Steinway Musical Instruments (LVB) has many of the attractive elements I look for in an investment: a dominant market position in its core business, solid downside protection, hidden asset value, smart and incentivized insiders, and several foreseeable catalysts all rolled into a small-cap, underfollowed stock. I believe this $25 stock is worth ~$47 (88% upside) and that there are several probable catalysts (as early as Q3 this year) that could drive the share price closer to my estimate of intrinsic value.
Since its founding in 1853, Steinway has dominated the high margin, high ticket ($130,000+) concert piano market by making the finest pianos in the world. They also have a “band business” which sells non-piano instruments, which is a less lucrative, more commoditized business. Finally, they own two properties in NYC that are listed on the balance sheet at ~$3 mm and $26 mm, but were appraised at $200 mm and $100 mm respectively during a debt refinancing in 2006. This stock has always traded at a discount to the sum of the parts because the company formerly had a dual class share structure that prevented activism. With management that did not have the urgency, willingness, or experience to realize the full value of their assets (particularly their real estate assets), a discount to the sum of the parts was appropriate.
However, in 2007, ValueAct Capital began building a significant position in the stock. ValueAct is a very successful activist hedge fund that has averaged ~13.5% returns since 2000 (versus an almost flat S&P). Their process typically entails building a large position in a stock, divesting non-core assets, and ultimately, negotiating sale of the business. Just in the last year, ValueAct successfully sold BigBand Networks to ARRIS Group (Nasdaq: ARRS), Immucor to TPG Capital, and S1 Corp to ACI Worldwide (Nasdaq: ACIW). ValueAct has been involved with Steinway since 2007 and it appears this investment is following their typical script. Current investors have an opportunity to invest at a lower cost basis right before several key catalysts, which should drive a tremendous IRR.
On June 2, 2011 ValueAct along with Samick Instruments, a Korean instrument company, purchased the Class A voting shares from the former CEO and Chairman of the board at $56/share, which was a 100%+ premium to the common share stock price at the time. As part of this process, ValueAct and Samick took control of the company and board, placing Private Equity veteran, Michael Sweeney, as Chairman and CEO. ValueAct currently owns 9.6% of the stock and Samick, which is a Korean instruments company, owns 32.31%.
The stock currently trades at $25, which is roughly the same price as in June 2011 prior to elimination of the dual class share structure. I believe that this discount is no longer warranted, especially given the high probability of multiple value driving catalysts over the next year. These potential catalysts include:
• A sale of the lower-margin band business, which would allow them to focus all of their efforts on their dominant Steinway brand and other piano operations. The company reached a tentative deal with Kyle Kirkland and Dana Messina, the two former directors who had previously owned the voting rights. While negotiations are still ongoing, the company was reportedly seeking around $76 mm for this division.
• Monetization of their NYC real estate properties. Their 450,000 sq. foot Steinway Factory was opened in the 1870’s and is listed on the balance sheet for only $3 mm, but was appraised for $200 mm in 2006. Their 217,000 sq. foot showroom in Midtown Manhattan is only carried on the books at $23 mm, but was appraised at $100 mm in 2006. These are prime real estate assets (look here for street view of Steinway Hall: bit.ly/RBbYwh). It is a waste for the company to own an 18 story building in the heart of Manhattan where it occupies only a fraction of the building and manufacture their Steinway pianos at such a valuable waterfront Queens property.
• A sale of the main piano business to Samick or other interested buyers. Samick paid a huge premium to gain control of the company, owns over 30% of the stock, and has their CEO on the board of Steinway for a reason. Adding the dominant piano brand worldwide into their portfolio is the next logical step. With a sale of the band business and the real estate, Samick could more easily bid for the whole company. This would also fit right with ValueAct’s typical strategy of using a sale of the business as an exit strategy.
• On the latest conference call, Chairman and CEO, Michael Sweeney (the PE veteran), said, “The special committee has been very active in evaluating a variety of strategic alternatives, and we expect the committee to complete its work during the third quarter. We will have an announcement as soon as possible.” ValueAct has been in this stock since 2007 and Sweeney has been working actively on this since 2011. I think that current investors have an opportunity to maximize their IRR by investing right before the culmination of this 5-year process by ValueAct is readily apparent to the market.
Of course, this opportunity is only attractive if the sum of the parts discount still exists. I think there is overwhelming evidence to suggest that it does. Before digging into the numbers, I think it is important to note that the stock price has essentially not moved since the dual class share structure was eliminated in June of 2011 despite very solid results from operations. That decision by Mr. Market does not make much sense to me, especially since management is suggesting that there will be an announcement about strategic alternatives soon. Perhaps this opportunity exists because there is very little analyst coverage and investor relations to publicize the several sources of hidden value to a largely retail investor base (e.g. see this recent seekingalpha article that says the 61 P/E is too expensive but mentions nothing of ValueAct or their real estate holdings, which are clearly pertinent to the investment: bit.ly/RBjHL0).
Here is how I think about the low and high valuation components for Steinway. I tried to err on the side of conservatism even for the high valuation.
1) Piano Business: I took the 4-year avg EBIT for this division. This is a pretty good division with strong margins (especially for their premium Steinways). Revenues and operating income have been increasing and there is still a significant growth opportunity in Asia. I chose 8X EBIT for the low estimate and 12X EBIT for the high estimate. I think both of these are fairly conservative, especially considering rival Yamaha trades at ~13X EBIT. Steinway’s core businesses have been slow growers with ~10% EBITDA margins and boast the world famous Steinway brand. Yamaha has had slightly negative top line growth, ~5% EBITDA margins, and is a more commoditized brand. Given these factors, I think giving Steinway’s Piano Business a Yamaha-like multiple is, if anything, conservative.
Piano Business EBIT 4-yr avg (mm) $19.90
Multiple Value (mm)
6 $119.40
8 $159.20
10 $199.00
12 $238.80
15 $298.50
2) Band business: The company is in serious negotiations to sell this business, and they were reportedly seeking $76 mm. I used this for the high estimate and took a 50% haircut on that valuation for the low estimate. Note that this business does ~$130 mm in sales/year, so the high and low estimates are about .6X and .3X sales respectively. Those do not seem too aggressive for a pretty consistent and profitable business.
3) Real Estate: As mentioned, Steinway Hall and their West 57th Street manufacturing facility were appraised for $200 mm and $100 mm respectively in an 8K filed February 10, 2006.
I used the 2006 appraised values of $200 mm for the Steinway Factory and $100 mm for the West 57th Street building for the high estimate. I took a 50% haircut to each of these values for the low estimate. I think both of these are pretty conservative given that most rent prices in Midtown NYC have actually increased since 2006 (~30%) and the Steinway Factory could be worth multiples of the appraised value if the company was able to get it rezoned to a residential area.
Item Low Value High Value
Piano Business $159.00 $238.00
Band Business $38 $76
Steinway Factory $100 $200
West 57th Street $50 $100
Net Cash ($31) ($31)
Value $316 $583
Value/Share $25.44 $46.94
Upside/Downside (%) 1.77% 87.76%
I think the assumptions made in the Low Value Scenario are pretty draconian. With a buyer lined up for the band business (former directors Messner and Kirkland with a tentative deal), a logical buyer for the core piano business (Samick) that paid $56/share to take control, and a proven activist in ValueAct to maximize the real estate value, I think the market price should be much closer to the “high value” scenario than the low value scenario, which the market is currently implying with the $25 stock price. Furthermore, the assumptions made in the “High Value” scenario are far from aggressive:
• The 12X EBIT for the Piano business is below competitor Yamaha’s valuation, even though Yamaha is a less attractive business.
• NYC midtown asking rent prices are up ~30% since the 2006 appraisal values (which I used in the “High Value” estimate), which should make the West 57th street property more valuable.
• The Steinway Factory could potentially be reclassified as a residential area, which would more than double the value of the waterfront Queens Steinway Factory real estate.
• I am giving zero value to their 221,000 sq. foot manufacturing facility in Hamburg, Germany: This factory was opened in 1880 and is carried on the books at $1MM but is probably worth substantially more today.
For all of these reasons, I think the “High Value” estimates are very reasonable.
Steinway is trading almost exactly where it was a bit over a year ago, but the investment is undoubtedly much more attractive today. ValueAct and Samick have showed a significant vote of confidence and “tipped their hand” as to their intentions by paying $56/share to remove the dual-class share structure and investors today have an opportunity to invest below their average cost basis. This move, along with the appointment of a PE veteran as CEO and Chairman are a game-changer for the stock. I think it no longer deserves to trade at a discount to the sum of the parts with ValueAct and their history of success leading the way to value realization. I think the stock with very reasonable assumptions is worth much closer to the “High Value” case of $46.94/share than the current price of $25.
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The Variant View 
The long term value of LVB lies in the people who design and manufacture the pianos. Selling the factory for real estate development would cause great consternation among both workers and musicians. The company would have to relocate somewhere at no small expense, and not everyone would go in the move. It is a classic 1980’s rape-the-company maneuver. I don’t think this is going to happen.
One other thing I was thinking about when I read your post:
You said, “The long term value of LVB lies in the people who design and manufacture the pianos.”
I disagree with this statement. A competitor could not come in today, even with the same work force, and compete with Steinway. While the workers are important, it is the company’s brand and history of success that is so valuable– that is difficult to compete with (even with the same work force).
Furthermore, the long-term value in my opinion is not in the core business itself. It’s from the real estate as I outline in my valuation. Monetize the real estate, divest it to shareholders, and let them invest it in other opportunities. In this sense, the “long-term value” is no different than the current net present value. And IMO, the NPV of the RE exceeds the core business.
Best,
Connor
Hey Connor,
Nice writeup, obviously part of your thesis hinges on the monetization of RE. Have you thought about a sale leaseback transaction with the two properties. With favorable terms for Steinway.
I’m not sure sale/leaseback is value maximizing to Steinway. I don’t see how you get a value close to appraisal if you lock the new owner into the same use. I think it’d have to be an outright sale.
DCX,
Thanks for the comment. It’s always good to get differing views.
There is always a trade-off for anything, and while I cannot speculate on the level of consternation workers would have if the real estate was sold, it seems undoubtedly the best interest of the company financially.
There is no reason they need to manufacture their pianos on a 450,000 sq. foot waterfront property in Queens. While maintaining good work relations is important, a $200 mm facility seems absurdly expensive. I do not really see why workers would be so opposed to moving to a cheaper location, and even if they did, Steinway could hire others or pay their less disgruntled workers slightly more to stay. With the sale of that property, they could afford to pay workers considerably more and still have it be an excellent financial move.
If you look in their 10-K, they break out very well the hourly rates of their labor force. Their highest grade manufacturers (grade 11) are making a maximum of $20.55/hour in 2012. I think it is a tough argument to say that the workers would be so disgruntled and refuse, say, $25/hour, if they are forced to switch. From an investors perspective, that’s fine because that $200 mm facility is so valuable (2/3 of mkt cap!) and a relocation would not be difficult. Bringing in that cash can more than make up for a slight increase in pay if you are truly concerned about workers being disgruntled.
For that reason, I do not think that workers’ potential disgruntlement at all affects their ability or incentive to sell off that valuable property, and I think that ValueAct is probably thinking the same given the huge premium they paid to acquire control. Thanks for the differing view though and let me know if you have any other thoughts.
Best,
Connor
Hi Connor,
Let’s think through this a bit more.
Okay, they’re going to sell the plant for $200M (that’s an appraised value near the peak in RE prices during a massive bubble, but let’s say it’s fair). Where are they going to move everyone to? If they’re going to buy another warehouse of comparable size in Queens or Brooklyn, why would they be able to get that for significantly less than $200M? I mean, I don’t know what a factory like that goes for off the water front but I’m guessing it’s not cheap.
Did you look at the property? Here is a link https://maps.google.com/maps?q=Steinway+%26+Sons+Factory,+NY&hl=en&ll=40.782247,-73.897004&spn=0.009407,0.019205&sll=37.269174,-119.306607&sspn=10.118071,19.665527&oq=steinway+piano+factory+&t=h&hq=Steinway+%26+Sons+Factory,&hnear=New+York&z=16&iwloc=A
If that doesn’t work, plug it in yourself: 1 Steinway Place
Long Island City, NY 11105
Are they going to redevelop that piece of land into a giant condo tower? Next to the Bowery Bay Wastewater Treatment Plant? Beautiful view!! (Then again, New Yorkers are idiots, people bought up condos on the former insane-asylum of Roosevelt Island so I wouldn’t put it past them…) Maybe. But I wouldn’t take an appraiser at their word.
So, they sell the plant and they’re moving everyone. Oh, is everyone unionized? Did you check on that? Cause that might really piss the union off. Unions usually aren’t cooperative on pay cuts, let alone closing down an entire factory, selling the RE and moving everyone like cattle somewhere else.
Okay, the union goes along with it. And then… where in the city do they go? Do you have the plot picked out for them? What if they can’t find one nearby. “No problem, it’s worth shipping them out to effin Nebraska for $200M!!” But what if they don’t want to go? I mean, THEY’RE not getting $200M… and the margins aren’t great in this business, so it’s not like they can pay them a whole heck of a lot extra to incentivize them to build pianos in Nebraska without it quickly being irrational from a business standpoint because now there is no money in it.
Not to mention, it’s probably nice having your big, heavy pianos closer to water transport than having to go overland by truck or train or plane…
I think you’re right that the brand is valuable. But the brand is valuable for a reason– unless they can easily replicate the quality and styling elsewhere, with newly trained workers, it will be really difficult not to kill the value of this brand by doing some of the things you imagine them doing.
I guess my issue, though, isn’t really with your analysis or with the likelihood of the company doing this, or with the potential motivation or ideas of ValueAct– it’s really that I am so amazed that you’re thinking so… formulaically about this? I can’t think of a better word.
I always hear people criticizing the models of economists which they say have these cold-hearted, calculating, profit-and-nothing-else motivated “rational” actors that they say don’t exist in the real world. It’s a strawman because that isn’t really how economists do things, but still. And yet, here I am staring “face to face” with one. I am aghast. Not in a “You’re an evil capitalist!” way but in a, “Wow, I can’t believe he is so easily brushing off the complicated coordination and massive impact an idea like this would have on the real-world operations of the business because he crunched a few numbers and is convinced things still way out in favor of a big value discrepancy.”
I know you went to a really good school, and I also know you don’t HAVE to have experience with business to have good judgment, but I am curious how close you’ve gotten to any business that is similar to the ones you analyze as an investor? I can’t claim I am the world’s most experienced business man but I have a hard time imagining a real business, particularly THIS business (whose factory I have visited), operating just like so.
But it’s entirely possible I am off my rocker and that’s what makes this such a screaming bargain. And I guess that’s why somebody like you might make the big bucks while I sit here and nay-say from the comments section like an armchair-investor 😀
Hi Connor,
I wanted to ask one more thing, in case my last post didn’t leave a bitter enough taste in your mouth (I do think it’s an interesting idea, I’m just trying to poke holes in it because I don’t know enough to add more the bullish thesis and I don’t think coming in here and cheering you on is productive, either):
What could derail this?
Is there anything you can think of that could upset this applecart? I take it Samick is trying to buy the business? Then why did they bring in the PE guy? I’m a little confused. And why aren’t they buying shares in the open market at $25?
It’s a great special situation but is there an MoS? Your low valuation is where the price is right now, which implies if things went awry an investor could suffer a permanent loss of capital because they don’t have a chance to buy below this “fair” price.
I’m trying to think of what could go wrong. If nothing could go wrong or the things that could are extremely remote, then I agree, we’re looking at a pretty lucrative no-brainer here and it’d be time to front-run the heck out of these guys.
Valueprax,
Thanks for the comments. It’s always good to play devil’s advocate and listen to others play that role. I’ll answer each question individually.
1) I understood your first post as basically asking, “This is way more complicated than you make it seem. Aren’t you worried about the details? Where would you move them? Etc.”
There certainly are a lot of moving parts here, and I think that any investment thesis for this stock (but really any stock), no matter how detailed, could be labeled an oversimplification.
That being said, I do not have control of the company and have no say in what actually occurs. For that reason, it is not that useful for me to know exactly what plot of land they should buy for their manufacturing. If I was an activist investor, perhaps things would be different.
Fortunately, we do have an activist investor, ValueAct, working in our favor with aligned interests. This is not just any activist investor either– ValueAct is smart. Very smart. If you have not read much about them, I very much encourage you to. They are certainly a firm you do not want to bet against.
They have sold three businesses in the last year, have a great track record, and have been involved in this name for over five years. They know way more about the nitty gritty details than I will ever know, recently paid a large premium to take control of the company, and have a higher cost basis than today’s prices. There is no way I would be in this stock if we did not have such an accomplished activist investor controlling the company.
I think it is unrealistic (and also a bad investment of time) for individual investors to try and figure out what plot of land they could buy for their manufacturing, or worry about details outside of their control. Much more useful, in my opinion, is identifying the winning side of the trade and running with it. In this case, I believe there is tremendous value here, I have done due diligence, and incredibly smart people with much more information (ValueAct and Samick) agree. Furthermore, we pay them nothing for working for over five years on our (current investors) behalf. Instead, we invest at prices lower than them right before they announce the results of their strategic review.
In my humble opinion, this is the way to bet as an individual investor– not quibbling over land plots for their manufacturing facility.
To some of your more specific points, look is my analysis really that outlandish?
-Selling band business– they already have a buyer and have been in discussions for a long time
-Selling piano business– competitor owns 30% of stock and paid a large premium to gain control
-Selling RE and moving manufacturing. This seems to be the one you take most issue with and perhaps rightly so. However, to say that Steinway must manufacture their pianos on waterfront Queens property valued at $200 mm does not make sense to me. Remember, their most profitable operations are their elite Steinways, which sell just a bit more than 2,000/ year on avg. You do not need a gigantic facility for this. Perhaps part of ValueAct’s plan is to only move the Steinway brand and sell their lower price point (and less profitable) piano brands to companies (perhaps Samick..?) which already have manufacturing facilities and could take the brands in house. Again, as an individual investor with no special knowledge, I have no idea if this will happen. However, I do believe value is there and that ValueAct and Samick have the ability and incentive to monetize it.
2) To your final question of what could go wrong:
-The operations of the business could falter, hurting both ongoing and sale value
-the RE could take too long to sell or not fetch my assumed prices
-There could be restructuring issues with multiple sales and relocations (as you mention)
Really, any number of things. There are no real sure things in equities– something, even the most remote possibilities, can make a bet turn for the worse (just ask Knight Capital investors). That being said, for all of the reasons mentioned above and in the post, I think this is a very strong bet.
Thanks again for the comments.
Hi Connor,
So, this is not sarcasm or a jab at you, this is how I read what you said but essentially your thesis really boils down to: “ValueAct is smart, I can coat-tail them at lower prices than they have paid.”
All the rest of the stuff in your blog post is essentially window dressing. Your entire thesis rests on coat-tailling smart guys, which if they were not present, you said you wouldn’t invest.
This is fine. I actually have no problem with this and think it could be as simple as this.
I still don’t think you have any idea what you’re talking about when it comes to the apparent ease, in your mind, of producing their pianos elsewhere, and I don’t think you understand how meaningless “waterfront” as a descriptor is in this particular case. But it doesn’t matter. It’s literally irrelevant– as you say, that’s something for the activists and insiders to work out, as your thesis is built on the likelihood of them doing X, Y or Z, not how they’re going to manage the details along the way.
I really think that’s fair and I appreciate your response. I guess for my part I have to figure out now:
1.) How much confidence I would place in ValueAct
2.) How much time I think might pass before they make something happen
3.) What the impact could be, at these prices, if their deal fell through
Just so I understand better, you think the shares will catalyze because they’ll get the company sold, or you think they’ll catalyze because they’re going to talk management into selling the property, or what? Do you think Samick is the buyer or you think someone else is going to come in that we haven’t heard of yet?
Definitely an interesting “special situation”, I enjoyed reading about it!
Valueprax,
That is certainly not the thesis. If that were the case, I would just find smart people and buy their stocks when I had the opportunity to get a lower cost basis. That is not at all how I invest.
I look for value independently. That is what all the research into Steinway and their various parts was for. This is bottoms up, fundamental research– not “window dressing.” After doing my due diligence, I concluded that the sum of the parts was worth more than the current price. Then, it is just a matter of if there is a catalyst to unlock that value (as many stocks trade at discounts to SOTP). You seem to be caught up in the fact they would have to move their manufacturing. While you consider that grossly naive, I consider it grossly naive to think that with a ~$200 mm facility, it is not painfully obvious that this is the right financial move. Furthermore, ValueAct has been working on this for five years, has a history of doing exactly this kind of thing, and has made a big bet on this. In my opinion, it is naive to bet against them. You are certainly free to have your own opinion, but mine is that SOTP value exceeds current market value and that ValueAct will realize that value for the benefit of all shareholders.
The reason why ValueAct is essential to the thesis is not just because they are smart and you can invest at a better price. It is because they are smart and can be the catalyst to unlock the SOTP value. In fact they have done this in a pretty repeatable and predictable pattern multiple times over the last year.
Connor,
I misread your previous post and understand what you’re saying now. I apologize for missing the nuance. I’m still not sure I understand what kind of margin of safety is available in the event things don’t go as planned, but your SOTP thesis makes sense and I see how the presence of the activists adds a level of comfort and anticipation.
Thanks for the reply!
Great post! Given the low carrying value of the properties, any idea about the potential tax implications if the RE was to be sold?