down everything from small drone aircraft to full-fledged fighter jets to cruise missiles at a cost of less than "$1 a shot," have been called the future of the U.S. military. As one of the first defense companies to get a working laser cannon up and running, Kratos is already taking a leading role in building the military of tomorrow.

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And that's not all. For the past few years, Kratos has been hard at work on a deeply hush-hush project to build a jet-powered combat drone of its own, one capable of flying at near-mach speeds, carrying weapons, and potentially taking on manned fighter jets in aerial combat. Once operational, it will be one of only a handful of pilotless jets capable of taking on such tasks.

Granted, valuation-wise, Kratos' prospects remain iffy. While technically "profitable" from a GAAP standpoint, the company hasn't generated positive free cash flow in more than two years, and it's deeply in debt -- to the tune of more than $400 million net debt. Substantial sales of its new whiz-bang defense products could help with that situation -- or a deeper-pocketed defense major could buy the company, then bring its new products to market.

Either way, alone or as part of a better-managed owner, Kratos looks poised to help move the defense industry into the 21st century.

Matt DiLallo
Drone-maker Aerovironment isn't content with simply being the world leader for the design and manufacture of small, unmanned aircraft systems (UAS). It wants to solve important problems by developing "first of kind" breakthroughs by focusing on innovation. It's working on a number of projects that could change the defense industry.

One of the innovative projects it has worked on in the past is to provide the power generation and management system for Objective Force Warrior performance augmentation, which is an exoskeleton system. An exoskeleton is an external covering of the body, which helps to manage additional weight and load -- think Tom Cruise's character in the movie Edge of Tomorrow.

Aerovironment's role in the project was to develop the power source to meet the exoskeleton system's energy needs. The idea behind such a system would be to enable people to use heavy tools in an almost weightless environment.

DREAM. Image source: Aerovironment.

A slightly less-science-fiction project that Aerovironment'scurrently working on is DREAM, or Deployable Renewable Energy Alternative Module, which is a system designed to provide off-grid electricity. DREAM incorporates three 1-kilowatt wind turbines, a battery pack yielding 3 kilowatts per hour, a diesel generator, and 63 solar cells. It's a system that can provide 3 kilowatts of continuous power for 15 days. It would lessen the need for refueling convoys, which are a prime target during times of conflict.

Aerovironment already changed the defense industry once when it launched its first small UAS system in 1987. It is focused on changing it again through innovative efforts to develop the next breakthrough solution to save lives and the environment.

Sean O'Reilly
In keeping with the idea that the massive ground wars of the past are over, and that the future of warfare is likely to be more nuanced, technologically advanced, and smaller in scale, my pick is cybersecurity market leader FireEye (NASDAQ: FEYE). The U.S. Department of Defense has started taking steps to actually invest in Silicon Valley start-ups, hoping not only to engender innovation, but to be first in line to reap the benefits of said innovations. This step doesn't directly affect FireEye, but the implication is clear: The wars of the future will likely be fought, at least partially, in cyberspace.

One only needs to read the news every few months to catch wind of the latest cyber attack from a terrorist cell or foreign state. While there are likely to be many actors in this increasingly important subsector of the IT industry, the market leader, as it stands, is FireEye. The company not only boasts the Department of Defense as a client, but more than 4,000 entities spread across 60-plus countries, including 650 of the members of the Forbes Global 2000 Index.

Revenue for fiscal year 2015 was up 46.2% for FireEye, and the company remains one of the few cybersecurity vendors that the federal government trusts. Last year, it was the first cybersecurity company to be awarded SAFETY Act Certifications by the U.S. Department of Homeland Security.

The company is not profitable just yet, electing instead to quickly reinvest any cash that comes in the door, but given that its revenues continue to grow at an astronomical rate, a venturesome investor could do worse.

The U.S. federal cybersecurity market is, according to Market Research Media, Ltd., expected to grow from $17 billion in 2017 to $22 billion in 2022, exhibiting an annual growth rate of 4.4%.Market Research also notes that U.S. federal government spending on cyber services exceeds that of any other country by at least twofold. The fact that FireEye is trusted by Uncle Sam is worth a great deal in such a world.

There will likely be many winners in the defense industry of the 21st century, and the weight of the evidence points to FireEye being one of them.

The article 3 Companies That Could Change the Defense Industry originally appeared on Fool.com.

Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends FireEye. The Motley Fool recommends AeroVironment. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.