(apologize in advance for the format below - tried my best)

I. Summary

Brunswick Corporation (“BC”, “Brunswick”, or the “Company”) is a leading global designer and manufacturer of recreation products including marine engines, boats, and fitness equipment.

At $52, BC is offering investors compelling absolute value with the stock trading at 12x 2018 EPS and compounding earnings at a mid-double-digit CAGR through 2020.  

From here, there is >50% upside in the stock as investors can get paid on earnings growth in the core business driven by new product launches, accretive deployment of significant balance sheet capacity, a re-rating of the stock as investors figure out that parts & accessories story, a separation of the business to realize the sum of the parts, and/or a change in the management team that has seen multiple years of de-rating and stock underperformance.

Thesis detail:

      i.         The parts and accessories (P&A) business within Marine Engine is misunderstood and undervalued;

     ii.         Investors are getting the Fitness business for free on a reasonable sum-of-the-parts; upside from a cardio equipment refresh that is written off for dead by Mr. Market; optionality from a spin or divestiture

   iii.         New outboard engine launch will drive upside to consensus 2018 estimates of at least ~$0.20

    iv.         Balance sheet optionality and optionality on a change in management as stock has derated significantly and not performed

II. Company Overview

a. Corporate History

Brunswick was founded by John Moses Brunswick as a manufacturer of billiard tables in Cincinnati in 1845. The company soon expanded into making a number of other products, including bowling equipment (balls, pins, etc.), and other diverse products such as toilet seats, automobile tires, and phonographs. While the Bowling and Gaming businesses are largely gone from Brunswick’s current corporate profile, the Company introduced innovations to the world through products such as the magic eight ball and air hockey, both of which were invented by Brunswick.

In 1960, the Company entered the marine industry through the acquisitions of two boat manufacturers, Owen Yachts (sold in 1970) and Larson Boat Works (sold in 1964). Brunswick subsequently acquired Keikhaefer Corporation, the predecessor of Mercury Marine (rebranded in 1971). In 1974, Mercury Marine introduced their outboard engine in Australia, and in the U.S. and Europe in 1974. In the 1980s, through several acquisitions, Brunswick became a major maker of yachts and pleasure boats, whose brands include Bayliner (1986), Boston Whaler (1996), Maxum (1988, organic), Sea Ray (1986), and Trophy (1988, organic). In 1993, Brunswick acquired Swivl-Eze, a fishing seat pedestal manufacturer, marking its first entry into the parts & accessories segment. In 2001, Brunswick increased its exposure to large luxury boats with its acquisition of Hatteras Yachts, as well as Sealine, and Princecraft. In 2004, Mercury introduced the Verado engine, a technologically advanced four stroke outboard engine, the only supercharged outboard in its class.

In 1997, Brunswick acquired Life Fitness, a manufacturer of strength and cardio fitness equipment, marking its first foray into the fitness. Later in 1997, Brunswick acquired Hammer Strength, adding to its offering of strength training to the professional segment of the market (health clubs, colleges, pro sports, etc.) .

Share Price History

b. Business Summary

Brunswick operates in two segments: Marine and Recreation. Within Marine, sales are broken down by Marine Engine (core engine / parts & accessories), and Boats. Recreation is entirely comprised of the Fitness business (Brunswick sold its retail bowling business in 2014 – the company still manufacturers lines of billiards, air hockey, and other gaming tables under the Fitness segment). 

Marine Engine

Mercury Marine manufactures and markets a full range of outboard, sterndrive and inboard engine and propulsion systems under the Mercury, Mercury MerCruiser, Mariner, Mercury Racing, Mercury Sport Jet, Mercury Jet Drive, Mercury Diesel, Sea Pro, Axius and Zeus brand names. In addition, Mercury Marine manufactures and markets marine parts and accessories under the Quicksilver, Mercury Precision Parts, Mercury Propellers, Attwood, Garelick, Whale, Land 'N' Sea, Kellogg Marine Supply, Payne's Marine Group, BLA, Seachoice and MotorGuide brand names, including marine electronics and control integration systems, steering systems, instruments, controls, propellers, trolling motors, fuel systems, service parts and lubricants. Mercury Marine also supplies integrated, high-speed diesel propulsion systems to the worldwide recreational and commercial marine markets.

Mercury Marine's outboard, sterndrive and inboard engines are sold to independent boat builders, local, state and foreign governments and to Brunswick's Boat segment. In addition, Mercury Marine sells outboard engines through a global network of more than 6,000 marine dealers and distributors, specialty marine retailers and marine service centers. White River Marine Group, LLC and its subsidiaries (including Tracker Boats) is Mercury Marine’s most significant external customer (not quantified).

Brunswick’s parts and accessories distribution and products businesses include: Land 'N' Sea, Kellogg Marine Supply, BLA, Payne's, Attwood Marine, Garelick Mfg. Co. and Whale. These businesses are leading manufacturers and distributors of marine parts and accessories throughout North America, Europe and Asia-Pacific, offering same-day or next-day delivery service to a broad array of marine service facilities.

Through Cycle Performance

Boat

The Boat segment consists of the Brunswick Boat Group (Boat Group), which manufactures and markets: fiberglass pleasure boats; yachts and sport yachts; sport cruisers and sport boats; offshore fishing boats; aluminum and fiberglass fishing boats; pontoon boats; utility boats; deck boats; inflatable boats; and heavy-gauge aluminum boats.

The Boat Group includes the following boat brands: Sea Ray L-Class yachts, yachts, sport yachts, sport cruisers and sport boats; Bayliner sport cruisers, runabouts and Heyday wake boats; Meridian yachts; Boston Whaler and Lund fiberglass fishing boats; Crestliner, Cypress Cay, Harris, Lowe, Lund and Princecraft aluminum fishing, utility, pontoon boats and deck boats; and Thunder Jet heavy-gauge aluminum boats. The Boat Group also includes a commercial and governmental sales unit that sells products to commercial customers, as well as to the United States government and state, local and foreign governments. The Boat Group procures most of its outboard engines, gasoline sterndrive engines and gasoline inboard engines from Brunswick's Marine Engine segment.

The Boat Group sells its products through a global network of approximately 3,000 dealer and distributor locations, which may carry more than one of Brunswick's boat brands. Sales to the Boat Group's largest dealer, MarineMax, Inc., which has multiple locations and carries a number of the Boat Group's product lines, represented ~24% of Boat Group sales in 2016.

Through Cycle Performance

Fitness

Brunswick’s Fitness segment is comprised of the Fitness division (Fitness), which designs, manufactures and markets a full line of cardiovascular fitness equipment (including treadmills, total body cross-trainers, stair climbers and stationary exercise bicycles) and strength-training equipment under the Life Fitness, Hammer Strength, Cybex, Indoor Cycling Group and SCIFIT brands. The Fitness segment also includes Brunswick’s active recreation business, including billiards tables, accessories and game room furniture.

Fitness' commercial customers include health clubs, corporations, schools and universities, hotels, professional and collegiate sports teams, retirement and assisted living facilities and the military and governmental agencies. Planet Fitness Inc. is the segment's most significant customer (estimated at anywhere from 10-20% of the segment’s sales). Fitness makes commercial sales through its direct sales force, domestic dealers and international distributors.

Through Cycle Performance

c. Management Overview

In February 2016, Dusty McCoy, BC Chairman and CEO, retired, and was replaced by Mark Schwabero.

Mark D. Schwabero was named Chairman and Chief Executive Officer of Brunswick in February 2016. He served as President and Chief Operating Officer of Brunswick from 2014 to 2016 and as Vice President and President - Mercury Marine from December 2008 to May 2014. Previously, Mr. Schwabero was President - Mercury Outboards from 2004 to 2008.

William L. Metzger was named Senior Vice President and Chief Financial Officer of Brunswick in March 2013. Previously, he served as Vice President and Treasurer of Brunswick from 2001 to 2013 and in a number of positions of increasing responsibility since his employment with Brunswick began in 1987.

d. Marine Market Overview

Below are the six most important charts that summarize the state of the marine market in 2017. They are summarized as follows:

      i.         New boat sales remain well below prior peaks

     ii.         Outboard boats (and engines) are taking share from sterndrive and inboard – this trend will continue

   iii.         Outboard engine attach rate (engines per boat) have been steadily climbing from 1.1 to 1.6, as a) boats are sold with more engines on them, and b) boats are “repowered” with new engines

    iv.         Boating participation and interest among adults remains healthy

     v.         Dealer inventory is healthy

    vi.         New boat sales are not keeping pace with obsolescence – a bullish indicator for future new boat demand

(i) New / Used Boat Sales
New and used sales are 43/7% off prior peaks
(ii) Marine Engine Market Share by Type
Outboard engines have continued to take share from sterndrive / inboard
(iii) Outboard Engine Sales per Outboard Boat Sold (attachment)
Outboard engine attachment rates have increased from 1.1 to 1.6 per outboard boat
(iv) Boating Participation Among Adults (mm, %)
Boating participation remains healthy
(v) Supply Chain	(vi) Obsolescence
Channel is healthy	Obsolescence should support new sales

The Setup

As discussed in Marine Market Overview, the marine business is healthy – we have had five years of M/HSD unit growth and MDD average retail sales growth. In 2017, we have seen softness in the large boat category (65’+). No one in the industry has a good answer as to what is driving the large boat softness – the most common response is that “dysfunction in Washington is causing small/medium business owners to hold off on discretionary spending”. Whether this is true or not is irrelevant given a) Brunswick’s exposure to engines is more affected by unit sales than dollar sales, and b) large boats are historically not an indicator of the health of the boating cycle. However, given the large ticket of yachts, MarineMax (HZO-USAA, the largest boat dealer in the U.S.), printed an ugly Q3 (July) and missed their comp badly. While units were up HSD (arguably a more important read-through for BC), mix weighed by double digits. This caused a panic selloff in Brunswick’s stock (see chart below, 7/20/2017). Brunswick’s boat segment was not immune from this softness and they saw a weak print in Q2 from the loss of these large ticket boats. In response to this large boat softness, Brunswick decided to furlough some capacity and to clean up the channel (allow inventories to normalize). We could see some further softness in Q3 on a wholesale level, but a) this is now much better understood, and b) retail sales have already picked back up. One last thing worth pointing out is the fact that the sample size in question is extremely small – for context, total U.S. Yacht sales in 3Q17 were 176 – so the “-10%” we saw in August, for example, was a decline of six boats. Again, the impact to sales is meaningful (these boats can cost anywhere from $1-500mm), but on a unit basis, it is almost irrelevant.

Additionally, in Q3 BC reported a $0.10 EPS miss and cut 2018 EPS guidance by 10% on continued large boat softness and increased competitiveness in the Fitness business in Europe. The Fitness performance was a disappointment, but as discussed further in the Thesis section below, this kind of lumpiness in Fitness sales is common especially ahead of a large equipment refresh, which is occurring late 2017/early 2018. The large selloff in the stock post Q3 was a result of poor communication by management as well as a mismatch of investor expectations in terms of when the sales of new equipment would start showing up. This has created a very attractive entry point for investors that understand the real earnings power of this business.

III. Investment Thesis

a. Misunderstood value in parts & accessories

Brunswick is seen as a boat manufacturer; the profitability of the business actually comes primarily from engines, and more specifically parts and accessories – the defensiveness and recurring revenue of the engine and parts business makes the company much higher quality than the stock is given credit for.

It is important to illustrate how misunderstood this stock is – many investors think of Brunswick as a boat company, but boats are actually only 12% of the Company’s profitability. Management has never quantified the profit margins of the parts and accessories business, but have indicated they are meaningfully above the corporate average. Conversations with formers and industry contacts reveal that P&A is at minimum 10% higher margin than core engines – assuming a 15% premium implies P&A margins are ~23% and engines are ~8%. These assumptions drive the profitability breakdown below:

While the engine business is obviously levered to the health of the boating cycle (although it is secularly growing, as discussed in Marine Market Overview), P&A is actually quite defensive. The P&A business is roughly broken down into 80% aftermarket and 20% OEM. Brunswick’s CFO notes that P&A OEM sales will cycle with engine sales, but the aftermarket piece is very steady – in the 2008 financial crisis, aftermarket sales contracted by less than 5%.

The table below is another way to think about how the P&A business is being undervalued. Assuming 8x EBITDA on the boat and core engine businesses, 12x on the fitness business and 10x on corporate expenses (see comps in Exhibit 4), the current stock price is implying the P&A business is trading for ~4.5x. Given the high quality nature of this business, this is unjustifiably low. It can be debated what multiple this business should trade at, but every turn drives $4.30 per share of value (or ~8% upside):

P&A Implied Multiple

Growing the P&A business is BC’s top priority for capital deployment – since 2014, BC has acquired 150mm+ worth of P&A sales, and has a stated goal to acquire 350mm through 2018. As of 3Q17, BC’s balance sheet was essentially untapped (~50mm net debt). Assuming the Company has a leverage limit of 2x EBITDA, it has ~1.2bn of dry powder. Further assuming a 10x multiple paid for P&A businesses, BC can acquire at least 120mm of EBITDA. Not only will these acquisitions be accretive, they will serve to further diversify the business into a more defensive segment which should drive the multiple higher.

b. Misunderstood fitness business; you are getting this piece for free

Under a similar framework, using reasonable valuation assumptions on the non-Fitness segments, investors are buying the Fitness business for less than nothing. As per comps (see Exhibit 4), a reasonable multiple for this business is more like 12x – not -4.5x. 

As discussed in The Setup, the fitness business has essentially been written off for dead. From conversations with industry contacts, including the former head of the Fitness segment, as well as analysis of the historical performance of this segment, it is immediately obvious that this kind of volatility is par for the course in fitness equipment. Management noted competition in Europe that drove some pricing softness – everyone seems to be forgetting that this is a very common pattern – this kind of promotional intensity comes and goes all the time. In fact, now that Technogym is a public company (the manufacturer that is reportedly causing the disruption), this has been happening with less regulatory than it once did. While it is not pleasant to see pricing pressure in a particular geography, there is no reason to think there is a structural change occurring.

Fitness Organic Growth

There is no rationale as to why the Fitness business belongs under the same parent company as the Marine business. Management acknowledges there are no synergies, procurement or otherwise, and the businesses operate as completely standalone entities.

There are subtle reasons to believe that we may be closer to monetizing this business than many think. When Dusty McCoy was CEO, management were generally staunch defenders of the Fitness business – they would argue that it provided diversification away from the cyclical marine business and that it was a core part of the Brunswick portfolio.

“You're going to see that we're talking about fitness still and we will; it's our core business.”

  – Brunswick Corporation, Analyst Day 2015

Today, management is upfront about the fact that they are not getting appropriate credit for Fitness (or P&A for that matter) and that all options were on the table in terms of realizing that value. In addition, BC hired a new President of Fitness in January 2017 – Jaime Irick – who was the former Chief Commercial Officer of GE Lighting, a ~$3.5bn business with 17k employees. Jaime replaced Chris Clawson, who was a lifer from Life Fitness. Feedback on Chris was that he was doing a great job growing this business – while it cannot be proven, Jaime’s hire could have been part of the new BC CEO’s strategy of preparing this business to operate as a standalone company.

Cardio Refresh

Brunswick is launching a complete refresh of its cardio equipment in 2018, with a focus on connectedness and integration with the cloud, smart devices, etc. PLNT has been proactively bringing up the launch in investor meetings and indicating their anticipation of a meaningful improvement to the quality of their clubs.

In 2016, cardio sales represented ~55% of Fitness topline. Cardio equipment has higher margins by “at least double digits” as compared to strength equipment. It is important to note that the majority of Fitness profitability is housed within cardio equipment – highlighting how impactful sales growth in this segment is.

The table below is self-explanatory – the last two cardio refreshed in 2004/2005 and 2010/2011 saw three year margin expansions of 400/900bps, respectively, and three year topline growth of 22/28%, respectively. While management is not forthcoming with details around the launch, management highlights that the 2010-2012 timeframe was a reasonable proxy to think about for the launch in 2018.

While the Q3 softness in Fitness looked scary on the surface, it is important to note that the softness was driven a) by European competitiveness, which as discussed has waxed and waned over time, and b) was on old equipment, not new. The new equipment began shipping late in Q3 and several products are still being released. Conversations with the former head of the Fitness segment indicate that this is a common occurrence – clubs will often delay purchasing until the full refreshed product suite has been made available. It is worth noting the soft organic growth in 2004 before the 2005/2006 refreshes (we see some softness in 2009/2010 but it is hard to disentangle from broad economic weakness).

Planet Fitness Vitality Upside

While the cardio refresh discussed above should drive upside to margins and topline over the next 2-3 years, there is another dynamic at play that is not fully appreciated by the market. As discussed, PLNT represents anywhere from 10-18% of Fitness segment sales. In 2015, Planet Fitness began enforcing strict vitality rules – clubs that operated with equipment that was of a certain age were mandated to order refreshes (from Life Fitness). Cardio equipment is mandated to be refreshed every 4-5 years, strength every 6-7 years. The chart below illustrates the tailwind from aging PLNT stores – from 2012 through 2015, PLNT locations essentially doubled. These stores will be forced to refresh their cardio equipment in 2017-2020, providing a nice tailwind for Fitness revenue. Assuming a 40% incremental on these sales, and using street estimates for net new PLNT stores, this drives an incremental 6% and 4% EBIT growth in 2018/2019. This analysis also conservatively assumes PLNT is 10% of Fitness sales – if the number is closer to 20%, those growth numbers will double. 

c. Misunderstood value in engine business; 2018 product launch and share opportunities

Mercury is launching a new class of engines for the 2018 season. While management has been reluctant to release any details to the public, management’s excitement is very self-evident:

“But it's no secret, we're investing significantly in a product program. And we get -- Bill and I get really excited about our opportunity there. But no, I can't really talk about it yet…   We want to talk about it, but we can't talk about it.”
– 3Q17 BC Earnings Call

Looking at the years with engine launches there is a clear correlation b/w an engine refresh and Marine Engine margin expansion. Management has indicated that this launch should be no different than year’s past – in other words, a 100bps lift to Marine Engine margins is a conservative assumption. A 100bps increase in margin will drive upside of $0.20-0.25 of eps vs. consensus estimates.

Engine Margin Expansion [platform refresh years in red]

Channel checks have revealed speculation that Mercury may be planning to launch 200/250HP four-stroke outboards – while Mercury currently manufactures 200-250HP outboards, they only make a two-stroke model. Two-stroke engines have been steadily losing share to four-stroke: (see chart above - formatting doesn't work)

Market share by two vs. four-stroke and different horsepower are difficult to discern – however, a reasonable guess is the 200-250HP four-stroke product is ~5-10% of the outboard engine market (currently dominated by Yamaha), and if Mercury’s average market share in outboard is 30-35%, this could be a market share opportunity of 150-350bps. Orders for 2018 boats should start hitting BC’s books in the fall – in theory, management should have a reasonable line of sight on orders and be able to present some degree of confidence at the Miami Boat Show in February.

d. Underperformance Since Management Change

It is notable that BC has had significant multiple compression since 2015 – BC has gone from ~18x forward P/E in 2015 down to ~12x today. Over the same time period, BC has grown EPS by ~50%. From the post-recovery period through late-2015, the stock traded consistently above 16x. Since then, the stock has traded pretty much under 14x, which coincidentally or not, coincided with the appointment of the new CEO Mark Schwabero, who took the reins in early 2016.

Some investors argue that the compression in multiple is a result of the aging marine cycle, but that is simply not the case when you look at the valuation of marine-related peers – multiples have actually expanded by 8% over the same time period (see below).

Of course, the compression in BC valuation cannot be solely attributed to the new CEO, but the sentiment is consistently negative and growing more so on the management team – a change at the top would be very well received. 

P/E Compression vs. Peers (indexed 08/2015)

IV. Risks

a. Consumer Cyclical

Boats are a cyclical good and a recession would have a direct impact on Brunswick’s sales and profitability. While the P&A business does provide some protection, as discussed earlier, the majority of Brunswick’s sales and operating profit are driven by highly discretionary consumer product. During the Great Recession, the Marine Engine, Boat, and Fitness business saw sales declines of -40%, -75%, and -25%, respectively.

For context, the P&A business was virtually non-existent during the 2001 recession – a year in which Brunswick’s total sales declined by 12%. If the aftermarket component of P&A is 20% of today’s sales, and would have declined 3% in the 2001 recession (sales declined MSD in 2008), that would mean the sales decline on the business with today’s mix would have been 10%. In other words, the P&A segment today makes Brunswick ~20% less cyclical. This is arguably understated given the relatively modest decline in 2001.

Like most big ticket consumer discretionary products, the majority of boat sales are made on credit. If credit should cease to be available, or rates rise meaningfully, we could see a decrease in demand for boats and engines.

b. Yamaha Product Launch

Yamaha has not done a real outboard refresh in several years – engine refreshes are a significant driver of engine sales. Channel checks reveal Yamaha plans to launch a 400HP F series to compete directly with Mercury’s 400HP Verado – currently Yamaha only has a 350HP offering. While Mercury engines have been taking share from Yamaha in saltwater markets, Yamaha’s refresh could in theory slow that trend. However, channel checks also reveal a generally more positive view towards Mercury products in general given quietness, reliability and lower replacement/maintenance costs.

It should also be noted that fulfillment is a concern for Yamaha product; multiple sources have confirmed that there is a delivery backlog through January on the Yamaha 350s, and that other products are unavailable for order given supply chain issues.

c. Planet Fitness Contract

Brunswick is the exclusive supplier of fitness equipment to Planet Fitness, which represents somewhere from 10-18% of the segments sales (management says 10%, others in the industry indicate it could be higher). This exclusive contract is coming up for renewal in 2018 – the loss of this contract, or the loss of exclusivity, could have a material impact on Brunswick’s Fitness sales. On PLNT’s latest conference call, they indicated they have RFPs out with the three main equipment OEMs: Life Fitness (BC), Technogym, and Matrix.

From conversations with industry contacts and channel checks, it appears the risk of BC actually losing the contract is fairly low. PLNT has been forthcoming with their excitement in several public forums throughout the year. While there could arise the situation where PLNT is able to negotiate more favorable terms to PLNT given a formal bidding process is underway (which is how PLNT 3Q17 commentary should be interpreted), this should be more than offset by the launches discussed earlier in this write-up.

In a worst case scenario, even if the entire PLNT contract is lost, that would only be a ~3.5% hit to consensus EBITDA in 2018.

EBITDA Impact from PLNT Contract Lost

V. Financial Summary and Valuation

Base Case Summary

Financials (Base Case)

Bull Case Summary

Financials (Bull Case)

Bear Case Summary

Financials (Bear Case)

DCF Valuation

Comps

Boat comps:  Malibu Boats (MBUU), MCBC Holdings (MCFT)

Fitness comps:   Technogym (TGYM), Amer Sports (AMEAS)

Marine comps:   Yamaha

Parts comps:  Dorman, LKQ

Comps