Monday, December 8, 2014

ATK's Sporting Division Spin: Vista Outdoor

I have made a few mistakes this year in spinoffs, particularly energy related ones like Civeo and Paragon Offshore (washed out/sold out of both) that looked cheap using past earnings but their futures have been brought in question with the quick drop in oil prices.  An upcoming non-energy spinoff, but also one with a potential cyclical earnings top is Vista Outdoor, the ammunition and hunting accessories business of Alliant Techsystems.  So before following me into another spinoff consider that risk up front.

Alliant Techsystems (ATK) has three main lines of business: aerospace, defense, and sporting goods.  In February 2015, the sporting goods business ("sporting goods" might be a stretch, really ammunition, guns, and hunting accessories with grander plans to diversify) which makes up 39% of ATK's revenue will be spunoff as Vista Outdoor (VSTO) to ATK shareholders, and the remaining aerospace and defense businesses will be merged via a Morris Trust transaction with fellow aerospace and defense contractor Orbital Sciences (ORB) immediately after to form Orbital ATK (OA).

Quite a few moving parts, but let's focus on Vista Outdoor.  Starting in 2001, ATK entered the sporting business with the acquisition of Blount International's ammunition group, and recently added BLACKHAWK! in 2010, and firearm manufacturer Caliber and accessories maker Bushnell in 2013.  All rolled up, Vista Outdoor will be the number one provider of ammunition for various markets, and then also sell hunting accessories, rifles, gun cleaning products, targets, tactical accessories, goggles/glasses, and range finders.  Below is a slide from their investor presentation to give you an idea for their product offering:
The sporting business has seen 15% annual growth for a decade, spurred on even more recently with the "surge" in gun demand due to the real or perceived threat of tighter gun controls under the Obama administration.  Only about 10% of their revenues are firearms, so think of Vista Outdoor as more the razor blades piece in the razor/razor blade analogy business model.  With the rise in number of guns purchased in recent years, the number of potential customers for Vista to sell ammunition and accessories into has also increased (also good demographics, young males, more females coming into the sector, etc).

Transaction Details
On April 28, 2014, ATK and Orbital Sciences entered into a deal in which ATK would spinoff Vista Outdoor first, and then merge with Orbital Sciences to form Orbital ATK, original ATK shareholders will own 53.8% of the new company, with Orbital Science's shareholders receiving the other 46.2%.  The deal was originally scheduled to close this year, but has been pushed back to February 2015 pending shareholder approval on 1/27 due to a rocket launch failure at Orbital (more on that in a bit).

What really makes this transaction work is both entities should be better off afterwards, I don't see a dump transaction taking place here.  Orbital trades at a significant premium to ATK, so this deal should be accretive to Orbital shareholders.  Institutional and long term investors in ATK should also end up sticking with the new Orbital ATK, ATK has been a defense and aerospace contractor first and foremost for its history, and the new company will remain in the same industry/market cap indexes.  The typical spinoff forced selling dynamics don't appear to be at play here.  There should also be a number of operational and financial synergies in the new Orbital ATK, the two appear to have a lot of complimentary business lines, natural fit between the two companies that should result in both cost efficiencies and revenue synergies.

ATK's CEO Mark DeYoung will be coming over to Vista Outdoor, he's been with ATK since 1985, well before they entered the sporting business space.  He lead the push towards sporting and his move to the spinoff is a further sign that Vista is really the crown jewel asset and not a dump transaction.  I believe it should end up with a premium market multiple as a niche consumer staple company over the old ATK which as a defense contractor has seen its margins and multiple contract in recent years.  Vista will also have limited debt, just $350MM in net debt, or about 1x EBITDA giving it flexibility to make additional acquisitions to diversify away from guns and ammo.  ATK acquired Bushnell in 2013 for $935 million in debt (10x EBITDA purchase price), interestingly most of the debt associated with the deal is going to end up on Orbital ATK's balance sheet making the spinoff even more attractive.

Antares Launch Failure
On October 28th, Orbital Sciences had an Antares rocket explode spectacularly on live TV 14 seconds after launching from NASA's Wallops Flight Facility in Virginia.  The rocket is contracted to provide periodic supplying trips to the International Space Station for NASA, although a significant reputational loss, insurance proceeds are supposed to minimize the financial impact of the launch failure.  Both Orbital and ATK's shares took a 10-15% hit in the aftermath of the failure as there was concerns the deal would fall through, but both sides have agreed to continue, yet the shares have only partially recovered providing an opportunity to buy Vista Outdoor synthetically even cheaper since the rocket business has no relationship with the sporting business.

In the first six months of ATK's fiscal year (starting 4/1/14), the sporting business has done $1.1B in sales, annualizing that figure gets you to $2.2B for the year which is slightly below management forecasts of $2.3B at the time of the spin announcement.  Using a 13% EBIT margin and $73MM in annual depreciation, I come up with roughly $360MM in EBITDA.  After interest expense and a 35% tax rate, Vista should have about $5.50 per share in projected earnings.  What is the market currently valuing Vista at?

Below is a quick comparables table I built using other mid-to-large capitalization defense and aerospace contractors.  If we assume the new stronger Orbital ATK trades at a peer average of 8.5x EBITDA and a market multiple of 15 (and roughly between where ATK and Orbital trade separately), my math shows the current share prices of Orbital and ATK essentially reflecting those valuations. 
By piecing out ATK, and backing out the Ortibal ATK position, the market is currently valuing VSTO at $53.59 per share, just under a 10 P/E or 5.7x EV/EBITDA.  That's pretty cheap for a company with a double digit long term growth rate, but that comes back to the question of peak earnings?  Management thinks the slowdown in the gun market should reverse itself in the back half of 2015, there's a decent amount of data to back that up (Black Friday had record gun sales), but just from a big picture viewpoint I can't see America's love affair with guns fading anytime soon?  But I could be wrong.

I struggled a bit on how to put this position together, the ATK options look a little expensive to my untrained eye, and by my math Vista Outdoor is really the undervalued entity, one can go long 1 share of ATK and short 2.23 shares of ORB to synthetically create a long position in VSTO ahead of the transaction.  So that's what I did today, the short ORB will cancel out the shares in OA I receive and will leave me with just the VSTO shares if/when the transaction is completed in February.  Within a few months, I would expect VSTO to be trading much higher than the mid-$50s.

Hat tip to a reader who brought me this idea.

Disclosure: I'm long ATK / Short ORB (synthetically long VSTO)


  1. I think Michael Maubossin in this report ( has Ammunition and Firearms as one of the industries with the highest pricing power (pg 17 I think search ammunition). From 2006-2011 the industry has increased prices by an astounding 9.5% CAGR. So a lot of the growth rate is price increases which can continue more or less indefinitely, rather than quantity increase which can't. This also explains why a mature business in a developed country is growing like gangbusters. This makes the company even more attractive in my eyes at least.

  2. Maubossin report is a great spot. However, it is worth noting that the study occurred between 2006 and 2011, quite abnormal years for the industry. I'm concerned that the current pricing increase is not sustainable, not to mention the trajectory.
    How far is this from a commodity business that enjoyed a few years of excess demand due to fears of changes of laws and stockpiling?
    What are the competitive advantages of Vista that could keep the prices where they are? How strong is the Savage, Federal Premium brand? Margins today across the ammo producers are quite a bit higher than what they were before 2011. The company noted that several of its competitors are lowering the prices and stated they won't follow suit. What gives them confidence to say that?
    MDC, thanks for the article.

    1. Interesting report indeed, and I agree, probably have to go even prior to 2006 to get a true sense of long term trajectory.

      I'm not a gun owner, never been hunting, so I'm far from an expert in the space, but in my head I'm comparing Vista's brands to Titleist golf balls. A clear premium product for the diehards that lasts through the cycles. Maybe that's the wrong analogy, but was my thought process in how they're going to try and maintain margins. Also - don't necessarily discount the Bushnell acquisition, its complements their sporting existing businesses but also should de-emphasize the reliance on ammunition and relieve some of the stockpiling concerns.

  3. "Management thinks the slowdown in the gun market should reverse itself". Probably the single worst source to use in judging future demand, IMHO. I agree with the notion that we are closer to peak revenues (nay, supra-peak revenues) as the loonies and nutjobs are not worried any longer about a Kenyan-born dictator taking away their shiny guns and their fat, toothless women (and in that order of priority).

    If you go back, say 20-30 years, and look at the long term growth rate for this sector, it roughly tracks population growth plus some pricing power. The last 6 years are an anomaly - not the right period to extrapolate.

    1. Ha. I agree with your overall assessment, but what's the right price given a lower long term growth rate? The estimates I used are lower than was first discussed at the time of the spin, lower than the few analysts that have estimates out there, and I still come up with Vista trading at 9-10x earnings. Maybe I'm still too high, but at the current valuation I think there's some room to be wrong and still come out ahead once the spin happens and investors are able to buy Vista directly. Thanks for the comment.

  4. You can look at the # of background checks here:

    It's interesting to note the stockpiling that occurred after Sandy Hook, is only a small number 2-3 million at most compared to the total number of checks a year which is around 18 million and growing. I found this when I was researching Smith and Wesson and for some reason I still didn't buy so there was something I didn't like about this trend but I don't remember what.

    1. I can't find it now, but I read that specifically ammunition was stockpiled after Sandy Hook more so than guns themselves. People doubled and tripled down on ammunition purchases so it might take some time for customer's personal inventory to be used up and purchases normalized again. I like the ammunition business over the gun business like Smith and Wesson, more that repeat purchase aspect and with the growing customer base I think it should return to strength once the stockpiling wears off. Thanks for the comment.

      An aside, while both ATK and ORB have fallen a bit since my post, the VSTO stub has remained about the same price (I'm showing $52.19 today). The implied valuation of the new OA is actually starting to look attractive and I might cover my short in ORB to participate in that side of the transaction too.

  5. I would recommend caution on this one as well (like Paragon). Why do you think ammo sales can't fall by 40% from here? If a republican president takes office the stock-piling will end no? Although I would agree that this situation is allegedly better: the larger installed base should increase annual demand for ammo. Do you have any thoughts on what the normalized annual churn for ammo is and how elevated are we?


      Gun sales actually rallied in December, NICS background checks only fell 0.5% from the 2013 surge to 2014's final numbers, demand can certainly fall from here but maybe those fears are overblown? At least in the short term (this is more of a medium term trade for me than a long term investment). I'll fully admit I'm a novice in this market, never handled a gun before, don't understand the irrationality of those who think Obama is about to restrict sales, but I'm just looking at the numbers and they still seem pretty healthy?

      I also think there's plenty to differentiate this spin from Paragon or Civeo, long time management is coming over to the spinoff, both ATK entities should be in a stronger place after the spin, Vista will continue to diversify away from guns/ammo and more into accessories or other markets, etc. I agree with recommending caution, I think I've sized this trade correctly, and it's up about 15% since posting. I still show it about ~50% below fair value and believe some of that will be made up in the next month before and after the distribution. Vista has much different dynamics than Paragon, Paragon was a dump/rush job, questionable management installed, more of a cut off the rotting limb before it infects the rest of the body type spin, whereas Vista seems much more rationale and has been years in the making.

      Thanks for the comment, and I enjoy your blog, keep up the good work.

    2. MDC - thanks for your comments. Perhaps my comment on PGN/SSE is inept, but I could easily see this being a RYAM. Here's why:
      - If you run the excise tax collected on guns & ammo, you can see an almost identical YoY trends. The CAGR accelerated from ~5-7% / annum to 15%+ since 2005 due to a confluence of factors.
      - There are some secular positives in-play, but if I run the excise tax @ 10% / annum, the current excise tax number is still 46% above this normalized trend.
      - Further, pre-2005 era, the gov basically taxes ~28-30 cents for every gun outstanding (excise / est. guns), this number ran to $1.15 in 2013. If I use a generous 60 cents (i.e. ppl shoot 2x as often), we still get to 40% over. if I use 35, it's 70% drawdown.
      - The fear-driven ammo stashing will quickly turn into lower-price-anticipating waiting if the pricing turns. Given the inventory in the channel and the hoarding the numbers will be abysmal, no?
      - I agree on the M&A aspect, in fact I think it's exactly why they spun w/ little leverage no? Makes me even more nervous about their core business. and they hadn't been exactly good at acquiring either. Savage is a disaster and Bushnell isn't too hot either.
      - I do think there is a trade here, and that's from event-driven tourists taking your shares higher. Once the numbers come to light I wonder how many will run for cover. I could be wrong, but I think the logic I laid out here is sound. There might be another 15-20% upside from here, but I wonder how quickly analysts get around this topic.
      - How do you handicap the 2016 presidential election risk?

      Overall I think mgmts got smarter over time and spins got more dangerous. Would love to hear your pushback.

    3. Good comment, I'll have to digest the excise tax numbers a little bit and get back to you. You've honestly done more channel checking work than me.

      But my overall thinking here is, let's say you're right and earnings fall significantly in the short to medium term, isn't that what's currently being baked into the price? Based on the spinoff ratio of 2 VSTO shares for each ATK share (so divide everything in my post by two), VSTO is trading for $29 per share, 6x EBITDA and 10.5x earnings, if earnings fell in the near term, it would still trade at or below the overall market.

      I don't know if you've had a chance to go through the road show presentation, it's obviously a bias pitch, but does include some interesting numbers regarding the growth in the consumer base, favorable demographics, increase in shooting ranges and the like.

      Regarding spinoffs as a whole, I've learned that lesson the hard way in the last year. At this point in the cycle, you're right, spins are getting more dangerous. The only ones that are on my radar right now are the BDC breakup plays (ACAS and PSEC) where the asset management companies hold a lot of value and the BDC pieces are terrible, but still have that retail yield trade holding them up for the time being. Other than that, I'll probably avoid spinoffs until things change, look for other pockets of value/special situations out there.

      No view on the presidential election, I view the stock piling based on politics as irrational. If a Republican were to win office, maybe you'd see a temporary blip, but nothing permanent. Guns seems more intertwined with American patriotism more now than anytime I can remember, and Republicans are good at invoking patriotism.

  6. I closed out the ORB short side of my position, while the Orbital ATK part of the transaction appears fairly valued you to me I don't want to miss out on both popping into and out of the spinoff/merger. Plus, Chris DeMuth has pitched Orbital Sciences twice on Seeking Alpha, I highly respect him and he's got a huge following which can move the market.

  7. Good read. I think that the question that needs answered is whether or not management can quickly and efficiently allocate capital horizontally into outdoor sports.
    Unlike the comments above, I think that Bushnell could actually be a crucial investment for the Company. Margins actually ticked up last quarter despite pricing pressures. I believe that this is the result of integrating the full line of ATK's legacy accessories business into the Bushnell distribution network.
    They're taking a writedown on Savage, but this is a vastly better time to be acquiring companies in the space and now hey have an improved platform on which to integrate and expand smaller brands and product types.

    I've entered the position, but I think it's a lower conviction one because of the potential for continued decline in ammo demand.

    1. Thanks, good comment. I agree, think the long term vision here is to horizontally expand across other sports as you say and create more of a consumer brands company.

      Also - I haven't read more than the headline, but interesting to see Smith & Wesson give positive guidance, maybe the downturn will be shorter and shallower than the market was expecting?

  8. Hi MDC,

    Trying to learn how this situation is analyzed. How did you calculate the following values please?
    * Market cap of post-spin Orbital ATK
    * Market cap of Vista Outdoor

    * Fair Value of ORB and ATK at present

    * I didn't understand where any of the values in the ATK Pieced Out section are coming from: FVs, Current values and Per share? Is there any other post or link that you could share to learn about this? If not, I think a brief explanation could help to know where to start... at the moment I just got lost looking into the figures.

    Many thanks in advance!

    1. Michael,

      Sorry I probably could have made my table a little more clear. For the two market cap numbers, that's my projection based on a 8.5x EBITDA for OA and 9.0x EBITDA for VSTO, quite a few assumptions on my part to come up with those values, you can adjust them as you see fit. The fair value at present, I used my assumptions in the market cap numbers and the transaction terms to then assign values to both ATK and Orbital (ATK gets all of VSTO, and then 53.8% of OA).

      ATK pieced out was then just breaking out the fair value of ATK at present out into VSTO and OA pieces. My table is a little dated since I assumed 1 share of VSTO for each share of ATK, but the company announced a couple weeks ago that ATK shareholders will receive 2 shares of VSTO for each ATK share, so my target price for VSTO is around $45. It's trading "when issued" right now for around $34. I'd probably revise my target price down a little given the latest quarterly results, maybe closer to $40.

      Hope this helps, thanks for reading.

  9. Many thanks for the explanation, more clear now!

    Regarding the long position in ORB. Taking into account that ATK is currently trading at $130 and VSTA's price OTC seems to be what you mentioned, $34. The post-spin ATK price would be $62, which would value ORB at the ratio of 0.449 as $27.84

    Do you still see the opportunity for a long position here taking into account that the current ORB's price is $28.09?

    1. The upside has gotten smaller. Looking back (it was only two months ago but feels longer for some reason) I was probably a little too generous to VSTO and too hard on OA. I still believe the upside is greater in VSTO as I see the ATK/ORB combination as more of a defensive move by two companies that needed to gain size and scale to compete in a more defense budget constrained world. But my EBITDA was backwards looking and didn't include any revenue or expense synergies to which they've guided.

      I estimated a combined value of $150 for ATK, I'd stick with that but give more of the credit to OA and take a little away from VSTO if I were rewriting the post today.

  10. Hi there,

    I am trying to do some work on this spin off and your post is very helpful for thinking about the implied valuation of VSTO.

    Michael S also asked a similar question, but there are a couple numbers in the table that I am trying to figure out. My apologies if I'm a little thick, but spin offs are relatively new for me.

    Where do the values come from related to your response "ATK pieced out was then just breaking out the fair value of ATK at present out into VSTO and OA pieces." ?? Specifically, I want to figure out how you got the values 1,826 and 1,711. I am guessing that 1,711 is a plug for the current ATK market cap (3,537 at time of post) and 1,826, but it is not clear to me where 1,826 is coming from.

    Any advice on this is greatly appreciated.

    1. The $1,826 (in millions) was the value the market was assigning to ATK's aerospace and defense business lines (that will be part of Orbital ATK starting tomorrow) based on values of ATK and ORB at the time and the transaction details.

      The $1.8B was 2.23 shares of ORB, or you could have backed into it via ATK which I did by subtracting out what the market pricing VSTO at ($1.7B or 1 share of ATK minus 2.23 shares of ORB) and coming to a valuation of ATK's aerospace and defense business which was being priced at $1.8B based on the total ATK market cap at the time.

      Both values are higher today, OA makes up $2.05B and VSTO makes up $2.4B. Hopefully that helps, looking back I can see why it wasn't clear and I'll try to fix that going forward. Thanks for the reading.

    2. That makes perfect sense. I really appreciate the clarification. It is very helpful.

  11. Just to close the loop here: I've exited both VSTO and OA, wish every one worked out this well but as of 2/20/2015 the combined value was $157 per share.