|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||260||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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We are recommending a long position in Steinway Musical Instruments, Inc. (LVB). Steinway is a classic long term small cap value investment opportunity, offering both an attractive operating business with a premium brand and strong returns on capital as well as a net asset value per share that is worth almost as much as the current share price and has some considerable hidden asset value components (primarily real estate ownership). In valuing the operating business at 10x free cash flow (normalized EBITDA less maintenance cap ex) and the real estate (which can be detached from operations) at $250 mil net of taxes, which we believe to be conservative, we derive a value of approximately $50 per share, a 65% premium to the current share price.
Steinway is the largest domestic manufacturer of musical instruments and is second only to Yamaha globally. The Company’s products include pianos, woodwind, brass, string, and percussion instruments, among others. Although some of the Company’s brands have existed for as long as 150 years, the current holding company was formed via two significant acquisitions: the 1993 acquisition of the Selmer Company, the largest
The piano segment operates under the brand names Steinway,
On a trailing twelve month basis, the piano segment generated approximately $227 million in revenue, up approximately 8% year over year, with gross margins of 36.5%. The piano segment has more than offset a weaker market in the
The band and orchestral segment sells a wide array of other musical instruments and accessories including brass, woodwind, string, and percussion instruments. These products are sold under various brand names such as Bach, Ludwig, and Selmer, maintaining significant market share in almost every product category. The instruments retail for between $300 and $20,000, and are sold through a network of approximately 1,700 independent musical instrument dealers. Roughly half of the revenue in this segment is derived from entry level student instruments, with intermediate and professional instruments representing the balance.
Given that the majority of the band segment products are sold to educational programs and professionals, the business is far less susceptible to macroeconomic factors, but rather to demographic trends and school budgets. The segment has, however, been affected by pricing pressure due to increased competition from lower cost foreign manufacturers. This has in some part been offset by revenue growth in markets outside of the
The first component to our valuation model is the Company’s owned real estate. In a press release dated February 10th, 2006, the Company released management’s estimates/appraisals of the current value for its assets as part of its debt refinancing. The chart below summarizes management’s adjusted balance sheet valuation from the press release:
|Asset Base ($MM)||Actual Balance Sheet 9/30/05||Market Value||Market Value|
|Total Current Assets||309.8||281.2|
|West 57th Street||26.0||Estimated value||100.0|
|Steinway Factory||3.4||Estimated value||200.0|
|Book Value per share||$18.38||$51.54|
As can be seen above, management estimates that the
The second component to our valuation model is the value of the brand / operating business. Over the past ten fiscal years, Steinway has averaged approximately $51.5 million of adjusted EBITDA from its operations, with minimal volatility, having never fallen short of $46 million in adjusted EBITDA and never exceeding $56 million. Over the past year, Steinway has had some one time adjustments to EBITDA, primarily due to a strike at its
Our sum of the parts analysis suggests that $650 million represents a fair value for Steinway, and after subtracting out net debt of roughly $220 million, we derive an equity value of $430 million or approximately $50 per share. This represents a 65%+ premium to the $261 million equity value today (or $30 per share). Another way to look at it is that the implied enterprise value of the operations of $230 million (current EV of $480 less $250 for real estate) equates to a normalized FCF yield of approximately 17% at today’s price. Perhaps just as important, while our adjusted book value is far more conservative than the $51 per share value implied by the Company in its February 10th press release, we believe there is in excess of $25 per share of net asset value per share, implying considerable downside protection to our investment.
|LVB Valuation ($MM)|
|Operating Business @ 10x normalized $40 mil of FCF||400.0|
|Plus Real Estate Value (Net of taxes)||250.0|
|Implied Enterprise Value||650.0|
|Net debt (including pension underfunding)||222.1|
|Implied Equity Value||427.9|
|FD shares outstanding (MM)||8.7|
|Implied Equity Value per share||$49.18|
Although we feel that this investment has a lower long term risk profile given the Company’s asset rich balance sheet, it is important to discuss the risks to our investment thesis. One risk is related to the lack of investor control due to the split capitalization structure. Chairman Kyle Kirkland and CEO Dana Messina have majority voting control due to their 100% ownership of class A stock, and therefore have full control of the major strategic decisions faced by the Company. Although management has a solid track record of adding value for shareholders since acquiring the businesses in the mid 90s, there is no guarantee that they will unlock the significant hidden asset value anytime soon. We are confident, however, that management has the best long term intentions for shareholders, and that this value will eventually be realized. In the recent third quarter conference call, upon being questioned by an unhappy shareholder on this very topic, Dana Messina admitted for the first time that the 57th street building is for sale and even followed this up with a statement that ‘everything is for sale’.
Perhaps the greatest risk to discuss is the Company’s exposure to discretionary consumer spending and the weaker
Steinway Musical Instruments is an under-followed small cap value investment opportunity with limited sell-side coverage, an attractive balance sheet with significant hidden asset value, and considerable market share in the niche musical instrument manufacturing industry. While not without risk, we are comforted by the fact that the company trades near our estimate of net asset value, has a normalized return on invested capital in the low to mid teens, and generates a normalized free cash flow yield of approximately 10% at its current price, without consideration for real estate monetization. Furthermore, although the investment thesis is not completely dependent on growth, we are optimistic that the Company is well positioned to capitalize on some positive trends within the industry. Internationally, Steinway is capturing market share both in more mature markets such as Europe as well as rapidly emerging markets such as
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