Description

B&C Speakers SpA (BEC.MI) - Investment case

• Opportunity to invest in B&C Speakers, the global leader in top-end electroacoustic transducers with a 20% market share. The customer base is made of the leading OEMs in the professional audio market. OEMs serve the entertainment industry with professional audio systems used for live events as concerts, fixed integrated audio systems for theaters/stadiums/discos and portable audio systems for bands, nightclubs and venues.
• The long-term fundamentals of the Company are strong: constant growth over the last 10 years with revenue touching €56m, Gross Margin ranging 38-40%, worldwide coverage in a niche business, return on invested capital (26%) largely exceeding WACC. The cash generation and the solid balance sheet make it possible to catch market opportunities and pursue the acquisition of smaller competitors to consolidate the leadership. Market cap in the region of €100m with virtually no debt.
• A recognizable moat represented by: 

  - Real internal expertise and specialization that allow the Company to differentiate itself from the competitors thanks to the widely recognized quality of products, innovation and long lasting reliability of industrial processes. Should you need to purchase the best transducer around you undoubtedly go to B&C Speakers. 

  - Trusted relationship and long-term partnership with the customers built over the years: the Company offers customized products to the OEMs.

• The effects of this crisis will require a period before the people massively approach entertainment as in the past. The current situation is affecting the financial performance of the Company and I expect a 30-35% decline of the top line this year with a recovery whose speed will be linked to the effective control of the ongoing pandemic. The opportunity exists as the stock price plummeted last March nearly halving in a few days. There is no reason to believe that the Company’s long-term fundamentals in any way deteriorated. I trust the industry will recover over the medium term and the demand will be back following a transition period that B&C can face thanks to the favorable financial position.

• My view is that the business may be valued at 16-17x the normalized earnings (€8m), consistent with an 8% cost of capital and assuming a 2% long-term growth. Target price is in excess of €12 per share with a potential 30% appreciation from the current level. There is no specific catalyst but the rise of the stock might emerge together with a better visibility on the progress with the pandemic and the related bounce in the market demand that will consequently materialize. This is the opportunity to pick up a quality and compounding business at a discounted price.

The Company at a glance

Founded in 1946, B&C Speakers SpA (“Company” or “B&C”) is the leading player among the top-end professional loudspeaker transducer manufacturers in the world. An electroacoustic transducer is a device that converts electrical energy into acoustic one (sound). B&C manufactures a wide range of electroacoustic transducers, including high and low frequency drivers, horns and coaxial speakers. 

More than 180 employees in Italy where there are the headquarters (Tuscany), the R&D and manufacturing sites as well. 

In 2007, the Company was listed at €5 per share on the Milan stock exchange and later got the “STAR” qualification from Borsa Italiana. STAR is the market segment of Borsa Italiana dedicated to midsize companies with a capitalization of less than €1bn, which voluntarily adhere to and comply with strict requirements of high transparency and disclosure, liquidity (a minimum 35% free float) and corporate governance in line with international standards. At the time of the listing on the stock exchange, revenue were €23m and in 12 years grew to nearly €56m (€44m excluding the contribution of an acquisition at the end of 2017). The floating occurred at 9x EBITDA and 16x P/E valuation multiple. 

Coppini’s family, through a holding, retains the majority and controlling stake into the Company (54%). B&C is led by Lorenzo Coppini, 57 (son of the founder). The shareholders’ base contemplates some institutional investors: Lazard Freres Banque holding (6.33%), Allianz Institutional Investors Series holding (3.27%), Berenberg European Micro Cap holding (2.80%), Alboran S.r.l. holding (2.07%). 

After many decades of patient organic growth, in 2017 B&C took the chance of an acquisition of a small Italian competitor, Eighteen Sound (“ES”), divested by an Italian group facing financial constraints. According to the management, ES is the second most important Italian brand in the professional acoustics market and enjoyed a good positioning; the acquisition has allowed B&C to enlarge its product offering and strengthen its leadership. 

80% of turnover refers to products specifically created for use by professional audio system manufacturers (Bose, Yamaha, Martin Audio, Nexo, D&B Audiotechnic, QSC Audio, L-Acoustics, Yorkville Sound, Turbosound) who purchase directly from B&C the customized products. The remaining 20% of the turnover is marketed through the Company’s distribution network (representatives in nearly 70 countries). The customers of the distributors are manufacturers of small and medium-sized loudspeaker systems and, to a lesser extent, end-users (among distributors’ customers there are also installers, resellers and sellers of spare parts). 

Summary quantitative information

The stock peaked last February at €14 per share and then collapsed below €8 per share in March. Since then, following an initial strong rebound, it went down again and currently trades at €9.5 per share.

Market and end-user of the Company’s products 

Below is depicted the global audio market’s structure. B&C operates in the professional audio segment (orange) Differently from Home or Automotive audio products, Professional Public Address (PA) and Musical Instrument PA components must be more efficient and handle higher levels of power, as the audience is larger and far from the sound source. Therefore, operating the MI and PRO segment requires specific exclusive competencies. 

The professional audio market splits between two main segments:

1. Musical instruments (“MI” or “MI segment”) systems – portable and 
2. Professional public address systems, broken down among 

   a. integrated sound systems (contractors) and 

   b. touring.

The MI segment includes portable audio systems for bands, nightclubs and venues. According to the management, the market is going to demand higher performance products compared to the past: low-cost solutions are no longer sufficient and many OEMs are shifting towards high-end transducers’ manufacturers as B&C.

The integrated audio systems segment includes fixed installations, such as those used in cinemas, theaters, discos, stadiums and churches. 

The touring audio segment includes systems for use during live public events such as concerts. Since the early 2000s, music-streaming services (file sharing) have caused the collapse of the recorded music revenue stream for performing artists. Most of them must go on tour to generate income. The new framework led to an increase in the number of events and consequent greater usury of the products due to the assembly and disassembly operations.

The global annual turnover of professional audio systems is around $3bn while the segment where B&C operates is worth about $250m (a real niche market). B&C enjoys a nearly 20% market share but in high-powered systems B&C retains more than 50% share. Since 1996 the market grew at a 8.8% CAGR. 

Strengths 

Below are described the B&C’s business core characteristics:

• Specialist in the niche production of top-end electroacoustic transducers. The Company is a supplier of key components to producers of integrated systems. It operates in full autonomy and independence from its customers (OEMs): B&C strategically avoids any potential situation of conflict of interest / overlap with the customers. B&C enjoys unique development agreements with virtually every significant OEM in the high-end, professional public address market segment, particularly in touring public address (concerts and live events).
• It has the ability to respond quickly to product customization needs working in close collaboration with the OEMs in the design phase. That allowed establishing long-term partnerships and relationships based on loyalty and trust.
• Extreme care in all aspects of product quality control, company organization as well as after-sales assistance.
• Continuous pursuit of economies of scale in order to keep the quality / price ratio constantly competitive. That, coupled with high quality standards of customized products, represents the recognizable moat of the Company that separates B&C from the other producers and makes extremely difficult the catching-up by low-cost producers.
• A competent, stable and experienced management with long run involvement in the business.
• Significant international presence: it markets products globally, proving its aptitude to internationalization since many years.
• Constant enlargement of the range of products offered (also through the implementation of innovative materials with better mechanical, acoustic and thermal characteristics). Ability to introduce new technologies thanks to continuous effort in R&D and internal solid know-how.

Products 

B&C’s products divide into 5 categories:

LF Drivers: transducers for the reproduction of low and medium frequencies with ferrite magnet.

LF Nd Drivers: transducers for the reproduction of low and medium frequencies with neodymium magnet.

HF Drivers: transducers for high frequencies.

Coaxials: a coaxial speaker is the combination of an LF Driver with a HF Driver. Compact coaxial transducers characterized by a wide frequency range, high efficiency and high quality of sound. 

Horns: rigid pipes with enlarging section; they are complements of the HF drivers, required for the optimal control of the sound system.

Below are some pictures that make clearer the range of products:

LF drivers represent nearly 64% of annual turnover while HF drivers account for nearly 24%. B&C is market leader in both the product lines thanks to its capacity to introduce innovations and implement new technologies. 

The most significant determinant of product quality in manufacturing loudspeakers is consistent assembly and quality control where B&C is committed to excel over time. The guarantee given by the Company on its products lasts 3 years. The very limited number of interventions under warranty and rare recall campaigns for defective products prove the long-term quality of the stuff and the reliability over time.

B&C leverages on the benefits of a lean and flexible organization. The industrial processes occur into a sole building in order to minimize material handling, ensure contiguous production lines and simplify supervision.

All woofer cones kits are assembled and treated at the manufacturing site. Thanks to expertise gained over time, the Company offers the best of woofer performance in the market. 

The high frequency drivers and diaphragms are still hand assembled. In addition to careful design, the production process requires very detailed measurement of materials, glues, and alignment in order to create ultra-high performance parts that are consistent. Customized robots ensure accuracy in applying the specially formulated adhesives (able to withstand considerable thermal and mechanical stress), which are tested on a regular basis throughout the day. Each driver is carefully tested using the state-of-the-art test equipment, to ensure strict control of “rub” and “buzz”, frequency response and distortion.

Main risks

Below are the key business risks and the mitigating factors that I identified:

• The main components purchased by B&C are the metal parts, the coils and the magnets while the core external processes outsourced by the Company are turning, casting and engraving. According to the management, the suppliers of two key components of the transducers, the cone and the coil, cannot be replaced without effects on the quality of the product. That represents a long-term risk characterizing the reference industry with which the Company has shown that it can live without ever having interruptions in its relationships with suppliers.
• The Company relies on the long-term skills and competences of the key top managers: Lorenzo Coppini (CEO), Simone Pratesi (CFO) and Alessandro Pancani (Chief Technology Officer) who jointly contributed to the massive success of the business over time. This is a family-led business and that represents one of its strengths in light of the small size of the reference market. My guess is that the management is still motivated and emotional for the products: they love the Company, proud of the success achieved and project to catch the opportunities in the developing markets.
• B&C exhibits a high degree of concentration of the customer base. This is because the OEMs globally are a limited number and B&C’s reference market is a niche. The life cycle of the products is typically very long (7-8 years). The component supplied by B&C, as highly customized, is difficult to replace. Furthermore, the partnerships established over the years with the customers ensure relationship stability and loyalty.
• The management recognized that there is the potential risk that in the future some of the customers decide to internalize the production of transducers. The market of transducers is pretty small ($250m worldwide) and that favors manufacturing conducted by independent players highly specialized in these niche products benefiting from extremely lean organization.

Competitive environment

Among the competitors: 

The largest is Celestion with $25m turnover mostly specialized in guitar speakers (it became famous following the adoption of its products by some rock stars in the 60-70s). A Hong Kong-based company - Gold Peak Industries - bought Celestion some years ago.

Eminence with a total turnover of about $15-20m, but it does not excel with quality and suffer competition of far-east products. 

Then, smaller competitors are Beyma and Sica with about $5-6 million each. 

Overall, B&C’s turnover is higher than the cumulative turnover of the closest competitors. Furthermore, the R&D team at B&C is made up of 20 people, more than any other competitor granting the Company a significant competitive advantage.

Financial performance

In the last couple of years, following ES’s acquisition, revenue was in the region of €55m. EBITDA exceeded €12m in 2019 while EBIT was approximately €10m. 

For the sake of comparability over time:

• As mentioned above, at the end of 2017 the Company executed an acquisition: that caused a jump in turnover but also a decline in gross margin in 2018 that B&C started to normalize in 2019 through integration actions. 
• In 2019, the Company started to report rents in accordance with the IFRS16 (operating leases): that improved EBITDA with minor effects on EBIT and net income: so NOPAT margin is comparable over time (in the region of 14-15%).

B&C is a small international Company and most of the revenue comes from export.

The Company benefits from some tax relief from deductibility of certain types of costs for innovation. That made the actual tax rate lower than the nominal one.

As of the end of FY19, net equity totaled €26m while the net debt amounted to €5m for an invested capital summing up to €30m. The expansion of invested capital in 2019 was due to the new accounting standard IFRS16 that provides for the recognition of operating leases as fixed assets (rights-of-use) and related liabilities as financial debt.

In 2019 with €8.0m NOPAT, the business reported 26% return on invested capital. 

Tangible assets are mostly plants and industrial equipment while nearly €4m refer to rights of use of real estate assets under operating lease. 

Working capital was made up of inventory for some €13.5m (turnover 90 days) and trade receivables for €12.8m (DSO nearly 80 days) while trade payables were around €5m. 

As far as the net debt is concerned, the Company reported cash and short-term securities exceeding €13m, amount granting great flexibility to B&C and proving a long-term prudent approach in the dividend policy. The financial assets cover both the long-term and short-term borrowings cumulatively being €14m: borrowings are loans with Italian banks, which are not subject to financial covenants. The last component of net debt refers to financial liability arising from rights-of-use of assets under operating lease (€4.2m); excluding the mentioned component arising from the adoption of the new IFRS16 and that does not correspond to a formal loan, the net debt would be nearly nil. It is important to point out that operating leases (rentals) are mostly set with the parent and controlling company of the group (related party).

Adopting some adjustments, I estimated an adjusted FCFF figure. Adjusted FCFF 2019 amounted to €9.0m coming from €12.6m EBITDA, net of €2.3m taxes and ca. €2.0-2.5m Capex (cash from investing figure influenced by the adoption of the new accounting standard IFRS 16). 

In FY2018 FCFF was depressed by a one-off expansion in working capital partially reversed in FY2019 while FCF 2017 is misleading as per the effects of ES’s acquisition (impact on working capital and cash flow from investing). 

Based on the analysis above, NOPAT at €8m appears a good proxy of long-term sustainable cash flow with the current perimeter of business.

Effects of the pandemic on the financial performance 2020

The Company operates in the entertainment industry. As expected, the effects of the pandemic are deeply affecting the 2020 performance via the healthcare risks and the related restrictive measures put in place globally by the governments. On top of that, the entertainment industry is cyclical and subject to the risks arising from macroeconomic downturn and reduced purchasing power of consumers. 

Since the beginning of March and the following 2 months, the group's plants were completely closed. The shareholders’ meeting held by the end of April resolved not to distribute dividends for the current year in order to preserve financial resources. 

In light of the strongly negative effect on market demand (especially in live events), the Company reacted by implementing a series of actions aimed at mitigating the economic impact. In particular:

1. Activated public benefits for employers to temporarily decrease the labor cost in accordance with the Italian law.
2.  Reduction of marketing expenses.
3. Suspension of all non-strategic costs and renegotiation, where possible, of outstanding contracts.

In the first half of 2020, B&C posted a 40% fall in revenue while a recovery is projected from the current quarter. In the period, EBITDA dropped to €2.9m from €6.4m last year but the Company remained slightly profitable with declining net debt. The results are reassuring, proving the company's resilience and ability to adapt to the circumstances: in the most critical moment for the business, the Company has not burned cash.

Visibility on the demand remains low as long as many live events continue to be “on hold”. The Company sits on a solid balance sheet and may afford the difficult scenario with no risk of financial distress. 

Recommendation

My recommendation is to acquire the stock at the current level (€9.5 per share) - envisaging a good discount to estimated intrinsic value - and accumulate more in case of further drops. I prudently prefer not to estimate the value of growth opportunities in emerging markets for the coming years: in particular, the Chinese domestic market will certainly grow and the Company appears ideally positioned to expand there also with production facilities (many of the customers have production facilities in China and a number of components come from there). I propose a valuation based on the existing business and the current earnings power of the Company: to me, the value is in the area of €12 per share.

The market price provides the opportunity to invest in a quality business with reliable long-term fundamentals and that surely will benefit of the return of the demand in the reference market.

Catalyst

Return of the demand in the reference market.