Alliance Techsystems(ATK) To Spin Off Outdoor Sports Division, Merge Aerospace And Defense With Orbital Sciences

Sometimes, businesses that begin based on natural synergies grow apart.  This appears to be the case with Alliance Techsystems(ATK).  The company has three divisions: Aerospace, Defense, and Outdoor Sports.  This once made a great deal of sense, as the ammunition the company sells to the military is a similar product to the ammunition it sells to hunters. As the company has grown each division in different directions, however, the overlap has diminished. Arrows and rocket motors are very different products.  This poses a potential problem for a strategic acquirer who only values part of the business.  Have no fear, “Morris Trust” is here!

This morning, ATK and Orbital Sciences(ORB) announced a complex series of transactions which will see the spinoff of ATK’s Sporting Group, followed by a merger between Orbital Sciences and the remainder of ATK in a “Morris Trust” transaction. Though somewhat less common then its backwards, reverse “Morris Trust” brother, a “Morris Trust” transaction spins off unwanted assets and merges the remaining company into a smaller company which is really the acquirer, but whose shareholders will hold less than 50% of the combination.

ATK CEO Mark DeYoung will become CEO of the Sporting group after the spinoff. The sporting group, which achieved $2.2 Billion in 2013 sales has had 16% annual sales growth over the last decade.

ATK operates in three business segments today: Aerospace Group, Defense Group, and Sporting Group. The company has grown significantly over the past two decades through organic growth and acquisitions, building leadership positions in several core and adjacent market segments.

The company’s Sporting and A&D businesses operate in two fundamentally different markets with very different operating dynamics, compliance requirements, customer sets and growth opportunities. As standalone companies, they will be more focused businesses, with clear and distinct strategic visions and objectives, additional operational flexibility and the financial strength to make the most of their unique opportunities in their respective industries.

Since entering the commercial ammunition and sporting accessories space in 2001, ATK has built a leading position in the shooting sports for hunters, shooting enthusiasts and law enforcement professionals. The acquisitions of Savage and Bushnell in 2013 enabled ATK to expand its core competencies while creating opportunities to enter into new, adjacent markets in the outdoor recreation industry.

In today’s growing market, the Sporting Group enjoys expanded distribution for some of the most widely known and respected brands in the industry:  Federal Premium, Bushnell, Savage Arms, BLACKHAWK!, Primos, Final Approach, Uncle Mike’s, Hoppe’s, RCBS, Alliant Powder, CCI, Speer, Champion Targets, Gold Tip Arrows, Weaver Optics, Outers, Bolle, Cebe, and Serengeti.

“Sporting continues to deliver excellent performance,” said DeYoung. “Results from our recently completed fourth quarter demonstrated continued revenue and earnings growth, and margin expansion. Full details on our fourth quarter results will be discussed on our May 15 earnings call.”

ATK believes that separating Sporting into a standalone entity will facilitate opportunities to further drive growth and marshal resources to broaden and deepen its market leadership. ATK believes that a more focused corporate leadership team, operating within a clearly defined commercial market with a competitive business model, will contribute to unlocking significant value for ATK shareholders.  Following the completion of the transaction, Sporting will also enjoy a strong balance sheet that will provide the ability to fund its growth strategy. Over the past 10 years, ATK’s Sporting Group has delivered annual sales growth of approximately 16 percent (14 percent organic growth).

Sporting is expected to be a world leader in outdoor recreation products with adjusted pro forma last twelve months ended December 2013 (LTM Dec) revenues of $2.2 billion1 and LTM Dec 2013 adjusted EBITDA of $361 million2 (see reconciliation table for details).

Though Orbital Sciences shareholders will hold only 46.2% of the combined Orbital ATK, the combined company will be led by current Orbital CEO David Thompson. The combined company achieved $4.5 Billion in 2013 revenue on a pro forma basis. It will also take on $1.7 Billion in ATK debt.

ATK A&D is the world’s top producer of solid rocket propulsion systems and a growing supplier of military and commercial aircraft structures and satellite systems. ATK A&D is an industry leader in ammunition, precision and strike weapons, defense electronics systems, missile warning solutions and tactical rocket motors across air, sea and land-based systems, and ATK A&D has consistently generated strong cash flows and profitability.

Following the completion of the transaction, Orbital ATK will be a focused and leading Aerospace & Defense player with combined LTM Dec 2013 revenues of $4.5 billion, EBITDA of $585 million (see reconciliation table for details), and contracted backlog of $11.0 billion, which includes $3.0 billion in unexercised options from Orbital and $0.2 billion in unexercised options from ATK A&D.3  The combined company will provide customers with advanced capabilities and a commitment to continuous innovation in support of the U.S. military and allied military requirements, space missions, and aerospace capabilities. Orbital ATK will serve the following core markets: aerospace through launch vehicles, spacecraft and satellites, military and commercial structures, and special mission aircraft; and defense through munitions, weapons systems, defense electronics systems, targets, interceptor vehicles and missile products. Both Sporting and Orbital ATK will continue to benefit from arrangements regarding the sale by Orbital ATK to Sporting of ammunition from the Lake City Army Ammunition Plant, which ATK currently maintains and operates for the U.S. Army, and the sale of components and gun powder from New River Energetics.

The combination is expected to generate pre-tax cost synergies of $70-100 million through the elimination of duplicate public company costs, economies of scale, and additional streamlining of operations. Additionally, Orbital ATK is expected to realize revenue synergies of $100-200 million through improved product offerings, improved competitiveness and strengthened customer relationships. The combined company expects to realize partial synergies in 2015 and fully recognize identified synergies by late 2016. Once fully realized, after accounting for the impact of cost-type government programs, cost and revenue synergies are expected to result in annual EBIT improvement of between $40-65 million. Orbital ATK will have a strong capital structure and with its ability to generate strong free cash flow, it will be well-positioned to grow, return capital to its shareholders and de-lever.

As is the case in many spinoffs, the sporting group will borrow money prior to the transaction and pay a large dividend to its parent. In this case, Sporting will borrow $750 million and dividend $300-$350 million to ATK.  Orbital shareholders will receive 0.449 shares of Orbital ATK for each share that they own of Orbital. The transaction is expected to close prior to the end of 2014.

Disclosure: The author holds no position in any stock mentioned