Clarus: Potential Compounding Machine In Outdoor Recreation

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About: Clarus Corporation (CLAR)
by: Mike Berner
Summary

Clarus Corporation is a virtually unknown company that owns several leading niche brands in the outdoors industry.

The company's owners and management have extensive experience building brands and creating a great deal of wealth.

Clarus's strategy of expansion through bolt-on acquisition and organic growth has proven merit.

Based on recent private market transactions (as detailed by Dan Roller), Clarus stock could reach the low-$20s or as high as the mid-$30s within several years.

Clarus Corporation (CLAR) is a rare under-the-radar growth stock that remains in its early stages. Although the name is virtually unknown to the general public, its various outdoor brands - including Black Diamond climbing equipment and Sierra bullets - have cultivated loyal niche followings.

Warren Kanders, the company's controlling shareholder and chairman, is a successful businessman who achieved monster returns for shareholders with his previous venture. Through both prudent bolt-on acquisitions and organic growth, there is a good chance that Clarus will successfully expand well beyond its current size and valuation.

Brand

The core Black Diamond brand traces its corporate origins to American mountaineer Yvon Chouinard, who founded a climbing equipment company bearing his name in the 1960s. In 1989, the company was forced to liquidate following a product liability lawsuit, and the remaining assets were later reconstituted as two separate companies: Patagonia and Black Diamond Equipment.

The beauty of Clarus's portfolio is that most of its brands are number one or two in terms of market share, and they have been around for many decades. Black Diamond goes back over fifty years, while Sierra Bullets has been in business over seventy.

Unique Strategy

In my previous article "An M&A Strategy That Builds Competitive Advantage And Outperforms," I cite Clarus as an example of a company taking a prudent approach to dealmaking. According to the press release that announced John Walbrecht's promotion to CEO, the company is charting a new course markedly different from the previous strategy.

As recently as 2017, Clarus mused about making acquisitions "potentially unrelated to the outdoor industry." Contrast that position with the statement that accompanied Walbrecht's ascension to the top job (emphasis mine).

...we remain fully committed to a long-term capital acquisition strategy. As we evaluate further opportunities, we now intend to be focused on the outdoor and consumer industries. We believe straying too far from companies in this space would under-utilize the great people and significant capabilities and goodwill we've built in these industries at both the Clarus corporate and individual brand levels. So, given this focus, and John's well-established and diverse background in the consumer industry, today's promotion is a strong commitment to this strategy.

Within the last two years, Clarus purchased two solid companies in Sierra Bullets and SKINourishment, a skincare products company with a focus on the outdoors industry. Clarus's capital allocation strategy is somewhat unusual in that it minimizes taxes and retains as much cash flow as possible for growth. Risk is contained through the company's minimal long-term debt burden, which amounts to just $22 million.

Over the last thirty years, Black Diamond grew sales by a CAGR of 10 percent. Following in the footsteps of the multibillion-dollar North Face brand, which also traces its roots to climbing, Clarus wants to build a footwear and apparel business based around Black Diamond. CEO Walbrecht has extensive experience in building brands, including helping to grow skiing apparel company Spyder from $6 million in sales to $135 million.

Net Operating Loss

As noted earlier, the Black Diamond and Sierra brands each go back decades. What about the Clarus name?

Here is where the story diverges from the norm. Clarus's corporate predecessor had nothing to do with the outdoors industry. In fact, it was a dot-com era technology firm that sold human resources software. After the implosion of the internet craze and subsequent market downturn, the company's financials crumbled.

In 2002, Warren Kanders and several partners began a proxy fight at the failing firm. They finally took control of Clarus in 2010, which by then was a shell company with significant net operating loss (NOL) carryforwards. Kanders then used Clarus as an investment vehicle to purchase Black Diamond Equipment and several other outdoor brands.

As of now, Clarus retains $141 million worth of net operating loss carryforwards.

Source: Clarus Annual Report, 2018

A key component of Clarus's capital allocation strategy revolves around using these NOLs to offset future income.

Our capital structure provides us with the capacity to fund future growth and our net operating loss and tax credit carryforwards are expected to offset our net taxable income, which is expected to allow us to retain cash flow for future growth.

This unusual capital structure, which minimizes cash taxes, likely keeps the company off many radar screens. In fact, we know that the company generates an adjusted EBITDA margin of almost 10 percent or some $20.7 million on $212 million in revenue as of FY 2018.

Warren Kanders

Most Clarus bulls point to Warren Kanders' involvement as a major linchpin of the investing thesis. Kanders, 61, made his first fortune weaving together a chain of over 200 eyewear stores, which he sold for $228 million in 1996. He then took $3 million of his $30 million personal gain and bought a small company that made body armor for police officers.

As CEO of Armor Holdings, Kanders built the company into a global defense/policing products juggernaut. Under Kanders, Armor Holdings stock appreciated from $0.75 in 1996 to $88 in 2007, when the company was bought by BAE Systems for over $4 billion. That represents an astounding 49 percent CAGR.

Armor Holdings not only expanded through organic growth but also followed an expansion strategy that relied heavily on tuck-in acquisition. Starting from one small firm, Kanders eventually made twenty acquisitions for AH. Even though he keeps a low profile, Kanders is undoubtedly one of the great capital allocators of our time, succeeding in two entirely unrelated industries. Clarus investors clearly hope that he will repeat his success a third time.

In any case, management incentives seem aligned with shareholder interests. Kanders and executive officers together own approximately 27 percent of the company's stock.

Valuation

In 2018, Colorado-based investment manager Dan Roller of Maran Capital wrote in his excellent analysis of the company that Clarus stock could eventually reach the mid-$30s based on his estimates of $60 million EBITDA within five years. Maran's case for Clarus factored heavily into my decision to buy this stock, and I highly encourage readers to check out his material for themselves.

Maran's memo notes that recent transactions within the outdoor industry imply a private valuation for Clarus higher than its present market value. If Clarus were to sell itself at 2.2 times sales, a multiple on par with recent private market deals, then it would be worth some $466 million - nearly $80 million more than the present market value.

Source: Maran Capital Clarus Memo, June 2018

Maran bases his valuation on the prediction that Clarus will build a successful footwear and apparel business at Black Diamond and add value at Sierra. His projection calls for $350 million in sales at Black Diamond within five years, up from $175 million today.

As noted previously, Black Diamond grew sales at a 10 percent CAGR over thirty years, at a time when the business consisted chiefly of hard goods. The climbing category itself is growing at a robust annual rate. According to IBIS, climbing gym revenue increased 7.2 percent annually over the last five years, with total gym count up 9 percent annually. Based on these factors, it seems likely that Black Diamond can keep growing sales at 10 percent a year. If Sierra grows at a similar rate, that means that from a combined base of $212 million, Clarus could achieve $341 million in sales within five years, which is pretty close to Maran's number for Black Diamond alone.

Again using the 2.2 times sales figure, Black Diamond alone would be worth $620 million by 2024 ($282 million in sales multiplied by 2.2). Even if Sierra stayed at the $80 million that Clarus paid for it, that still gives us a total value of $700 million. That is at least a 12.5 percent annual return over five years.

Negatives

With its portfolio of leading niche brands and clean balance sheet, there is little risk that Clarus is going away any time soon. Still, the stock's performance was somewhat disappointing until fairly recently. Prior to new management taking over, Clarus seemed largely rudderless and bereft of a clear strategy. As recently as 2015, when organic revenue growth at Clarus was flat, it looked as though Kanders would sell the firm. In 2014, Clarus divested Gregory Backpacks for $85 million (a $40 million profit in four years). Many investors fled the stock after a deal for the full company failed to come to fruition.

While investors hope for another Kanders' compounding miracle, I doubt that he plays much of a day-to-day role at the company. In addition to his Clarus position, Kanders serves as CEO of policing products company Safariland, which he bought back from BAE after selling Armor Holdings. Kanders' past victory at AH probably informs Clarus's present strategy, but I do not expect a repeat of his previous coup.

Conclusion

Although the valuation is significantly higher than last year, I believe that the stock will continue appreciating based on the company's strong performance and execution. My estimate of a $700 million company implies a future stock price in the low $20s per share - at least 70 percent upside over a five year period. Under Dan Roller's most optimistic scenario, which includes share buybacks at attractive valuations, one can envision a stock valued in the mid-$30s.

In a less rosy future, Clarus does not perform as expected and Kanders tries selling again. Maybe instead of growing sales at 10 percent a year, it only manages 7 percent and gets taken out at 2.2 times $297 million. Even in that underwhelming scenario, investors still earn a decent return.

Based on the evidence, though, this seems like a bet with above-average prospects. With management's track record, I think there is a good chance that Clarus could turn into a compounding machine over the next 10-20 years.

Disclosure: I am/we are long CLAR. 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.