It was announced Friday that Smith & Wesson’s (SWBI) Board of Directors approved the spinoff of their “Outdoor Products and Accessories” business line as American Outdoor Brands, which generates just under $170M in annual sales and is the product of a series of acquisitions. The segment is described as “a leading provider of outdoor products and accessories encompassing hunting, fishing, camping, shooting, and personal security and defense products for rugged outdoor enthusiasts.”

Spinoffs such as this one, especially given the relatively small size of the child company, often create opportunities for enterprising investors through mispricings of both the parent and child. The distribution of American Outdoor Brands (AOUT) stock will be completed on August 24th, and the new stock should then begin trading.

Firearms

The parent company of the American Outdoor Brands spinoff will remain trading with the ticker SWBI, and be a pure-play firearms business. I believe focusing in on a core business line and spinning off non-core business is a great move and demonstrates good business sense and shareholder focus of management, regardless of one’s beliefs regarding the firearms industry. While I find the child of this spinoff much more interesting, I’ll provide some trading comps on the parent as well since often both the parent and the child do well after a spinoff for a variety of reasons. Joel Greenblatt discusses this at length in “You Can Be a Stock Market Genius.”

The firearms industry, as far as pure-play stocks go, is effectively a duopoly between Smith & Wesson Brands, Inc. and Sturm, Ruger & Company, Inc. (RGR) Both are roughly the same size in terms of revenues, enterprise value, and market cap, and therefore Sturm, Ruger & Company makes for a very simple comparison with the remaining parent of Smith & Wesson. Sturm, Ruger & Company is valued at about 2.6x EV/Sales and 13.5x EV/EBITDA, while Smith & Wesson Brands currently trades at 2x EV/Sales and 13.6x EV/EBITDA. Spinning off a lower-performing division and focusing on their core business will likely raise the parent’s valuation closer to Sturm, Ruger & Company’s 2.6x, but may stay flat in a more bearish scenario.

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With $529.6M in sales for the remaining “Firearms” business segment, this places the parent’s enterprise value between $1.05B and $1.38B. The “whole” company currently has an enterprise value of $1.4B. Unfortunately, this is a wide range of values, but it does give an idea of what the spinoff stock may look like: somewhere between $20M and $350M in EV, likely on the lower end since we ought to see multiple expansion upon divesting the Outdoor Products business, since firearms companies command a higher multiple of sales than general outdoor and sports products.

American Outdoor Brands

Per Smith & Wesson’s 10-K filing, the “Outdoor Products and Accessories” segment that is being spun off as American Outdoor Brands generates around $152M in sales from external customers with little growth. It does about 41% gross margins, and posted an operating loss for the year ending April 30th, 2020 of $111M. This includes a $98.7M impairment of goodwill, leaving an adjusted operating loss of $12.3M.

Given the large amount of goodwill and other intangible assets ($64.6M and $68.8M, respectively) that must be amortized over time, the stated adjusted EBITDA earnings come out to $12.3M, and may be materially higher. $12.3M in EBITDA on about $167M in total revenues and $127M in tangible assets – a 10% ROIC and 7% EBITDA margin. These are indicators of a strong, profitable business.

The most obvious trading comps for the Outdoor Products segment are Sportsman’s Warehouse Holdings, Inc. (SPWH), Dick’s Sporting Goods, Inc. (DKS), and Clarus Corporation (OTC:CLAR). Sportsman’s Warehouse Holdings trades at around a 1.1x EV/Sales and 17.7x EV/EBITDA, while Dick’s Sporting Goods has a slight discount: 0.9x EV/Sales and 14.8x EV/EBITDA. Clarus Corporation commands a premium on both of these metrics, at 1.7x EV/Sales and 23x EV/EBITDA.

All peers have EBITDA margins around 7% and slightly lower gross margins (33%, 27.5%, and 34.61%, respectively), which may be accounted for because the Outdoor Products segment reporting does not include all general corporate expenses. Therefore, while EV/EBITDA may be valuable to gain insights, EV/Sales is the most apples-to-apples comparison since it is capital structure and tax-agnostic and does not depend upon assumptions or adjustments based on unknown financials.

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EV

Sales

EBITDA

EV/Sales

EV/EBITDA

SPWH

$1.08B

$959M

$60.98M

1.13

17.73

DKS

$7.36B

$8.16B

$496.84M

0.90

14.81

CLAR

$376.62M

$221.77M

$16.28M

1.70

23.14

AOUT

?

$167M

$12.3M

?

?

Clarus Corporation, due to its similar size, is likely the closest peer. However, Clarus has net operating loss carryforwards of $132M and some sales growth (0.76% YoY and 7.32% 5-year CAGR), neither of which are features that American Outdoor Brands possesses. Therefore, Clarus’s valuations should be used as a ceiling for the American Outdoor spinoff.

The average EV/Sales of these three peers is 1.24x, which is a fair yet conservative estimate. At 1.2x sales of $167M, AOUT stock should trade at an enterprise value around $207M. Assuming 13.8M shares outstanding and net debt between -$25M and $0 per the investor presentation, AOUT shares are likely fairly valued at somewhere between $15 and $17. This valuation would represent an EBITDA multiple in the mid to high-teens, which is in line with management’s expectations.

Opportunity

There’s a few ways to play a spinoff, especially prior to the shares getting distributed. The most intuitive is to simply purchase shares of the parent prior to the distribution date, and hold until they reach fair value. As discussed, both parents and children of spinoffs tend to perform well following a spinoff – but often, the child stock is subject to short-term price volatility due to forced selling.

This forced selling following a distribution of the child company’s shares can happen due to a number of reasons: indexers selling it because it is not included in a benchmark, stockholders who bought the parent as a pure-play firearms company, and institutional constraints of size and liquidity. While I cannot guarantee that this forced selling will occur (it barely did with Otis Worldwide Corp. (OTIS)) it is quite likely that there will be at least some opportunity to purchase shares of AOUT cheaply.

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As far as I can tell, no insiders have discussed what they plan to do with the shares of the child company, but insiders at Smith & Wesson do own about 2.79% of the stock (or $36M) and executives are compensated mostly in stock. For the spin-co, an incentive plan has been filed that discusses “performance stock unit” grants based upon the spin-co’s stock’s outperformance relative to the Russell 2000 index. Though we don’t have dollar or share values yet, this aligns the incentives of management and shareholders fantastically.

One interesting aspect of this transaction is that on August 10th, Smith & Wesson stock will have a “when-issued” market for the child under the ticker “AOUTV,” allowing for investors to purchase the child stock in advance of its distribution. This can also allow investors to “create” the parent stock by going short AOUTV and long SWBI.

I believe that both owning the parent and child and simply purchasing the child once it begins trading (or on the when-issued market) present interesting and compelling investment opportunities, as so many spinoffs do. Given the vast difference between actual economic earnings (taken as adjusted EBITDA) for American Outdoor Brands and GAAP net income, there may be opportunity for even greater mispricing than a typical spinoff of this size, so I lean heavily towards the child stock.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AOUT, AOUTV over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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