Today we will look at the positives and negatives of American Outdoor Brands Corporation (NASDAQ:AOBC) (recent name change from Smith & Wesson Holding Co.) as a potential security holding. I will alternate discussing pros and cons lest in leaving all the cons until the end you decide against investing in a company that may meet your investment criteria, or vice-versa. The goal is not to talk you into or out of buying, holding, or selling, but rather to provide information so you can make your own informed choice.
Shareholders recently approved the name change from Smith & Wesson Holding Co. to American Outdoor Brands Corporation. Many consider it a huge misstep to give up one of the most iconic and recognizable brand names in American history and replace it with a bland label. But the name change aims to encompass more than just guns as the company is branching out into accessories and other rugged outdoor gear. AOBC now sells firearms, laser sights, tactical lighting, cases, knives, camping gear and much more.
Pro: The company is ambitiously engaging in both organic and inorganic growth to branch out beyond guns. Here is a list of relatively recent acquisitions:
- Battenfield Technologies: With this acquisition in 2014 came a small army of brands including Caldwell shooting supplies, Wheeler gunsmith supplies, Tipton gun cleaning supplies, Frankford Arsenal reloading tools, Bog-Pod gun rests (monopods, bipods, and tripods), Lockdown vault accessories, Golden Rod humidity controls, Hooyman tree saws, and Non-typical Wildlife Solutions which basically sells fences that helps you regulate deer access to your crops. Acquisition made with cash and on credit. Battenfield had compound annual revenue growth of 12% in the years leading up to the acquisition.
- Ultimate Survival Technologies: Bought in 2016. Provider of fine outdoor camping and survival equipment. Bought with cash on hand and by utilizing a revolving line of credit. UST had a compound annual revenue growth of 49% 2012-2015.
- Taylor Brands: 2016. Taylor Brands makes high end knives and specialty tools. Paid with cash on hand. The ttm revenue of Taylor Brands was $39 million marked from the date of acquisition.
- Tri-Town Precision Plastics: Also bought in 2014, this company provides plastic molding and parts for firearms as well as for the medical, aerospace, communications and automotive fields. Made with cash on hand.
- Thompson Center Arms: Purchased in 2007 this company specializes in designing pistols and rifles with interchangeable barrels that allow for the flexibility to fire various calibers from the same stock and body. They are also credited with the 1970's resurgence of black powder hunting with muzzle loaded rifles.
- Crimson Trace: Bought just last year in 2016, Crimson Trace is a leader in laser sighting systems and tactical lighting. Compound annual revenue growth was 10% for the 10 years preceding the acquisition. Bought with cash on hand.
AOBC has been on an absolute spending spree. However, they had the cash on hand to do it and each of these acquisitions will be quickly accretive due to their tuck in nature. The acquired companies were already suppliers and product licensees for Smith & Wesson for many years, so AOBC will now save money not having to buy from these companies. This emphasis on vertical integration is a money saver and money maker, as opposed to just buying out companies here and there that seem related to the field of firearms and hunting but have previously had little business with one another. For example, per AOBC website, the Crimson Trace acquisition made in the middle of 2016 will be accretive by 2017.
This is due to the fact that AOBC no longer has to purchase from Crimson Trace, instead getting the products in house while also benefiting from any sales of Crimson Trace products at Cabela's, internet retailer Optics Planet Inc., and others. This improves margins in addition to increasing revenues. AOBC is making smart acquisitions of only the best companies with strategic products.
These acquisitions appeal to different segments of the firearm user and outdoor enthusiast population. Crimson Trace has a huge buyer-ship in law enforcement and the military, ensuring consistent and reliable revenue streams since the need will be ever present. Thompson Center Arms appeals to the novelty shooters, hunters, and hobbyists. Ultimate Survival Technologies and Taylor Brands markets to campers and fishers. Add these to the already wildly successful sale of the Smith & Wesson branded products for hunting and personal defense and you have a company that appeals to every subsection of the gun enthusiast market and anyone who likes nature.
In terms of organic growth the company is constantly researching, developing, and marketing new weapons to meet new needs and wants amongst gun owners. From their annual report we read 'Our product development strategy is to understand our customers needs and then design and develop products to uniquely meet those needs'. For example, in 2016 they put to market existing models equipped with new sights, introduced next generation models of their sporting rifles to include forward bolt assist and an ejection port cover, issued a newer version of the .22 target pistol, and expanded their M&P pistols to include Laserguards (a laser sight that secures to the trigger guard and is activated by simply holding the weapon in a natural firing grip). AOBC values research and development and chooses to spend money in response to new trends and customer preferences. At this years SHOT show they launched 100 new products spanning their diverse business segments between firearms and accessories.
In short, the company is growing fast. All of it's acquisitions were of solid companies that were already recording impressive growth. It's R&D and marketing team is on target to continue meeting customer wants and needs.
Con: AOBC's reputation, sales, and the ensuing implication for its stock value is subject to enhanced volatility due to the unique and complicated politics surrounding guns in America.
The recent election of Donald Trump to the presidency has seen gun manufacturers stock take a hit. Both AOBC and Sturm/Ruger (NYSE:RGR) have seen their stock price drop 20% since the election. This is based on the assumption that sales will go down because there is no longer an urgent felt need among 2nd amendment advocates to stockpile guns. With Republicans in control of the presidency, the senate, and congress, little pressure will be felt by the American populace to buy a firearm. Hence the downside in the stock. However, this could all change whenever a democrat is elected. An important caveat: this is only a con if you don't have the stomach for volatility. Politics in America will have a poignant effect on gun manufactures for the foreseeable future. If seeing your stock sea-saw doesn't bother you, elections and other political events/talk can create awesome buying/selling opportunities. The recent downturn is where I initiated a small position in AOBC. No prolonged discussion will be attempted here of what will happen to gun laws in the USA. The individual investor will have to decide for himself/herself what the long term trajectory will be for firearm regulations in this country. The threat is indeed present for tighter laws that could make it harder to buy guns, which would naturally devastate AOBC. This is not just hot air. The Federal Assault Weapons Ban from 1994 to 2004 prohibited the manufacture and sale of some semi-automatic weapons and large capacity magazines for civilian use. A renewal of the ban was proposed in 2013. This is an inherent and considerable risk to owning stock of gun manufacturers. Whatever does happen, count on volatility.
Pro: Management is very informative and transparent about the current state and future prospects of the business.
Reading the annual report for AOBC is quite the experience. A LARGE portion is devoted to devolving information to shareholders concerning micro and macro-economic factors affecting the company. The section is entitled 'Risk Factors'. It is so thorough that about halfway through it almost felt like management was trying to talk you OUT OF investing in the company. This, to me, is positive. The management team and board of directors treat their shareholders like owners, which they (the managers) should because they (the stockholders) are the owners. This is becoming more rare with publicly traded companies. Many annual reports are stuffed with fluffy generalities, platitudes, catch phrases, vague promises, and buzzwords that shed little light on what is actually going on with the company. At AOBC, shareholders are treated as equals who have the right to know everything there is to know about the company. This team of leaders, led by CEO James Debney, wants you to be in the know. Their discussion topics include a wide range of issues to include diverse headers such as "We often rely on third parties, including independent sales representatives and agents that act on our behalf", "The failure to manage our growth could adversely affect our operations", and "We may incur substantial expenses and devote significant resources in prosecuting others for their unauthorized use of our intellectual property rights". They leave no stone left unturned when it comes to being upfront with shareholders about the challenges facing the company. A management team that has investors interest at heart is a huge plus.
Con: AOBC has quite a few legal problems to deal with.
By the nature of the business they are in, AOBC is going to get sued. There are no two ways about it. They are currently the defendants in seven product liability cases, and they say they are aware of nine more. The charges brought against them are what one would assume; "defective product design, defective manufacturing, or failure to provide adequate warnings." When accidents happen with guns investigators will look at the weapon itself to see if the accident could have been avoided if it were better designed, if it happened as a result of a defect, or if there were better warnings on the item. The weapon manufacture will have to answer for any problems uncovered in these categories. If nothing else the company pays money to hire legal defense teams to handle these cases, which can be quite costly, while also having to pay fines if they lose a given case. In their annual report they describe all their lawsuits as "unfounded", and anticipate winning the cases. However, they also say that financial damages resulting from current lawsuits are not estimable at the present time. They can't even give a ballpark figure for how much these charges will cost them, meaning that the sky is the limit. In fiscal year ending April 30, 2016, AOBC paid $618,000 total for litigation. This represents hardly a drop in the hat for a company with $723,000,000 in revenues. Plus they have insurance coverage for such occurrences. Nevertheless it is a problem that can not be shrugged off. We live in a sue-happy society. Couple that with the spread of liberalism and this may become more of a significant factor as time goes on. Lawsuits against AOBC may become more common and they may not win many of them.
On the product defect side, in September of 2016 Thompson Center Arms had to recall all bolt action rifles of the Compass model due to accidental discharge risks. Apparently the gun could misfire upon being dropped and the safety was in the "fire" position. A similar thing happened in 2013, with guns being recalled because the safety function was not operating properly. Obviously, recalls are COSTLY. They include shipping charges and fixing the defect for free, not to mention the fact that their reputation can be damaged and customers will be hesitant to buy that model/brand in the future. The sad fact is that these defects are only discovered when something BAD happens to someone. That's when the lawsuits roll in and the recalls are made.
It's not only private citizens bringing AOBC to court;
We have been and may continue to be subject to governmental investigations and inquiries. Such investigations and inquiries could subject us to various sanctions, including significant civil and criminal penalties, the indictment of our company or various of our officers and employees, our being prevented from bidding on domestic military and government contracts, our disbarment by the U.S. Department of State, private civil litigation arising out of the outcome of the investigations or inquiries, the diversion of time and attention of our management from normal business operations, and a negative impact on the perception of our company by investors, customers, and others.
They go on to cite an instance in 2014 where the SEC brought charges against then Smith & Wesson Holding Corporation for dubious dealings with overseas nations that violated the Foreign Corrupt Practices Act. Basically, S & W made illegal payments and gifts to foreign governments to try and win contracts. This amounted to about $2,000,000 in settlement fees and for two years S&W had to report to the SEC to prove they weren't doing those things anymore. As I mentioned before this doesn't amount to much in terms of hard financial results but the non-tangible effects can be weighty such as damage to reputation, management diversion, and the precedent that these current legal issues set for the future.
Pro: The company has considerable intangible assets.
Brand recognition and legal protections are becoming increasingly important in our highly competitive free market. The minute someone comes up with a novel product or service it isn't long before a host of competitors emerge to try and steal market share. This is where trademarks, patents, and name recognition can protect a company with the proverbial wide moat. AOBC is the keeper of many said intangibles.
Smith & Wesson has been around since 1852 and has a rich history that has led to true fame as. An article from May 2006 embedded on the Smith and Wesson website referred to a study done by the American Sports Data Institute that found that Smith & Wesson has an unaided brand recognition of 89% amongst consumers. The importance of this can not be understated. If someone decides they are going to buy a firearm Smith & Wesson will be one of the first names that comes to mind or that they will recognize when reviewing their choices at the retailer. While people might be willing to risk a buck or two on an off-brand bottle of ketchup the same thrift is not applied to more expensive purchases. You buy established brands that are trusted and proven. While certainly experiencing its ebbs and flows, Smith and Wesson has weathered the storms and have become incredibly established. A few facts follow showing the rich history of S&W and, therefore, how entrenched AOBC is:
- The rimfire cartride, though not invented by Smith & Wesson, was developed, improved, popularized, and patented for use as the .22 Short in their first revolver, the Model 1.
- It's first form debuting in 1899, the Model 10 revolver (known at different times as the Smith & Wesson .38 Hand Ejector Model, Smith & Wesson Military & Police, Victory Model) may be the most popular revolver ever. It has been continually manufactured since its introduction. It has been used pervasively by various militaries around the world, particularly during WWII by Britain, Canada, Australia, and New Zealand and South Africa. Most recently it was used by the U.S. Army in 1991 Operation Desert Storm.
- Smith & Wesson is patriarchal amongst gun manufacturers. Winchester firearms got it's start using an original lever action designed by Smith & Wesson.
- AOBC has patent protection on 42 items and trademark protection on hosts of labels sold under the AOBC corporate umbrella.
- S&W .44 Magnum was featured and made famous by Clint Eastwood in the movie Dirty Harry.
- In 2016 Smith & Wesson shipped its 1 millionth M&P shield. The company introduced the shield in 2012. AOBC is the largest handgun gun manufacturer in America today.
The company indeed has a moat.
Con: Successfully integrating acquired companies is challenging.
A study conducted by the Harvard Business Review in 2015 showed that between 70 and 90% of all mergers and acquisitions fail. Management at AOBC acknowledges that this could happen to them:
Our recent acquisitions and any acquisitions that we undertake in the future could be difficult to integrate, disrupt our business, and harm our operations.
Expected synergies often don't materialize. Unexpected charges and challenges arise associated with integrating the new company. Company cultures clash as two business entities are brought together. These factors often overwhelm management and over-burden the acquirer. This can happen with a single acquisition, but AOBC has had the wherewithal to buy MANY companies over the past few years. Even before a temperature can be taken regarding how well one business is being integrated they undertake another buy-out. There is a reason you let the foundation set before you build the house. One must ask if AOBC is allowing enough time for things to settle with one acquisition before purchasing another. While growth is exciting, there is growth that happens too fast. If nothing else acquisitions cost money. In 2016 $212.3 million was spent on acquisitions, representing nearly 30% of revenue for that year. This is a lot of money paid all at once for intricate businesses to be subsumed by another business. Could that money have been spent in a more measured way, allowing for one acquisition to fall into place before making another? Initiate a dividend or pay a special dividend? Buy back more stock? Invest in existing manufacturing facilities or build a new one (they only have 3) to increase efficiency and output to avoid being capacity constrained (which has happened to AOBC in every fiscal year since 2014)? The acquisition spree can be problematic.
That's all for now. Please comment below and tell me what you think so I can become a better contributor. And thank you!
Disclosure: I am/we are long AOBC.
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.