Randy Luth was surprised to learn in 2006 that Cerberus Capital Management wanted to buy his St. Cloud (Minn.) business. What would Manhattan financiers known for investing in distressed debt and troubled companies want with DPMS Firearms, a manufacturer of semiautomatic rifles?
Cerberus had more than DPMS in its sights. From April 2006 to January 2008 it bought three other firearms companies: Bushmaster, Remington, and Marlin. And it kept adding to its collection. Cerberus now controls 13 brands in a holding company it created, Madison (N.C.)-based Freedom Group. With sales of $848.7 million in 2009, Freedom Group is the largest gun and ammo maker in the U.S. That means Stephen A. Feinberg, Cerberus' founder and managing member, is the country's top civilian gun magnate.
Cerberus' gun play is one of the latest moves for the secretive Feinberg, 50, who founded Cerberus in 1992 to buy the debt of struggling companies. The firm's strategy evolved over the past decade to include private equity takeovers, and its assets have grown to about $23 billion. Cerberus' investments have ranged from biotech firm Talecris Biotherapeutics (TLCR) to Japan's Aozora Bank. In 2006 and 2007, Cerberus led a group of investors that paid a total of about $15 billion to buy a majority stake in GMAC and about 80 percent of Chrysler. Cerberus cut its GMAC position to less than 15 percent as part of a government bailout and saw its stake in Chrysler's auto operations wiped out when the company went bankrupt in 2009. It kept its stake in Chrysler's financing business.
Luth, the rifle maker, says that when he arrived at Cerberus' Park Avenue offices to negotiate a deal in 2007, he discovered that Feinberg and several of his partners "are real gun guys." Feinberg stalks pheasant in upstate New York and has taken a bull elk in Colorado, according to hunting buddy T.K. Duggan, a New York money manager. "He's a dedicated sportsman, nothing fancy," says Duggan. He adds that as far as his friend is concerned, "what your hobby is doesn't determine what you do with your investors' money." Cerberus closed on the acquisition of DPMS in December 2007 for an undisclosed sum.
For a while, the roll-up looked smart. The election of Barack Obama in November 2008 had firearms buffs worrying about possible gun prohibitions. Consumers stocked up on guns and ammo throughout 2009. Freedom saw sales rise 17 percent for the year and posted net income of $54.4 million, vs. a loss of $28.6 million the year before.
Then President Obama proceeded to do nothing on gun control. With no new restrictions on the horizon, "Freedom Group was thought to be a huge home run," says Steven M. Davidoff, a law professor and private equity expert at the University of Connecticut. In October 2009, Cerberus filed with the Securities & Exchange Commission to take Freedom public. Eight months later, gun sales are slowing and Feinberg hasn't pulled the trigger on the initial public offering. "The equity market isn't as welcoming [to IPOs] as it was just a few months ago," Shelly Lombard, an analyst at Gimme Credit, said in a June 2 note to clients about Freedom.
One reason for assembling a portfolio of brands was the potential for cross-selling—a Remington shotgun dealer can recommend Freedom-made ammo. With sales slumping, it's not clear whether that strategy will pay off. "On paper, it made lots of sense in 2008 and 2009," says Cameron Hopkins, an industry consultant in Henderson, Nev. "Today, with the Obama surge ending, that doesn't look so obvious."
A Cerberus spokesman declined to comment, citing the quiet period in advance of Freedom's pending IPO. Linda Powell, a spokeswoman for Freedom, said the holding company "is really just a financial creation of Cerberus. We want our customers to focus on Remington and our other historic brands."
Speaking by cell phone on his way to a shooting tournament, Luth, who has retired, says Cerberus' roll-up was "a brilliant strategy" to achieve marketing efficiencies. In an SEC filing in May, Freedom reported that it is No. 1 in the U.S. in shotguns (31 percent market share); traditional rifles (37 percent); modern military-style rifles (48 percent); and ammunition (33 percent).
The company's latest financial results are less impressive. Earnings for the first quarter of 2010 fell 58 percent, to $5.6 million, compared with the same period in 2009; first-quarter sales dropped 9 percent, to $174.2 million. In the May filing, Freedom acknowledged that the Obama-related jump in ammo sales was easing. "As a result," it said, "we may experience a decline in sales and/or net income [in 2010] as compared to prior fiscal years, and these declines may be material." Industrywide, U.S. revenue from small arms and ammo is expected to dip 5.7 percent in 2010, to $9.8 billion, according to the research firm IBISWorld.
Cerberus has not soured on the security sector. In April it agreed to acquire DynCorp International (DCP), a large defense contractor based in Falls Church, Va., in a deal valued at $1.5 billion, including the assumption of debt. The deal, Cerberus managing director Timothy Price said in a statement, "underscores our successful record in the government services sector and furthers our goal of continuing to grow our portfolio in this area."
The bottom line: What looked like a great strategy with gun sales rising looks less promising now that fears of new gun control efforts have subsided.