During my usual comb through some Q1 13Fs, I noticed that Bruce Berkowitz had taken a fairly large position (6.5% of his portfolio) in Vista Outdoor Brands (VSTO). Bruce is a heavily concentrated investor who – at least in the past – has strong opinions about his portfolio companies, and sizes his investments accordingly.
Upon digging into the company for a few hours, my guess would be that the investment is a bet on the sale of various assets of the company, including their firearms brands within their Shooting Sports segment (generating about 50% of 2018 revenue of $2.3 billion), as well as share buybacks, a recovery of sales caused by a tense political environment, and further debt reduction. I can’t seem to come up with another reason for going long, given the company’s industry decline, margin profile and average fundamentals.
Back of the napkin math indicates the firearms segment, with over 50 brands, many of which have hold the #1 spot in the industry in terms of market share, would go for multiples of revenue, or something close to the entire market cap of Vista itself ($1B).
Company Description
Vista Outdoor is a leading global designer, manufacturer and marketer of consumer products in the outdoor sports and recreation markets. Vista Outdoor operates in two segments, Outdoor Products and Shooting Sports. The company is headquartered in Farmington, Utah and has 18 manufacturing operations and facilities in the United States, Canada, Mexico, and Puerto Rico along with international customer service, sales and sourcing operations in Asia, Australia, Canada, and Europe.
Vista serves the outdoor sports and recreation markets through a diverse portfolio of over 50 well-recognized brands that provide consumers with a wide range of performance-driven, high-quality and innovative products, including sporting ammunition and firearms, golf rangefinders, hydration products, outdoor accessories, outdoor cooking solutions, outdoor sports optics, performance eyewear, protection for certain action sports, and stand up paddle boards. We serve a broad range of end consumers, including outdoor enthusiasts, hunters and recreational shooters, athletes, as well as law enforcement and military professionals. Our products are sold through a wide variety of mass, specialty and independent retailers and distributors, such as Academy, Amazon, Bass Pro Shops/Cabela’s, Big Rock Sports, Dick’s Sporting Goods, Sports South, Sportsman’s Warehouse, Target.
It’s no secret that the last year has been a nightmare for any company manufacturing, distributing, selling or marketing firearms, ammo or gun-related materials. The current political climate is incredibly tense, and there have to be questions, especially as it relates to the potential next generation of gun owners, whether the firearm industry will experience a recovery in terms of sales growth and positive sentiment. I’m not here to talk politics, but the point is that one has to believe that most of the negativity has been baked into the share prices of many gun manufacturers and retailers.
Vista Outdoors is no exception, and following similar announcements from various other sporting goods retailers including Dick’s and Wal-Mart, in early 2018, Vista said that it’s “potentially” selling its Savage brand of shotguns and rifles, including AR-15-style rifles, and also its Stevens brand of shotguns.
From the press release:
“Vista Outdoor is exploring strategic alternatives, which include potentially divesting the remaining Sports Protection brands, Savage/Stevens firearms, and Jimmy Styks [paddle boards,]” said the company, in a statement provided to CNNMoney. “We will begin the process immediately, but will take the time necessary to make prudent decisions.”
In their shooting sports segment, Vista Outdoor has 50 brands, ranging from ammo reloading kits to Bushnell scopes and golf range finders to Bollé safety glasses. It’s also one the nation’s largest ammunition makers, with eight ammunition brands.
“They dominate the shelf” when it comes to ammo, said Brian Rafn, gun industry analyst for Morgan Dempsey. “I think that’s their legacy.”
From the company’s most recent 10K:
The Company plans to explore strategic options for assets that fall outside of these core product categories, including its remaining Sports Protection brands (e.g. Bell, Giro, and Blackburn), Jimmy Styks paddle boards, and Savage and Stevens firearms. Vista Outdoor expects that the execution of this process will significantly reduce the Company’s leverage, improve financial flexibility and the efficiency of its capital structure, and provide additional resources to reinvest in core product categories, both organically and through acquisition. We intend to begin the portfolio reshaping immediately, and anticipate executing any strategic alternatives by the end of fiscal year 2020.
It appears that the company’s strong brand recognition and leading market share in many of the 50 brands the company owns in the shooting sports category would provide a lot of value to an acquirer in any potential sale.
Here’s a snapshot of a few of the major brands and their market position:
BLACKHAWK – no. 1 market share in gun holsters
Savage Arms – nationally recognized long gun brand
Federal Premium – no. 1 market share in ammo
Hoppe – no. 1 market share in gun cleaning accessories and solutions
VSTO has also spent years developing their manufacturing and distribution capabilities, currently operating 18 distribution centers across the US. According to Vista, the manufacture and sale of firearms and ammo is a capital intensive, highly regulated and high barrier to entry business, with long approval processes for new entrants. As mentioned above, Vista brands sit on the shelves of a variety of leading retailers, giving the company an enviable market position.
However, I believe the investment thesis here, and I’m assuming for Bruce Berkowitz relates to the value of the shooting sports division in a potential sale, or a slow divestiture of the major ammo/firearm brands over time. It appears that the shooting sports division alone could be worth multiples of the current share price, assuming management doesn’t rid itself of the segment at a trough valuation. Moving forward, I don’t think shareholders can depend on major increases in revenue, EBITDA or free cash flow given the state of the industry and current political climate, but the company should still perform well as an investment even with flat or slightly higher top line growth. The reasons for this include possible continued share buybacks, a return to normalized earnings, debt reduction, and the potential sale of nearly half the business.
Some interesting characteristics of any potential investment thesis for VSTO:
Vista was a full corporate tax payer, at somewhere above 40% through 2016. Their guidance for 2019 includes a 25% tax rate
The company has repurchased 10% of shares outstanding since 2015, and the board has authorized a $300m share repurchase program, which represents nearly a third of the company’s market cap – share repurchase program was finished as of y/e 2018 however, with no new program on the table
Shares were hit hard following the company’s Q2 2018 earnings release, which outlined profitable pro-forma adjusted EPS, but a real net loss of over $2.00/share, including an asset impairment charge (write-down) of over $150 million, this follows a $450 million write down in 2017. In addition, the current political climate and negative sentiment regarding everything firearms appears to be included in the current valuation
The company still guides for $55-$75 million in free cash flow for 2019, down from $200 million in 2018, giving it a 6-8% free cash flow yield from the low end of guidance
As mentioned above, in early 2018, the company announced they would be exploring strategic alternatives for their guns and ammo divisions
The shooting sports segment contributed 50% of total revenue at around $1.2 billion, with normalized EBITDA margins around 14%. A 1x revenue and 8x EBITDA multiple would value the segment at around $15-22/share
In order to believe in the investment thesis/story here, you’d have to get past a few huge risks, including the poor performing operating segment leftover following any potential sale of the shooting sports segment. Remember, the major asset write-downs have come from failed acquisitions on the part of management relating to their Outdoor Products business, a segment they have struggled to grow for some time.
Additional risks (with some mitigants) include:
Continued write-downs – over the past two years, VSTO has written down over $600 million of assets, or nearly a third of their EV, while experiencing a nearly 9% decline in sales. Acquisitions of outdoor sports businesses either need to be scaled back in a major way, or stopped completely. Additional asset write downs will harm EBITDA profitability metrics, and further weaken the outdoor brands segment.
Falling firearm and ammo sales – while the government doesn’t keep a metric for firearms sold, but firearm background check applications can be used as a rough proxy. According to a recent Bloomberg piece, 2,030,530 firearm background checks were logged this January, down from 2,043,184 in the same month last year and 2,545,802 in 2016, which was a record year.
According to the article: “The January number again came in seasonally weak and represented another month of stack declines following last month’s drop off (-31.8% vs. -29.6% in December and +3.7% in November),” wrote Brett Andress, an equity research analyst at KeyBanc Capital Markets, in a report released Monday. “Further, today’s print is the lowest January check since 2012.”
Selling at a trough valuation – a quick Google search on firearms reveals plenty of negative sentiment surrounding the industry, and rightfully so.
VSTO appears to have bad news, the current political climate, missed guidances, poor recent results, and unfavorable industry conditions baked into the current valuation.
Sturm Ruger currently trades at less than 10x EBITDA, and American Outdoor Brands is sitting at less than 8.5x EBITDA. This compares to about 14x for the defense industry as a whole, and 13x for consumer products. With any positive shift in fundamentals or the business climate, there appears to be some room for upside or mean regression.
Debt maturities – VSTO has a net debt position of around $915mm, with a 43% debt to capital ratio and normalized debt/EBITDA of >3.0x. The company has done a decent job of reducing leverage over the past few years, and the majority of debt maturities take place years from now.
If the company were to go through with the sale of the shooting sports segment, what could shareholders expect in terms of value creation?
For a quick comparison/sanity test for valuing Vista’s shooting sports segment – Sturm Ruger, a $1.05B dollar company, reported TTM sales of around $500 million, with nearly $100mm in EBITDA. RGR is a much more streamlined operation, with one operating segment to focus on – the manufacturing of firearms – and much higher EBITDA margins, profitability metrics, and a cleaner balance sheet. RGR trades at around 10x EBITDA.
There’s not much to report regarding RGR, and I haven’t taken a deep dive into the business, but one could imagine via back of the napkin math and a slight discount applied to VSTO given their recent struggles, that a sale of Vista’s entire shooting sports segment could fetch at least 1x revenue, or 8x EBITDA, or something around $1.0 – $1.2 billion.
American Outdoor Brands (AOBC) is a $700mm company doing $664 million in revenue for the trailing twelve months, and $109mm in EBITDA. They too, have a better margin profile, higher cash flow generation, but have also been hit hard by poor working capital management, increased debt, and declining firearm sales. AOBC trades at less than an 8.5x EV/EBITDA multiple.
So let’s say that VSTO sells their entire shooting sports division for $1.0B, or $17/share. That would be some solid value creation assuming VSTO can fetch top-dollar in a sale, which doesn’t appear likely at the moment.
Summary: Potential Catalysts to Unlock Value
Sale of gun and ammo brands – as discussed above, the firearm and ammo brands are worth hundreds of millions if not close to a billion dollars for a sale of the entire shooting sports division – the #1 market share leaders in categories such as ammo, cleaning equipment and holster would have value to an acquirer
Debt reduction and share buybacks – a transfer of EV to the equity holders from creditors upon additional debt reduction. Currently no share buyback program in place, but if management were to resume buying back shares, that sort of capital allocation could be accretive
Return to normalized earnings – excluding the most recent asset write down of $152 million, VSTO would have reported around $1.60 in EPS (including perhaps one-time favorable tax changes which caused a revaluation of $74mm). A P/E of under 10 is pretty cheap for a company that may have the worst of headwinds and asset write-downs behind them.
Conservative multiple of free cash flow – placing a 10x multiple on TTM free cash flow of $186 million (adding back $152mm impairment charge which I don’t love to do) get us to a $1.9B EV before subtracting out net debt of $892mm, which gives us an EV of $1.1 billion. Dividing by 57mm shares gets us to a share price of around $18.00. This is before tax changes, any sales uptick, improved inventory management, additional buybacks and the sale of any brands.
I’d call a fair value for the entire shooting sports segment alone around $15-22/ per share, which is less than 1x revenue, and an 8x multiple on a return to normalized EBITDA of $150mm – in line with management’s guidance of 14% EBITDA margins – and assuming you can find a willing buyer in the current political climate. If the investment thesis plays out, there appears to be significant value multiples above the current share price.
After the Remington bankruptcy, Vista might have trouble getting private equity interested in buying its firearms division. Cerberus Capital Management had previously tried to sell Remington several years ago, but it failed to attract sufficient interest. A group of creditors has now agreed to take control of the business.
VSTO will ultimately be a ‘pass’ for me, but I am going to keep following the business and see how the next few quarters unfold. After digging in a bit, one can start to see why Berkowitz entered into his position.
Full disclosure: no position.
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