Newtown shooting jolts firearms industry

Written by Chuck Wilbanks

(MoneyWatch) With the decision to sell the Freedom Group, whose subsidiary Bushmaster Firearms made the military-style weapon used in last week's massacre in Newtown, Conn., private equity group Cerberus is bowing to the intense anti-gun sentiment racing through the country. On another level, the move amounts to a cut-your-losses business decision that may say little about the future of the gun industry.

Given the intense public scrutiny on the firearms business following the December 14 shooting at Sandy Hook Elementary School, selling Freedom Group could prove difficult for Cerberus. Along with a possible backlash against gun manufacturers that could deter potential buyers, a move by Congress to re-institute a ban on semi-automatic rifles of the kind used in the attack and numerous other mass shootings in recent years could bite into gun makers' sales, lowering Freedom Group's value.

But for Cerberus, which entered the arms business six years ago with high ambitions, shedding its gun assets even at a loss would be less costly than losing business from deep-pocketed institutional investors. The California Teachers' Retirement System said Tuesday that it would review its roughly $750 million investment with Cerberus. The pension fund noted in a statement that "current policies require that the risks associated with products that pose significant threats to human well-being be taken into account before an investment is made by CalSTRS investment managers."

Through September, Freedom Group reported profits of $118 million, before taxes, interest and other costs, on net sales of $677 million. To put that in perspective, Cerberus has about $20 billion from all its investors that it can in turn use to make acquisitions such as the spree that created Freedom Group. With the prospect of major clients threatening to walk, the rewards may not have seemed great enough.

Cerberus, named after the three-headed mythological dog that guards the gates of the underworld, bought Bushmaster in 2006 -- four years after one of the company's rifles was used in the Washington Beltway sniper killings -- and then began what's known in the merger and acquisition trade as a "roll-up."

The firm also bought Remington, a storied maker of hunting rifles and shotguns, as well as military style semi-automatic handguns whose design dates back to the first world war; Dakota Arms, a maker of high-end rifles designed for hunting anything from gophers to elephants; The Harrington & Richardson company, which offers affordable shotguns and rifles designed for deer hunting; Parker Shotguns, immaculately engraved and extremely expensive shotguns; DPMS Panther Arms, which, like Bushmaster, manufactures military style rifles; TAPCO, which makes various accessories for such guns; and Advanced Armament Corp., which makes silencers. Freedom also has units that contract to government, such as Remington Military and Remington LE (Law Enforcement).

As with other such buyouts, the plan was for Cerberus to realize a profit by selling Freedom Group or by taking it public. In 2009, the firm filed with the SEC for permission to sell shares of Freedom in an initial public offering, only to withdraw the filing two years later.

It's not only Cerberus that is under pressure, with other gun sellers also now in the spotlight. In addition to the comments by CalSTRS, California Treasurer Bill Lockyer said Tuesday he is considering ordering that fund and its sibling, the California Public Employees' Retirement System, or CalPERS, to divest themselves from any investment in firearms manufacturers.

Meanwhile, although President Barack Obama did nothing to promote gun control during his first term despite a series of horrific massacres, gun company share prices climbed anyway, fed in part by fears promoted by the National Rifle Association and other groups that gun control or even gun seizures were around the corner.

Stock prices haven't reacted that way this time. New government curbs on assault rifles are expected, and retailers such as Wal-Mart (WMT) and Dick's Sporting Goods (DKS) aren't waiting for federal action -- they're already pulling some semi-automatic rifles from the shelves.

Shares of Smith & Wesson (SWHC), once known for well-made double-action revolvers but now heavily into the military-style rifle and handgun sector, lost 4 percent the day of the Sandy Hook shootings and lost another 10 percent Tuesday. Sturm Ruger (RGR), an old Connecticut manufacturer that has similarly veered into the tactical market, has taken a similar shellacking. Opinion polls also show strong public support for banning these guns.

"In almost every other developed country, people ask what can we do to make sure such shootings never happen again," said David Hemenway, a professor of health policy at Harvard University and an expert on firearms policy. "We're unique in that we don't have sensible gun control laws."

Led by Stephen Feinberg, who has a home in Connecticut as well as Manhattan (his father lives in a retirement community in Newtown), Cerberus may be best known for its failed journey into automaking. It bought Chrysler in 2007 for $7.4 billion, put it in the hands of former Home Depot (HD) CEO Robert Nardelli and sent it into bankruptcy two years later.

An ill-advised bet on the home mortgage business through another $7.4 billion deal, a 2006 deal to join other investors in purchasing  GMAC, was another debacle. In that case, Feinberg chose Ezra Merkin, a former confederate of Bernard Madoff who had steered hundreds of millions of dollars to Madoff's funds. Cerberus had to seek a government bailout in 2008, prompting investors to reclaim more than $4.7 billion from the firm's funds.

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Cerberus did not return a call seeking comment on its decision to sell Freedom Group.

In a statement announcing that it would seek to sell its gun assets, Cerberus expressed sadness over the Newtown shooting and said that "no words or actions can lessen the enormity of this event or make a dent in the pain that was inflicted on so many."

Yet if it succeeds in selling the gun conglomerate it assembled, the new owner would likely take up where Cerberus left off, marketing military-style weapons as sporting weapons.