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Chapter .22

16 June 2015 By Rob Cox

The American gun business has been notoriously volatile over the past few years. Sales spike at any whiff of new laws regulating their ownership, and then plunge when barriers fail to materialize. Those swings have made it difficult for the likes of Remington, Smith & Wesson, and Sturm Ruger to manage their businesses with any predictability.

But the problems that sent the 179-year-old Colt Defense – arguably the industry’s iconic brand – into the protective arms of a U.S. bankruptcy court on Sunday go well beyond the vagaries of the American weapons trade. Colt’s failure looks to be less about guns than mismanagement. Over the past two decades, Colt’s private equity owner sucked the company dry, wound up owning its headquarters and left the company struggling to compete.

As if that weren’t enough for the maker of the revolver that won the West and its creditors, the financiers at Sciens Capital Management may be in a position to keep their fingers on the trigger. Colt’s new Chapter 11 filing – its last was in 1992 – caps a tale of how financial engineering can ruin a legendary manufacturing business.

Colt is carrying debt of around $355 million, costing it about $30 million a year in interest. In the first nine months of 2014, the latest period for which full financial statements are available, Colt had operating losses of $3.6 million before $23.4 million of interest payments. The numbers just don’t work.

It’s a sad state of affairs for the company that grew out of Samuel Colt’s patent for the first commercially successful revolving cylinder firearm in 1836, and which 10 years later began supplying U.S. and international military customers. The latest trouble, though, dates back only about two decades. An investment firm run by Donald Zilkha in 1994 funded Colt’s emergence from two years in bankruptcy.

Colt’s ownership later passed to one of Zilkha’s junior partners, John Rigas, who founded Sciens. The firm controlled 87 percent of Colt’s equity going into its latest bankruptcy. Under Sciens, Colt was generous paying out dividends and redeeming equity. From about 2003 through 2009, such distributions totaled some $212 million, according to Bloomberg Businessweek. They were financed with a $150 million leveraged recapitalization in 2007 and the sale in 2009 of $250 million of unsecured senior notes, which mature in 2017.

Sciens found other ways to milk Colt. According to an affidavit filed with the U.S. bankruptcy court in Delaware by Chief Restructuring Officer Keith Maib on Monday, under a July 2007 financial advisory agreement Colt pays Sciens an annual retainer of $330,000, monthly in advance. And under a July 2013 consulting agreement, a related firm called Sciens Institutional Services receives an annual fee of $650,000 payable quarterly, also in advance.

While such fee arrangements are not uncommon in the world of private equity, they are increasingly controversial, and have become a focus of ire for institutional investors. In this instance, they arguably helped accelerate the demise of an investment firm’s portfolio company.

Even so, these arrangements could prove less consequential to Colt’s future as a going concern than a deal Sciens did a decade ago to buy Colt’s West Hartford, Connecticut headquarters. According to Maib’s affidavit, after Colt’s landlord threatened to terminate the lease and sell the facility to a real estate developer, Sciens formed a group to acquire the property. Today Sciens indirectly owns or controls 30 percent of NPA Hartford, the landlord of Colt’s facilities, on which the company’s $68,750-a-month lease runs out in October.

The extension of that lease is critical to Colt’s ability to conduct business on an ongoing basis, Maib wrote in his affidavit, saying it would take two to three years for Colt to pick up and move its manufacturing operations to a new site.

Though the decision on whether to extend the lease to Colt will be made separately by the investment group in which Sciens is a minority partner, it is a key feature in the firm’s current “stalking horse” bid to buy Colt’s assets out of bankruptcy, according to a person involved in the transaction. It’s not clear that any other buyer would be in a position to offer the necessary reassurance.

After years of emptying Colt’s financial ammunition, that may give Sciens the leverage to walk away after the bankruptcy retaining all of Colt’s assets at its current offer price of zero dollars and the assumption of about $125 million in debt, including $20 million in new funds.

Sure, other factors have also contributed to Colt’s decline. And the Sciens offer, in total, values the enterprise at about seven times its shrunken EBITDA, as estimated by the company. That may be enough to keep Colt producing guns on the banks of the Connecticut River.

It would, however, leave in charge the same financiers who helped drive Colt into the ground. And for holders of those $250 million in unsecured notes it would be a bullet in the head.


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