Fender stock buyers will gently weep

July 12, 2012

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Fender’s initial public offering documents read like the 12-bar blues. The iconic maker of guitars favored by the likes of Eric Clapton and Jimi Hendrix is aiming for a rich valuation. But the company has questionable global expansion plans, is loaded with debt, depends on a big shaky customer and generates only pick-thin margins. There’s just too much to make investors fret.

The best thing Fender has going for it is an association with rock royalty. It’s also an asset the company hasn’t fully exploited. Less than 1 percent of revenue comes from licensing fees and royalties, leaving room to expand in this area. The IPO will leverage the brand, too. Owning shares of the creator of the Stratocaster is the closest a slew of middle-aged portfolio managers and individual stock-pickers will ever get to Eddie Van Halen or Joe Walsh.

But the numbers aren’t anywhere near as cool. While Fender’s revenue increased by 53 percent, to $700 million, between 2007 and 2011, the cost of goods sold and operating expenses grew at an even faster clip. Net profit margins were less than 3 percent last year. And while the newly raised capital is earmarked to pay down some of its $260 million of debt, Fender is loaded with it, at about five times 2011 EBITDA.

At the top end of Fender’s $13 to $15-a-share range, it would be valued at approximately $395 million. That’s over 20 times last year’s net earnings while also valuing the whole enterprise at a multiple of about 13 times last year’s EBITDA. Those sorts of figures imply a lot of growth ahead.

Fender is counting on Europe for much of it, but economic woes there mean continentals will be stuck playing a lot of air guitar for some time. And some 17 percent of first-quarter sales came from Guitar Center, a retail chain with debt troubles – Standard & Poor’s in May described its liquidity profile as “less than adequate” – and the same private equity owner as Fender.

That leaves little for potential stock buyers to riff on beyond Fender’s 65-plus years of history and cachet. Any purchase at the guide price would be worthy of the classic Clapton-enhanced refrain, “While My Guitar Gently Weeps.”

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