Strong interest in an auction of electronic surveillance and intelligence company Applied Signal Technology Inc has sparked a rally in tech firms likely to be targeted by defense contractors facing cutbacks.

At least four defense contractors -- Raytheon Co, Cobham Plc, L-3 Communications Holdings Inc and Science Applications International Corp -- have submitted initial bids for Applied Signal, people familiar with the matter told Reuters on Friday.

As big contractors search for takeover targets to quickly grow their cybersecurity offerings, KEYW Corp and Mercury Computer Systems could follow Applied Signal to the auction block in coming years, bankers and analysts say.

KEYW, co-founded by Leonard Moodispaw, former chief executive of high-tech defense manufacturer Essex Corp, collects, processes and analyzes data and information for government agencies, including the National Security Agency and the Department of Defense.

Moodispaw sold Essex to Northrop Grumman Corp in 2007 and founded KEYW in August 2008.

Investors appear to expect a rerun of the Essex story, pushing shares of KEYW up 40 percent since it went public on October 1 and giving it a market value of $350 million.

No doubt about it, said one banker covering the defense sector when asked if KEYW was likely to be eventually merged into one of the large defense contractors. I think Leonard's trying to repeat his Essex experience here.

The banker, who spoke on condition of anonymity, said it would take some time for KEYW to consider a sale of the company because it has struck nine deals since its launch in 2008 and management believes it can create more value by rolling out newly acquired technologies.

They need to make sure the financials catch up with all the deals they have done, said the banker.

Another banker, however, said the timetable might be accelerated, given the scarcity of sizable cybersecurity assets in the marketplace and a dealmaking spree in a challenging defense budget environment.

Mercury Computer Systems, based in Chelmsford, Massachusetts, is another cybersecurity firm likely to draw interest from defense contractors, bankers said.

The firm makes digital signal and image processing systems and software, which process real-time radar, sonar and signals intelligence data in military reconnaissance and surveillance platforms. Its market value is about $480 million.

Mercury shares have risen 86 percent in the past six months, outperforming a 14 percent rise in the Standard & Poor's Aerospace & Defense index.


In many respects, the auction of Applied Signal is similar to the bidding war for bigger rival Argon ST, which was sold to Boeing Co earlier this year for $775 million.

Rich valuations seen in the Argon deal -- Boeing paid a 41 percent premium -- and expected in any deal for Applied Signal could raise expectations for the next cybersecurity targets.

Boeing, Raytheon and Cobham were the final bidders for Argon, sources have said. With final bids for Applied Signal set for December 17, Raytheon and Cobham appear keen to acquire the firm, one source close to the process said on Monday.

Applied Signal hopes to clinch a deal before Christmas, the source said.

Boeing's purchase price for Argon was 14 times Argon's earnings before interest, tax, depreciation and amortization (EBITDA).

Applied Signal's current share price of $35.20, or a market value of over $470 million, already implies a multiple of 14 times projected 2011 EBITDA.

The source familiar with the matter said Applied Signal was seeking as much as $38 per share. Though bidders revolted against the suggested price-tag, the winning bid is likely to be at a premium to the current market price, the source said.

It's just a function of valuation, a third banker familiar with the matter said. From a strategic fit, it fits very well with every one of them. It's only a function of how much they're willing to pay.

(Reporting by Soyoung Kim; editing by John Wallace)