-- A special committee of the Board of Directors of U.S.-based Steinway
Musical Instruments Inc. has ended its strategic alternatives evaluation
process, and will neither divest its band division nor the entire company.
-- We are raising our corporate credit rating to 'B+' from 'B' reflecting
improved credit metrics following better operating performance and debt
-- We are also raising the issue-level rating on the company's 7% senior
unsecured notes due 2014 to 'BB-' from 'B+'. The recovery rating is '2'.
-- The outlook is stable, reflecting our expectation that the company
will sustain its improved credit measures while maintaining adequate liquidity.
On Jan. 14, 2013, Standard & Poor's Ratings Services raised its corporate
credit rating on Waltham, Mass.-based Steinway Musical Instruments Inc. to
'B+' from 'B'. The outlook is stable.
At the same time, we raised the issue-level rating on the 7% senior unsecured
notes due 2014 to 'BB-' from 'B+'. The recovery rating on this debt is '2',
indicating our expectation for substantial (70% to 90%) recovery in the event
of a payment default.
The upgrade of Steinway Musical Instruments Inc. reflects Steinway's decision
to end its strategic evaluation process without selling any (or all) of the
company. In addition, we believe credit metrics have improved following a
substantial debt prepayment in 2011. The ratio of adjusted debt to EBITDA
improved to 3.3x as of June 30, 2011, following about $80 million of debt
prepayment, and has since improved to 2.9x as of the 12 months ended Sept. 30,
2012. Despite these improved metrics, the potential sale of the company or its
Band division and our uncertainty regarding financial policy, management, and
direction of the company, had been a constraint on the rating.
The ratings on Steinway reflect the company's "significant" financial risk
profile and "vulnerable" business risk profile. Steinway's financial risk
profile reflects the company's significant reduction in debt, as mentioned
above. The company's ratio of adjusted funds from operations (FFO) to total
debt remained near 20% for the 12 months ended Sept. 30, 2012, the same as the
prior year. Both these ratios are near our "significant" indicative ratios of
leverage of 3x-4x and FFO to total debt of 20%-30%.
Key credit factors in our assessment of Steinway's business risk profile
include its narrow business focus in a highly fragmented and competitive
market, the discretionary nature of its products, its vulnerability to
economic cycles, and weak governance. We also considered the benefits of
Steinway's good market positions, its well-recognized brand names, and the
geographic diversity of its sales.
Steinway's product sales and profitability remain concentrated in pianos,
although it has a diverse portfolio of product offerings in the band and
orchestral instrument segment. Piano sales were 62% and band instruments 38%
of 2011 revenues. The company holds a dominant market share of the premium
grand piano market, and is the leader in certain band instrument product
categories. Although the company maintains strong brand recognition through
its key Steinway and related brand names, we believe sales will remain
vulnerable to economic cycles because of the discretionary nature of its
products. We believe the musical instruments and accessories industry is
highly fragmented and very competitive, based on such factors as name
recognition, sound quality, style, and price. The company has diversified its
geographic reach and now has about 47% of its sales (in fiscal 2011) outside
of the U.S., a large portion of which are in Europe.
For the 12 months ended Sept. 30, 2012, Steinway's net sales were up about 2%
compared to the prior-year period in 2011, in part reflecting a favorable
recovery in the band segment, which had been weakened by a strike in its Ohio
brass instrument manufacturing facility during the second half of 2011. Still,
some of the company's key piano businesses remain soft, especially in the
premium-priced grand pianos market. Gross margin has remained flat at about
33% as the improvement in the band segment outweighed the additional costs to
increase headcount at its Hamburg facility. Adjusted EBITDA margin declined
about 50 basis points to 11.1% compared to 11.6% in the prior-year period, in
part because of additional sales, marketing, and promotional costs for new
We expect Steinway's operating results will improve modestly as sales growth
in emerging markets (particularly in Asia) offset a generally weak global
economy and margins remain pressured by high input costs. This should lead to
moderate credit measure improvement in fiscal year 2013. Our base-case
scenario assumptions include:
-- Revenue growth of about 3%, reflecting continued improvement in the
band segment, and sales growth in China, other emerging markets, as well as
Japan, despite ongoing weakness in the piano segment, particularly in
premium-priced and higher-margin pianos.
-- Adjusted EBITDA margin near 12%, reflecting better fixed cost
absorption thanks to a building backlog of orders, particularly in Asia.
-- No dividends or share repurchases.
-- We anticipate free operating cash flow (FOCF) to improve to at least
$15 million in 2013.
Based on the above assumptions, we expect credit measures to continue to
slowly improve, including projected adjusted debt to EBITDA of 2.5x and FFO to
total debt above 25% by the end of fiscal year 2013. Our projected credit
measures do not consider the potential sale of the West 57st Street property.
Management and governance
In July 2011 the company's then-chairman, Kyle Kirkland, and CEO, Dana
Messina, and certain members of management made an offer to purchase the
company's band instrument division, and the board of directors formed a
Special Committee to explore other strategic alternatives. Despite Dana
Messina stepping down from his management role, he remains on the board, as
does Kyle Kirkland, though not as Chairman. Additionally, an independent
director, Michael Sweeney, became Chairman in July 2011 and was then appointed
interim CEO in October, which we view as an additional constraint on
governance. We believe these circumstances created additional uncertainty
regarding the direction, policies, and operating strategies of the company. We
view Steinway's management and governance as "weak," primarily based on the
duration (18 months) of the recently concluded strategic alternatives
evaluation, and the potentially limited independence of the board, given
multiple management and director changes as the company transitions to a
non-controlled publically traded company.
Additionally, the company has been trying to sell its leasehold interest in
its flagship West 57th Street property in New York City for several years. If
the sale were completed, the company expects about $56 million of net
proceeds; however, the company is negotiating offers with several parties and
no further details on the potential use of proceeds and timing of the
transaction are available at this time.
We believe Steinway's liquidity is "adequate," with sources of cash likely to
exceed cash uses over the next 12 months by more than 1.2x. Our assessment of
Steinway's liquidity profile incorporates the following expectations,
assumptions, and factors:
-- We expect liquidity sources will continue to exceed uses, even if
EBITDA were to decline by 15% from current levels.
-- The company is not subject to maintenance financial covenants. The
asset-based revolving credit facility agreement contains a springing covenant
consisting of a minimum fixed-charge coverage test of 1.1x, which only comes
into effect if excess availability declines to below 15% of the total
-- We believe Steinway will maintain adequate cash balances and
availability on its credit facilities to fund seasonal working capital needs
and its debt service requirements, including adequate availability on the
revolving credit facility to meet its 2014 bond maturity, albeit possibly
constraining liquidity thereafter.
-- The company has sound relationships with banks in our view.
As of Sept. 30, 2012, Steinway reported about $46 million in cash on its
balance sheet and had about $93 million of availability on its ABL, with no
borrowings outstanding on this facility. The company also has access to
foreign credit facilities that provided an aggregate of about $22 million of
additional borrowing capacity.
The issue-level rating on Steinway Musical Instruments Inc.'s 7% senior
unsecured notes is 'BB-' (one notch above the corporate credit rating). The
recovery rating on this debt is '2', indicating our expectation for
substantial (70% to 90%) recovery in the event of a payment default. For the
complete recovery analysis, see Standard & Poor's recovery report on Steinway
to be published following this report on RatingsDirect.
Our rating outlook on Steinway is stable. We expect the company's sales to
modestly grow from increased sales in emerging markets, which should result in
improved credit metrics, including debt to EBITDA near 2.5x and FFO to total
debt of over 25% by fiscal year-end 2013.
We could lower our ratings if business conditions weaken such that leverage
rises over 4x. We estimate EBITDA would have to fall over 18% from current
levels for this to occur. We believe this could occur either from a
significant cancellation in sales orders (possibly stemming from a
weaker-than-expected economy) or a major manufacturing disruption.
Although unlikely given the company's narrow business focus, we would consider
raising the rating if debt to EBITDA is reduced to and sustained near 2x or
below. We estimate this could occur if EBITDA increased over 50%, possibly as
a result of strong global growth in its Piano segment.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Criteria For Rating The Global Branded Nondurable
Consumer Products Industry, April 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Steinway Musical Instruments Inc.
Corporate credit rating B+/Stable/-- B/Developing/--
Senior unsecured BB- B+
Recovery rating 2 2