Five Reasons To Play Steinway (LVB) | May 23, 2008 | By Will Ashworth

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Five Reasons To Play Steinway (LVB)

May 23, 2008 | By Will Ashworth

Ask any piano player to name the best brand of piano ever made, past or present, and many will answer Steinway. Henry Engelhard Steinway started the business in 1853 in Manhattan, selling the first piano for $500. It now sits in the Metropolitan Museum of Art. The company has made pianos continuously ever since. Today, Steinway Musical Instruments (NYSE:LVB) is the world's leading producer in terms of pianos and band/orchestral instruments.

In 2007, company sales were $406 million, up from $385 million a year earlier. While sales aren't exploding, they are quite stable, producing decent profits to the bottom line. Many investors wouldn't take a second look at this slow grower, but I'll examine five reasons to own this iconic gem. You be the judge as to whether or not my arguments warrant consideration.

Reason 1 - The BRIC get Richer
Brazil, Russia, India and China: this is where the real economic growth is, accounting for more than 30% of the total global economy. China appears to be the strongest of the four and Steinway has an ever-increasing role to play in the future of musical instruments there. By the end of 2007, the company's three piano brands- Steinway, Boston, and Essex held 5% of the Chinese market for grand pianos. Furthermore, its grand piano sales to China grew 35%, making a healthy contribution to the 23% overall international growth in piano revenue. The U.S. market may be suffering, but the overseas markets are jumping. (To learn more about the BRIC countries, read Going International.)

Reason 2 - Gross Margins Increasing for Band Instruments
The band segment's gross margin in 2007 improved 140 basis points to 20%; primarily due to an increase in the sales of professional instruments, which are more profitable. But, that's only half the battle. If Steinway truly wants to become a growth company, in addition to building sales, it needs to increase both gross and operating margins. In 2007, the segment accounted for 42% of revenue but only 6.9% of the operating profit. That's anemic at best. The company made good on its promise to improve gross margins by boosting them 140 basis points in 2008's first quarter to 21.6%. It's not spectacular, but a marked improvement from the same time last year. If it can continue to chip away at costs, it's conceivable that the band instruments will make a more serious contribution to profits at some point.

Reason 3 - Book Value Increasing Steadily
Since Kyle Kirkland, Chairman, and Dana Messina, CEO, took over the company in 1995, its book value per share increased at a compound annual growth rate of 10%. Assuming they do this for another 10 years, the book value at that time should be approximately $51.30 per share. Based on the current price-to-book of 1.32, the stock price in the future should be $67.72, and that's not including the dividends paid out over those 10 years. Slow and steady wins the race. (For more on calculating book value, check out Value By The Book.)

Reason 4 - Value Investors Circling
Back in June 2007, the stock was trading at $37. It's been in decline ever since. One hedge fund that's taken a shine to Steinway is ValueAct Capital Management, a San Francisco-based investment firm who manages $6 billion for 250 wealthy individuals, corporations and foundations. The fund makes value plays in misunderstood firms like Iconix Brand Group (Nasdaq:ICON) and InfoUSA (Nasdaq:IUSA). Its Small Cap Management fund owns 868,410 shares, or a little over 10% of the stock. The most encouraging part is that ValueAct paid in the high 20s for most of its shares. Unless it reconsiders, you can be confident that if you buy at today's prices (around $27), you won't be too far off the mark.

Reason 5 - Strategic Use of Cash
Two pieces of news caught my attention recently. The first was the announcement it had acquired Arkiv Music LLC, an online classical musical retailer for $4.5 million. Sure with sales of $8 million, it won't compete with online sales giant Amazon.com (Nasdaq:AMZN), but it is growing at 30% year-over-year. Niche acquisitions like these can help Steinway become even more of a musical powerhouse. The second attention grabber is a $25 million share repurchase program announced May 19. It's a clear sign management feels its shares are the best place to invest excess cash. (To learn more about repurchases, see A Breakdown Of Stock Buybacks and How Buybacks Warp The Price To Book Ratio.)

Bottom Line
Steinway is a bit of an anomaly. It makes the world's greatest grand pianos for the world's greatest pianists, but also makes all those musical instruments like the recorder that you played in the fifth grade. So far the recipe has produced a slow but steady growth vehicle.

CEO Dana Messina is a seasoned pro who's seen tough times in the past. According to him, 2001 and 2002 were much more difficult than today's economic stew. Obviously, the managers over at ValueAct agree. I say go ahead and make your play for Steinway.

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work. At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.