In it, but not of it. TPM DC

Six Months After Newtown, An American Gun Giant Struggles To Find A Buyer

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Finance professors who talked to TPM said the deal may raise some eyebrows, but they added the agreement could be explained by the fact that it's not easy to sell a company with a poisoned reputation that's surrounded by political uncertainty. But the same academics also said the secretive nature of the business prevents the public from determining whether Cerberus' top brass is trying to escape bad P.R. while holding on to the company or even whether Feinberg is setting himself up for a sweet deal.

Cerberus Capital Management is one of America's biggest private equity firms, which means it is invested in a wide array of companies. Cerberus acquired a stake in Freedom Group in 2006. Four days after Newtown, faced with mounting headlines, Cerberus announced its intention to sell it off. (A spokesperson for Cerberus declined to comment on this story.)

Since then, the sale, at least publicly, has gone nowhere. So finally last month, Feinberg reportedly stepped in and began planning a potential a bid for Freedom Group with the help of other Cerberus investors.

According to Pavel Savor, an assistant professor of finance who focuses on the private equity industry at the Wharton School of the University of Pennsylvania, having the head of a firm lead a bid for one of its holdings is "not typical in any way."

That maneuver is rarely deployed because, Savor said, it raises the specter of an obvious, "immediate conflict of interest" and opens up the possibility that the buyers could engineer themselves a cheap deal at the expense of their fellow investors.

Despite the clear risk of double dealing, Savor and other professors said, the task of unloading a gun giant amid a wave of unparalleled anger about shootings may have created the need for an unusual transaction in this case.

"In this instance, you can kind of have two stories for why this happens," said Savor. "One would be just that, because of potentially PR reasons, there are no other buyers and their limited partners are really eager for them to divest it."

Indeed, there were indications the decision to sell Freedom Group was made because some of Cerberus' higher profile investors said they wanted no part of any gun companies following the Newtown massacre. When Cerberus revealed its plan to drop its stake in Freedom Group, it released a statement noting the company makes "investments on behalf of our clients who are comprised of the pension plans of firemen, teachers, policemen and other municipal workers and unions, endowments, and other institutions and individuals." Some of those public pension funds were clearly eager to exit the gun business after the shooting. Many of those public pension funds announced their intention to stop investing in firearms manufacturers following the shooting. That included the California State Teachers' Retirement System, which said it owned 2.4 percent of Freedom Group through investments in Cerberus.

But while the toxic cloud of the massacre likely caused Cerberus to attempt to unload Freedom Group, it also meant the sale almost immediately ran into trouble.

According to the Bloomberg news service, at least three major banks declined to work on the deal because of "potential damage to their reputations." Anonymous sources speculated to the news service that Cerberus might have "to take a lower price or be unable to sell the business because so many banks are unwilling to work on the deal." Eventually, Cerberus managed to hire the investment bank Lazard Ltd. to run the auction.

Even with a bank lined up, finding someone to pay top dollar for a gun company in the post-Newtown environment was tricky.

Both Bloomberg and the Wall Street Journal have reported Freedom Group could be worth as much as $1 billion. However, the ups and downs of the gun industry in recent months seemingly made it difficult for buyers to gauge the company's prospects and feel confident about paying such a large price

On the one hand, Freedom Group made a slim profit last year off nearly $1 billion in net sales of firearms, ammunition and accessories. In the first three months of 2013, the company saw a 55.7 percent increase in sales, fueled by talk that Congress could limit future sales of firearms.

On the other hand, as the The Deal Pipeline, a subscription-only news service for the financial industry, noted last month, figuring out how much the company is worth "is difficult, especially after the Newtown shooting" because the spike in sales may be a temporary effect of firearms enthusiasts stocking up in anticipation of restrictions or bans. Future sales are also difficult to forecast because the gun control legislation proposed after the school shooting could also cost Freedom Group.

"While we do not believe that existing federal and state legislation relating to the regulation of firearms and ammunition will have a material adverse effect on our sales, no assurance can be given that more restrictive regulations, if proposed or enacted, will not have a material adverse effect on us in the future," the company's most recent quarterly report said.

All of these factors complicating the Freedom Group sale may have pushed Feinberg to enter the auction to purchase the gun giant from his own firm.

Feinberg's bid for Freedom Group may also have been driven by a desire to kickstart an auction that was having trouble getting off the ground. Cerberus reportedly hopes to complete the deal for Freedom Group this summer. Though multiple potential buyers have reportedly expressed interest in buying the group, as of last month, when reports of Feinberg's potential offer first surfaced, no other bids had been submitted. His bid, which reportedly would serve as a "stalking horse," or an early bid that sets the pace for the auction, could help push other potential buyers to come forward. Indeed, once the news came out about Feinberg's bid, a trio of other weapons manufacturers reportedly expressed interest in buying Freedom Group.

With Feinberg and his partners potentially participating in the auction, Cerberus reportedly put safeguards in place to ensure Feinberg and his partners can't use their insider status to take advantage of other bidders or other Cerberus investors. These measures included a committee established to negotiate the deal for the firm without Feinberg and a stipulation that his group must drop out of the auction if another bidder tops their offer by 10 percent or more.

Christine Parlour, a finance professor at UC Berkeley's Haas School of Business, also noted Feinberg has substantial incentive to give other Cerberus investors a fair price for Freedom Group because, in the world of private equity, "everything is driven by reputation."

Savor agreed that it would be difficult for Cerberus to get future investors if Feinberg gave himself a sweetheart deal in the situation.

"If you want to stay in business, it's not a good move to antagonize people who provide capital for you," he said.

However, Savor noted Feinberg and his partners may have managed to secure themselves an exceptionally low price for the gun giant even with safeguards and other bidders possibly entering the mix. Even if several other companies look at Cerberus, they may not want to top Feinberg's offer.

"Often, buyers are very reluctant to go against managers or partners of a firm because they may know that these guys have the most information, so if you outbid them, there's risks," said Savor.

Apart from the conflict-of-interest concerns, Feinberg's bid also raises the possibility that some top Cerberus investors could dodge bad media attention by conducting what is essentially a sale in name only while maintaining undercover ownership. Because of the secrecy that surrounds elite private equity firms, it would be difficult for outside observers to tell whether or not an auction that left Freedom Group in the hands of those Cerberus investors was just an empty gesture.

Parlour said Feinberg and other Cerberus partners purchasing Freedom Group from their own firm could mean the company ends up with the same management. However, at the same time, she said removing other Cerberus investors could constitute a substantive change in ownership. Overall, Parlour said it would be difficult to determine whether this deal is something most people would consider a genuine sale because private equity transactions are so "opaque."

"It is not dubious per se," she said.