Summary

American outdoor brands' management team is expected to separate the firearms business from the outdoor products and accessories business by August 2020. This is represents a 180 degree turn from the trajectory that management was on a few years earlier, but is welcomed news given the nature of the businesses that the company has under its umbrella. The outdoor products and accessories business, despite sharing target markets with the Firearms business, presents a bigger challenge to the company, and is potentially a major distraction for management. At the same time, there are a number of ongoing challenges in the Firearms business that require careful attention.

Management Had a Different View 4-Years Ago

In November 2016 the company, under the leadership of P. James Debney, proposed to the shareholders that they vote for a name change from Smith & Wesson to American Outdoor brands, which shareholders accepted. At the time the rationale was that the Smith & Wesson name is synonymous with firearms, and the company was about to embark on a strategy that would expand the range of brands beyond firearms. It was also felt at the time, that the company needed to diversify as the firearms business was highly cyclical while outdoor categories were much more stable. According to statement in form 10-K:

In fiscal 2017, which ended April 30, 2017, we changed the name of our company from Smith & Wesson Holding Corporation to American Outdoor Brands Corporation to better reflect our expanding strategic focus on the growing markets for shooting, hunting, and rugged outdoor enthusiasts. We believe that the name “American Outdoor Brands Corporation” better reflects our family of brands, our broad range of product offerings, and our plan to continue building upon our portfolio of strong American brands.

Conveniently, the Outdoor Products and Accessories division was created shortly after the company had acquired Battenfeld Technologies Inc., Hooyman LLC, and Power Tech Inc. Subsequent to the name change the company then went on to acquire 3 additional businesses for the outdoor products and accessories business line.

What Has Changed ?

Over the last 4-years there have been significant changes in the management team, the market and the relative sizes of each business line. Since 2015, the outdoors segment has grown from US$20.6Mn in sales to US$167.5Mn today. Last fiscal year - which excludes the impact of COVID-19 - the outdoor division did approximately US$177.2Mn in revenues. Today, the "Firearms" business does US$529.6Mn in revenues. The board of directors of the company replaced CEO P. James Debney on account of "conduct inconsistent with a non-financial company policy" in January 2020. Going into the spin off, the board announced that Mark Smith and Brian Murphy - who were executives of the company - would both become co-CEOS with, Murphy elected to run the outdoor division after the spin-off. The company noted that Murphy was president of the outdoor products and accessories unit and Smith the president of the manufacturing services unit. The market for Firearms has been re-emerging from a cyclical low which saw the stock price of the company bouncing from US$6 to now US$21.30 per share.

What is the Outdoor business today?

According to form 10-K the outdoor part of the business focuses on the design, source, distribution and manufacture of products and services that serve people who are interested in shooting, hunting, and rugged outdoor activities. The range of products covers the following:

  • gunsmithing
  • gun cleaning supplies
  • stainless steel cutting tools and accessories
  • flashlights
  • tree saws and related trimming accessories
  • shooting supplies
  •  laser grips and laser sights
  • vault accessories

The division sells these products under several different brands namely: Caldwell, Wheeler, Tipton, Frankford Arsenal, Lockdown, Hooyman, BOG, Crimson Trace, Imperial, Schrade, Old Timer, Uncle Henry, BUBBA, Smith & Wesson, M&P, Thompson/Center, and UST. As at April 2020, the division had gross profits stood of US$69.3Mn (41.3% margin) and an operating loss of US$111.3Mn. In the previous year the division did US$80Mn in gross profits (45% margin) and operating loss of US$18.4Mn. Given that the company had a non-cash charge of US$98.7Mn and US$10.4Mn in 2020 and 2019 respectively, it appears that the division was operating cashflow positive before the spread of COVID-19.

How Does A Spin-off Fit

In-spite of the risks inherent in every corporate restructure, a spin-off can help the company in many ways. The competitive dynamics of the firearms business is entirely different from that of the outdoors segment. The Smith and Wesson brand  is over 168 years old and is well established when compared to the suite of brands under the outdoor segment. In this context, significantly more management attention is needed to groom the brands in the outdoor segment to maximize their "differentiable potential". In previous reports, we mentioned that Smith and Wesson has a distinct cost advantage in the firearms manufacture space, a space which is highly concentrated. In cyclical downturns the company's cost advantage allows it to weather margin compression. Unfortunately, this is not the case in the outdoor segment. The outdoor segment is in a highly fragmented industry with numerous small players. This requires a different strategy, that of consolidation, a strategy that requires focus and intimate knowledge of the industry. 

The size of the outdoors segment has increased immensely from 0.5% to well over 25% of the consolidated business. This growth in size has led to a few complications. First, the management team of the outdoors segment needs to expand faster than the firearms segment, which requires a different type of organizational culture than that required for a well established stable business. Second, the demand for capital will become increasingly greater as the business grows. At this point the Smith and Wesson business needs its free cashflow for its own capital needs. The outdoors segment would be a great fit for another larger business that is already in the space, and that has significant excess free cashflow.

Concluding

The spin-off of the outdoor brands segment from Smith and Wesson​ Brands could create some opportunities for investors. Over the past year Smith and Wesson stock has grown by well over 130% on the back of a significant recovery in the purchases of guns and munitions. At the same time, the outdoors business segment has become unfavourable in the eyes of the public as sales, gross profits and operating income deteriorated in the face of COVID-19. After the spin-off of the business there will be significant selling pressure as investors realign their portfolio. Over the near term however, there will also be a recovery as economies re-open, and as the management team continues their consolidation strategy. These factors create the "perfect storm" for a short term bargain.