Smith & Wesson (NASDAQ:AOBC) thinks it just bagged a 12-point buck of a bargain, but is it right?
Earlier this month, Smith & Wesson announced that it had finalized the purchase of gun accessories maker Battenfeld Technologies, a deal first announced in November. Battenfeld, bought from private-equity house Clearview Capital for $130.5 million, sells "shooting, reloading, gunsmithing, and gun cleaning supplies" to gun enthusiasts, according to its website. Its products feature brand names such as Caldwell Shooting Supplies, Wheeler Engineering, Tipton Gun Cleaning Supplies, and Lockdown Vault Accessories.
The purchase mirrors the flurry of deal-making we saw at ATK (NYSE:ATK) last year, when that company bought long-guns manufacturer Savage Arms, and then Bushnell Group Holdings. (ATK subsequently spun around and announced plans to spin off its shooting products division this year, in preparation for merging its space exploration business with Orbital Sciences (NYSE:OA).)
This latter path, however, is not one Smith & Wesson is likely to follow. So what does Smith & Wesson hope to gain from this acquisition?
Smith & Wesson, you see, is doubling down on its firearms business in hopes of goosing a lagging growth rate. Over the past five years, according to S&P Capital IQ, S&W's core firearms business grew revenue at only 7% annually. In contrast, S&W said in a press release that its new Battenfeld subsidiary has achieved a "compound annual revenue growth rate in excess of 18%" since 2006.
And it's expected for perform even better for one of Smith & Wesson's auxiliary businesses -- at least initially.
According to S&W's latest 10-K filing, handgun and long gun sales account for the vast majority of company revenues, while only about 6.8% of sales -- $42.7 million -- come from "other products & services." But S&W expects Battenfeld to produce fiscal 2016 revenue "in excess of $55 million." This will more than double revenue from S&W's "other products and services" category.
...for a high price
Will this acquisition be good for shareholders? It depends. Battenfeld has more going for it than just growth. The company is also extremely profitable, with earnings before interest, taxes, deductions, and amortization, or EBITDA, expected to surpass 27% of revenue in the coming year. That's even better than the (quite respectable) 23.9% EBITDA margin that Smith & Wesson proper earns. Between the added revenue and better profits Battenfeld will contribute, management expects the acquisition will be "accretive to Smith & Wesson gross margins, earnings per share, and cash generated in fiscal 2016, which begins May 1, 2015."
But is it worth it?
That said, I see two significant downsides to this deal. First and foremost, the growth that Smith & Wesson aims to buy might not be worth the price it's paying.
Consider: At $130.5 million, S&W is paying nearly 2.4 times Battenfeld's sales, a valuation more than twice S&W's price-to-sales ratio of 0.9. Granted, Battenfeld is growing revenue at more than twice (18%) S&W's pace (7%), but Capital IQ figures show that, while its sales growth might be lagging, S&W has grown EBITDA at close to an 18% pace over the past five years. So unless Battenfeld is growing its profit faster than it is growing revenue (a claim S&W has not made), the logic of paying up for faster (revenue) growth at Battenfeld might not be as sound as it ... sounds.
Second, in paying up for Battenfeld, S&W is digging itself deeper into debt. Already, S&W's balance sheet shows $64 million in cash against $175 million in debt. After anteing up for Battenfeld, though, the company could be looking at a net debt load (debt minus cash) of roughly $240 million -- nearly half its own market cap, versus just 21% of market cap today.
In the best case, therefore, I think this deal adds little value to Smith & Wesson stock (an opinion it seems many investors share, given that S&W's stock price hasn't improved much at all since the deal was announced).
And worst case? Suffice it to say, more debt is rarely a good thing.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Orbital Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
More from The Motley Fool
How to Invest in Gun Stocks
The firearms industry can be a complicated sector for investors, and not just because the catalysts that move gun sales can seem counter-intuitive.
Why American Outdoor Brands, MoneyGram International, and Community Health Systems Slumped Today
Find out how a failed takeover hit one of these stocks hard.
What to Expect from American Outdoor Brands Corp in 2018
It doesn't look like a turnaround is on the horizon for American Outdoor Brands.