Smith And Wesson: Keep Shares Locked And Loaded, Part 2

Jul.29.13 | About: Smith & (SWHC)

On July 12th, I published an article about the Smith and Wesson (NASDAQ:SWHC) tender offer of $11/share to purchase up to $75 million of the company's common stock. In the article I advised that long-term shareholders should reject the tender offer and hold onto their shares. This article will provide an update on the tender offer and further support my case as to why investors should continue to hang onto their shares.

On July 24th, the company announced the preliminary results of their tender offer which expired at midnight on the evening of the 23rd. Based on the preliminary count; the number of shares tendered and not withdrawn was 1,431,747. The number of shares represents 2.2% of the shares outstanding.

Longs Still Not Selling

Once again this was a lukewarm response to the tender offer. Even though the company increased the tender offer price by 10% from $10/share to $11/share, they were still only able to purchase 21% of the shares the tender was authorized to buy back. The tender offer was for up to 6,818,181 shares and they could only get 1,431,747 shares tendered. The results of the tender offer show that the longs are not willing to give up their shares at this price level. This is a bullish sign because it shows that most of the owners feel like their shares are worth more than $11.

Buyback on Open Market

Now that the tender offer is complete, the leftover funds from the tender offer under-run will be used to purchase shares on the open market. These funds will be added to the $25 million the company has already authorized to buy back shares on the open market. From the company's press release they have not yet started buying back shares on the open market and are not allowed to do so until 10 business days after the tender offer is complete. There is $59.3 million remaining from the tender offer and combined with the $25 million from the buyback program means that there is now $84.3 million authorized to purchase shares on the open market. Longs are in a good position now that there is still significant capital that can be used to support the share price in the event of internal or external adverse events.

Valuation After Buyback

Let's look at an analysis of Smith and Wesson's market cap and the effect the tender offer and buyback program could have on the company's share price. Before the announcement of the tender offer and the buyback, Smith and Wesson had 64.3 million shares outstanding. Over the last few weeks shares have been trading around $11 and the company has a market cap of $707.3 million at the $11/share price.

Share Price Shares Outstanding (Millions) Market Cap (Millions)
$ 11.00 64.3 707.3
Click to enlarge

By taking out the 1.4 million shares purchased in the tender offer, the shares outstanding will be reduced to 62.9 million. At this number of shares outstanding, in order for the company to have a $707.3 million market cap, the shares would have to be trading at $11.24.

Share Price Shares Outstanding (Millions) Market Cap (Millions)
$ 11.00 62.9 691.9
$ 11.24 62.9 707.3
Click to enlarge

The remaining amount of the buyback program is $84.3 million. To make the analysis simpler, we will assume that the price will continue to hover around $11.00 and the buyback can be completed at an average cost of $11/share. If the full buyback took place at this average price, a total of 7.7 million shares would be able to be purchased, reducing the float to 55.2 million shares. In order to trade at a $707.3 million market cap, shares would have to be trading at $12.81. This represents an upside of 16.4% to the $11/share price.

Share Price Shares Outstanding (Millions) Market Cap (Millions)
$ 11.00 55.2 607.2
$ 12.81 55.2 707.3
Click to enlarge

Cabela's and Ruger

On Thursday, July 25th, Cabela's (NYSE:CAB), an outdoor sportsman's retailer, reported its 2nd quarter 2013 earnings. Cabela's is an online and nationwide retailer that has benefited from the gun boom as they sell firearms and ammunition in addition to outdoor sporting goods. Their report gives a glimpse of Smith and Wesson's next quarterly report because they are on different reporting schedules. Cabela's results contained the months of May, June and July while Smith and Wesson's next quarterly report will contain May, June and July. During Cabela's conference call CEO Thomas Millner stated that, "excluding firearms, comp store sales increased 9%. While much of the comp increase was a result of strength in firearms and shooting, we realized double-digit comp growth in hunting apparel, archery and optics." Smith and Wesson investors can now deduce that for the 2nd fiscal quarter gun sales continued to remain high.

Investors in Smith and Wesson can also get another preview of things to come as competitor Sturm and Ruger (NYSE:RGR) reports their quarterly results on July 31st. This will further affirm the health of gun sales for the current quarter. In addition to the quarterly report, Ruger also announced on Friday, July, 26th that a severe thunderstorm caused a portion of the roof to collapse at its Prescott, Arizona production facility. Ruger stated in a press release that "this temporary disruption may have a material impact on the Company's results of operations for the third quarter of 2013, but is not expected to have a material impact on the financial position of the Company". This could be an opportunity for Smith and Wesson to pick up some additional sales in the coming quarter, as Ruger will see production dip a little bit in the 3rd quarter.

Short Interest

Short interest still remains very high. According to NASDAQ, as of 6/29/13 there were 11.8 million shares short. This represents a short interest of 18.35% using 64.3 shares outstanding. This percentage will increase even further to 18.7% once the tender offer transaction is finalized and could balloon over 20% if the entire buyback program is executed.

The large short interest also represents an opportunity for longs. The stock is trading around the $11 range right now and the 52 week range is $7.40 to $11.40. For the majority of this timeframe, the stock has only briefly traded above $11. This means that a lot of the short interest in the stock is underwater or near breakeven. If there is further rise in the price, there could be potential for a short squeeze.

Conclusion

In addition to the reasons outlined in my prior article, there are now a few more reasons to consider hanging on to Smith and Wesson shares. The company has been able to increase the price per share without using much of its share repurchase funds. The $84.3 million remaining will provide a boost to shares or cushion any drop in price due to internal or external factors. As a result of my analysis above, if Smith and Wesson purchases the remaining $84.3 million of their buyback around the $11/share range, the price per share will have to increase to the high $12's to maintain the same market capitalization as it does now. This is a potential double-digit percentage gain in the making. There is also a large short interest that is underwater in the stock, and moving up into the $12 range could spark a short covering rally that could send the stock even higher. Investors can also sleep soundly now that Cabela's reported strong retail sales of guns in their second quarter as this shows that Smith and Wesson's gun sales should be strong in the second quarter as well. Investors should consider to keeping their shares locked and loaded as there are many catalysts to drive the stock price higher in the future.

Disclosure: I am long SWHC. 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.