Military contractor ATK (NYSE: ATK), née Alliant Techsystems, is bulking up its consumer firearms business -- and that's not a good thing for ATK stock.
Over the past half-year, ATK has spent $1.2 billion on acquisitions to expand its presence in the consumer firearms (hunting and target shooting) market. And sure, on the one hand, this is understandable, given the limited prospects analysts give ATK for growing its business organically, and indeed, the very real risk that a downturn in military spending will cause the company's earnings to shrink.
That's the one hand. But it's ATK's other hand I'm worried about -- the hand that's throwing away ATK's shareholders' hard-earned cash on a series of overpriced acquisitions.
A history of bad decisions
ATK spent $315 million buying Savage Sports and its rifles and shotguns business. It will soon spend $985 million more for Bushnell's shooting accessories portfolio. This adds up to $1.2 billion, or nearly 40% of ATK's own market cap -- a market cap that has doubled, incidentally, over the past year.
Now, if ATK had played things smart, and used the inflated share price of its stock to pay for its acquisitions of Savage and Bushnell, that wouldn't have been so bad. Instead, the company paid cash for Savage, and plans to pay cash again to acquire Bushnell.
This is cash, incidentally, that ATK does not have. What it does have is debt -- nearly $1.3 billion in debt, versus less than $100 million in cash in its bank account. And it's going to have even more debt on its books after taking out $900 million in senior secured financing to fund the Bushnell buyout.
Take Bushnell for example -- the company's more recent, and bigger mistake. By ATK's own admission, it will take until 2016 for Bushnell to add $1 to ATK's earnings per share. ATK only has 32 million shares outstanding, so this means management hopes that a company -- that ATK is paying $985 million to buy today, let's not forget -- might possibly earn it $32 million two years from now.
That works out to ATK paying 32 times (very) forward earnings for its new prize... at a time when ATK's own shares cost less than 12 times earnings. Now, granted, Bushnell is a bit more profitable than ATK's core business. (I calculate a 13% EBITDA margin for ATK, 16.4% for its target). But it's not three times more profitable -- which is what it would take to justify paying three times ATK's own P/E ratio for it.
...and you'll underdeliver
When I look at ATK as-is, I see a stock selling for 11.7 times earnings, 9.5 times free cash flow, and growing earnings at less than 4% annually (projected). The stock doesn't look particularly cheap to me. But even if you disagree, and think a P/E in the low-teens means ATK is "cheap," then that argues in favor of management using what little cash it has, to buy back its own stock -- not run around paying 32 times earnings for new subsidiaries.
If you ask me, mistakes of the magnitude that ATK's been making lately -- remember, this is 40% of the company's own market cap being spent on acquisitions, so nearly a wholesale remaking of the company -- will be the undoing of ATK. I think as the full implication of these too-pricey purchases become clear, they'll weigh down the stock for years.
And... I'm staking my reputation on this prediction. Although I'm not short ATK stock presently (indeed, per Fool disclosure rules, I cannot sell the company short for at least three days after this article runs), I will publicly rate ATK stock an underperform on the Motley Fool CAPS stock ratings service. Think I'm wrong?