A substantial body of research supports the idea that spin-offs can be attractive long-term opportunities, and this article showed recently how an index of spin-offs outperformed the market by a significant amount. Likewise, a number of great investors including Charlie Munger say individuals can do well by looking at spin-offs. So with that in mind, I was interested to learn about the recent spin-off from Smith & Wesson Brands (SWBI) which began trading just over one month ago as American Outdoor Brands (AOUT).
The first step in investigating a spin-off is to try to understand the business itself including its profitability, competitive position and long-term prospects. The second step in my opinion is to try and develop an opinion as to why the company was spun-off from its parent. The third step is to form a thesis about whether or not (and under what conditions) this stock could make a good investment.
1. American Outdoor Brands’ business
American Outdoor Brands sells “outdoor products and accessories” which were once part of Smith & Wesson Brands (see Preliminary Information Statement). This is a list of products from the company’s business description in the most recent 10Q:
Description of Business
We are a leading provider of outdoor products and accessories encompassing hunting, fishing, camping, shooting, and personal security and defense products for rugged outdoor enthusiasts. We conceive, design, produce or source, and sell products and accessories, including shooting supplies, rests, vaults, and other related accessories; premium sportsman knives and tools for fishing and hunting; land management tools for hunting preparedness; harvesting products for post-hunt or post-fishing activities; electro-optical devices, including hunting optics, firearm aiming devices, flashlights, and laser grips; reloading, gunsmithing, and firearm cleaning supplies; and survival, camping, and emergency preparedness products. We develop and market our products at our facility in Columbia, Missouri and contract for the manufacture and assembly of most of our products with third-parties located in Asia. We also manufacture some of our electro-optics products in our facility in Wilsonville, Oregon.
We focus on our brands and the establishment of product categories in which we believe our brands will resonate strongly with the activities and passions of consumers and enable us to capture an increasing share of our overall addressable markets. Our owned brands include Caldwell, Wheeler, Tipton, Frankford Arsenal, Hooyman, BOG, MEAT!, Uncle Henry, Old Timer, Imperial, Crimson Trace, LaserLyte, Lockdown, UST, BUBBA, and Schrade, and we license for use in association with certain products we sell additional brands, including M&P, Smith & Wesson, Performance Center by Smith & Wesson, and Thompson/Center Arms. In focusing on the growth of our brands, we organize our creative, product development, sourcing, and e-commerce teams into four brand lanes, each of which focuses on one of four distinct consumer verticals – Marksman, Defender, Harvester, and Adventurer – with each of our brands included in one of the brand lanes. Our sales activities are focused and measured on how we go to market within the e-commerce and traditional distribution channels. These two channels involve distinct strategies to increase net sales and enhance market share. Our sales team is organized by customer groups, which we refer to as classes of trade, within the e-commerce and traditional channels and sells our products from all brands in all four of our brand lanes. We measure our success through sales performance in these distribution channels against prior results and our own expectations.
Our Marksman brands address product needs arising from consumer activities that take place primarily at the shooting range and where firearms are cleaned, maintained, and worked on. Our Defender brands include products that help consumers aim their firearms more accurately, including situations that require self-defense, and products that help secure, store, and maintain connectivity to those possessions that some consumers would consider to be high value or high consequence. Our Harvester brands focus on the activities hunters typically engage in, including hunting preparation, the hunt itself, and the activities that follow a hunt, such as meat processing. Our Adventurer brands include products that help enhance consumers’ fishing and camping experiences.
I’ll point out that this includes everything related to sport-shooting and hunting except the actual guns and ammunition (more on this later).
AOUT earned a net profit for the most recent quarter after a loss from the same quarter a year ago, which suggests both good news and bad news:Quarterly Report, page 6
Quarterly Report, page 8
We see large adjustments for depreciation and amortization. It makes a big difference as we analyze this company what kinds of intangible assets are being amortized. Based on the descriptions in Note 4:
Quarterly Report, page 15
It appears to me that these intangibles represent values assigned to the going concern of the business (such as contract rights, licenses or patents that expire) rather than assets we would need to replace. So I think it’s reasonable to add back the amount of amortization from the cash flow statement (over $5.3 million in each of the two quarters we’re looking at) net of amounts needed to re-invest in the business such as R&D expenses of $1.2 million and cash flows used in investing activities from the cash flow statement of almost $1 million. I’m sure I’ll come in for criticism for imprecise use of accounting terms, but this is a not unreasonable approach estimating the owners’ real earnings from this business. To that end, would say the company earned $3 million more than it reported as Net Income in the two quarters we’re looking at.
The good news is that the company is profitable and taking advantage of trends such as the growth in outdoor activities in response to shut-downs related to the Coronavirus. The bad news is if it took the biggest shift in behavior in memory in order to earn this amount of money, what happens if future years revert to a mean that is more similar to the same quarter in 2019?
All-in-all, this looks to be a profitable consumer products business.
2. Why did they spin it off?
In my experience, companies give you almost all the information you need but they may make you read between the lines in order to understand what it means. To that end, I find the timing of this spin-off which was first considered in November of 2019 to be very interesting. In the wake of mass shootings at Walmart stores in 2019, Walmart announced in September of that year that it would limit sales of guns and ammunition. On November 12 of last year, the Supreme Court allowed a lawsuit to proceed against the manufacturer of a gun used in a well-known mass casualty shooting. It appears to me that this timing is critical background when you read the sentence in AOUT’s Preliminary Information Statement, “On November 13, 2019, SWBI announced that it was proceeding with a plan to spin-off its outdoor products and accessories business.”
Based on the close timing of these events, I believe that the goal of Smith & Wesson’s management in spinning off American Outdoor Brands was to protect or save as many assets as possible from an increasingly likely exposure to lawsuits. This view combined with the fact that the company has no financial debt and recent insider purchases indicates to me that it’s likely AOUT was spun off to try to do well, not to hide or shift problems to another publicly traded company.
3. What would make this a good investment?
If you believe that AOUT is a profitable business, based on the recent quarter and taking the good while leaving the bad from the previous 5 years’ summary results, then two coming events could make this an interesting time to buy.
The first is that one reason spin-offs can be a source of high returns is because the new company may be unfamiliar to shareholders. Imagine owning 1000 shares of Smith & Wesson but not following the company closely, when all of a sudden you get paperwork for a spin-off and then one day your brokerage account has shares of something you don’t recognize and don’t remember purchasing. Many people in this situation will sell without investigating the background of the spin-off, the qualities of the new company or the changes to the old company. This extra motivation for selling suppresses the share price, and it may be more pronounced around both the end of the quarter on September 30 and again at the end of the year as people consider taking profits and losses for tax purposes.
The second reason this could be an interesting time to consider the spin-off is because of the US Presidential election. As described in this article “Americans Are Frantically Buying Military Gear Before the Election” Republican candidates have generally supported the gun industry and Democratic candidates have generally opposed it, and this has led to incongruous results for gun manufacturing companies: a Democratic win may mean gun buyers accelerate purchases in anticipation of new restrictions. To that end, the Trump administration has actually been a hard time for guns sales (see for example the bankruptcy of Remington). To that end, one could develop a thesis around anticipating the results of the election and expecting gun sales and perhaps the sales of shooting accessories to either increase or decrease.
Normally I only write articles about companies when I have a firm idea to buy or sell them. In this case, I thought the opportunity was interesting enough to just want to start watching it. The most valuable thing I get out of writing an article for Seeking Alpha is actually the feedback from knowledgeable commenters and subsequent interactions and relationships. For that reason, I just want to say that American Outdoor Brands is a stock I want to watch closely from now on.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.