Very few gun manufacturers have the kind of history that Colt has. The Connecticut-based company is a pioneer of sorts in the gun industry. It's diverse assortment of guns and firearms have fueled American adventures in the West and abroad. They were also the preferred weapons of choice for local law enforcement agencies and gun enthusiasts.

That is why it made news when the iconic gun manufacturer filed for bankruptcy in June of this year. In its bankruptcy filing, the company said it was unable to pay $500 million that it owed to dozens of creditors. Recently, it defaulted on payment worth $10.9 million to holders of senior bonds. It's long term bonds have received a "Junk" classification from ratings agency S&P. In addition, Colt's plans to restructure its senior bonds at a 55% discount have been roundly rejected by investors.

So, what went wrong at an iconic company that made guns used to "win the West"? Tne answer to that question is a complicated one and involves a mix of bad management, product portfolio and imprudent financial engineering.

Missing The Mark On Products And Markets

To be sure, Colt is no stranger to bankruptcy proceedings. In fact, the company's first bankruptcy was in 1842, just six years after it was started. Subsequently, the company's eponymous founder Samuel Colt went back to the drawing board and designed a range of new products, such as the iconic Colt .45, for the company. The new products powered American expansion and, at one point in time, Colt was one of the 10 richest businessmen in the United States.

Regular wars and political crises fed into the company's profits. For example, the company's sales surged during the Vietnam war in the 1960s. As the war ended, the firearm industry courted new customers in disenchanted males fearful of America's economic decline. The United States' military adventures in the Middle East during the early 1990s and the last decade resulted in similar profitable infusions to the company's bottom line.

In the intervening period between the two wars, however, Colt's fortunes dipped as design patents for its firearms expired. The company's products, which set the standard for the rest of the industry, became also-rans as a flood of discounted competitors hit the market in the 1980s.

The company also lost key profitable markets. For starters, law enforcement agencies exchanged their Colt weaponry for Glock's machines. The Austrian weapon manufacturer began by making firearms that were cheaper and lighter than Colt's products. Moreover, they held more ammunition. Glock was not the only one: Smith & Wesson Holding Corp. (SWHC) also stole a march over Colt by introducing similar guns. Both companies reaped the benefits of this innovative approach during America's war on cocaine in the 1980s, when police officers relied more on their weapons in the fight with armed criminals.

Simultaneously, the company lost vital defense contracts to foreign players. For example, the company's iconic M1911 reigned as the primary sidearm of the U.S. military for 90 years before being replaced in 1985 by Beretta M9, made by the Italian arms manufacturer. Similarly, in 1988, the army replaced Colt with FN Manufacturing, a subsidiary of Belgium-based FN Herstal, as its primary provider of M16 rifles. These were originally designed by Colt and used extensively during the Vietnam war.

As a result of losing market share across the board, Colt filed for bankruptcy in 1992. Industry experts cited excessive debt, reduced civilian demand and loss of government contracts as primary reasons for the company's problems. The government exacerbated those problems. The Clinton administration tightened the screws on the personal firearms and ammunition industry by introducing strict gun control measures. A wave of litigation and lawsuits followed, resulting in increased spending by gun lobbyists in Washington.

Iraqi-American financier Donald Zilkha, who bought Colt in 1994, attempted to steer the company away from consumers to military contracts and new markets. Colt was trying "to be a different animal," he said in an interview to The New York Times at that time.

But, the company's move to court new customers ended in disaster.

The introduction of smart gun technology, which was designed to make guns safer, alienated Colt's core customer base of gun advocates who misconstrued the move as one that provided provided further ammunition to gun control advocates. These developments have occurred despite prevailing market trends that were favorable to the industry. Thus, even though the number of gun owners has declined in recent years, the number of guns per person (or, the number of repeat purchases) has increased, thanks to the Obama administration's attempts to introduce gun control legislation. (For more, see: How does gun control policy affect the stock price of firearm companies?)

Colt's competitors Smith & Wesson and Sturm, Ruger & Company Inc. (RGR) reported record profits and sales in 2012 and 2013.

But, Colt doesn't seem to have learned from its mistakes. It's products are still floundering in the consumer market and the company has not made up for those losses in the government contracts market. For example, the U.S. military replaced Colt with FN Manufacturing once again in 2013. The contract, which required production of 120,000 next-gen M4s, was worth $77 million.

The Connecticut-based company could have potentially offset these losses by ramping up its presence in the foreign arms markets. But, foreign markets accounted for just 2% and 1% of the company's total sales in 2013 and 2012 respectively. The United States's foray into the Middle East increased the company's sales to $75 million. But, the company's earnings represented a small portion of the total windfall made by other gun manufacturers. (For more, see: America's Gun Love Boosts Firearm Stocks As Sales Surge.)

Financial Engineering Gone Wrong

The company's product woes are just one part of the equation, however. The reshuffling of business and executive priorities has further complicated Colt's already-precarious financial position. The company's latest owner, private equity firm Sciens Capital Management, took control of the gun manufacturer in 2005 after Zalkhi lost interest in the business. The transfer resulted in a $300 million debt for the company.

Most private equity firms attempt to wring their maximum possible profits from their investments. Sciens was no different. Immediately after the transfer, the firm created a separate arm for Colt's defense operations and let its consumer division languish. Even as the company lost money over the next couple of years, the firm awarded generous bonuses and consulting remuneration to its officers. According to one estimate, at least $131 million of the total debt incurred by Colt during its recapitalization in 2004 was used to "make distributions to Sciens in 2007." Sciens also attempted to take the company public in 2005 but had to abandon plans after investors remained unconvinced about the gun maker's ability to turn a profit. Colt has been on a borrowing spree since then. The company borrowed an additional $250 million from the bond market in 2009 before its current filing.

The Bottom Line

Colt's new owners may turn out to be its old ones. An affiliate of Sciens Capital Management has already made an opening bid to assume the company's debt obligations. Another suitor, a Native American tribe, has also offered to bid for the company. According to the Wall Street Journal, the tribe owns the $250 million Morongo Casino, Resort & Spa, its own water bottling plant in partnership with Nestle, and fruit orchards.

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