Guitar Center Growth Could Hit a Sour Note; Neuberger Overvalued

Guitar Center (GTRC) Jim: Don’t Buy

Mike: Don’t Buy

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Jim: I’d figure Guitar Center can tap into an endless demand for its musical instruments, Mike, because each generation brings us a wave of teenagers who want to be the next Eddie Van Halen--or maybe now it’s the lead guitarist for Blink-182.

Mike: Really? I’m hoping my kids want to be the next Chet Baker or Stan Getz.

Jim: Naturally. Anyway, Guitar Center is the nation’s largest retailer of guitars. It also sells amplifiers, keyboards, drums and electronic audio equipment.

Mike: But if you want a sax, clarinet, trumpet or violin, you’ll have to go elsewhere.

Jim: Hence the chain’s name.

Mike: Right. That’s one of the issues I have with this company. But you can go on.

Jim: Gee, thanks for holding back your issues momentarily. I was just going to note that this company was founded in Hollywood in 1964 . . .

Mike: And then, like a lot of former Hollywood residents, it moved on up to Agoura Hills, where it’s now headquartered.

Jim: Guitar Center has nearly 80 stores nationwide. In 1999 it made a big expansion move by acquiring Musician’s Friend, a leading provider of musical instruments via catalogs and the Internet. Now, what are your issues?

Mike: To start with, everything I’ve read tells me that consumer purchases of musical instruments are increasing about 7% a year. So, let’s take that as the cap on Guitar Center’s top-line growth.

In fact, that was the percentage rise in the company’s same-store sales last year--that is, stores open at least one year.

Even if Guitar Center gets the lion’s share of that industry growth, I’d argue it’s still pretty modest. This chain also pitches itself as the Home Depot of music stores and, like Home Depot, when Guitar Center opens a store in a new area, mom-and-pop competitors get hit hard. Guitar Center’s nearest rival, Sam Ash Music, a private company, might suffer a bit but seems to be hanging on.

Jim: Where are you going with this?

Mike: I wonder how Guitar Center will be able to keep opening enough stores to accelerate its sales and earnings growth, given the expected modest expansion in consumer spending on guitars and other instruments.

Jim: Indeed, Guitar Center took a hit about 18 months ago when, among other things, its same-store sales growth slowed measurably.

Mike: One reason was that the company would move into an area, then move again into the same area.

In other words, it would open so many new locations that it would cannibalize sales at its old locations. This is, of course, the familiar quandary of retail expansion.

Jim: I would argue that Guitar Center faces more potential roadblocks in the general slowdown in the economy and the drop in consumer confidence. That is expected to put a lid on consumers’ discretionary spending.

Mike: You can debate the degree to which a musical instrument is a discretionary purchase. In my house, the first musical instrument is not a discretionary purchase. Though for most people the fourth or fifth guitar would be.

Jim: There’s another wrinkle here. For reasons I can’t figure out, a year or so ago Guitar Center stopped selling the well-known Gibson guitar brand.

Mike: At the time of the split, both sides said it was perfectly amicable. That’s the same thing I’ve been reading about the Tom Cruise-Nicole Kidman split.

Jim: The point is, there’s a very popular guitar brand that Guitar Center isn’t carrying in its retail stores, though its Musician’s Friend unit carries it.

Mike: Right, Guitar Center is a place to go for all your guitar needs, as long as they’re not Gibsons.

Jim: All of this knocked the stock for a loop in ’99 and early 2000, then it mostly treaded water the rest of last year. Lately, though, the stock has resurged, and Monday it closed at a 52-week high of $18.25.

The company signaled in early January that its fourth-quarter sales were stronger than expected. On Monday, the chain said fourth-quarter operating earnings per share jumped nearly 29% to 45 cents a share, from 35 cents a year earlier. Total sales rose 25% to $240 million.

But I still wonder how much more profit growth this chain can squeeze out of its operations if sales turn so-so this year.

Mike: I agree.

Jim: So I’d avoid the stock, even though it’s pretty cheaply priced at about 15 times analysts’ average estimate of earnings per share for 2001.

Mike: Me, too. I have real questions about how strong earnings will be going forward.

Neuberger Berman (NEU)

Jim: Don’t Buy

Mike: Don’t Buy

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Mike: The party line on Neuberger Berman, a money management and mutual fund operator, is that it has always been known for contrarian investing. And, wouldn’t you know it, its own stock has been a great contrarian pick for the last year--meaning it has soared even as shares of some rival firms have slumped.

Jim: That shouldn’t surprise you, if you think about it.

Mike: Maybe I haven’t thought about it much.

Jim: I’ll explain, but first let’s note that Neuberger Berman has long catered to the wealthy and . . .

Mike: Excuse me, but doesn’t everybody cater to the wealthy? I mean, it seems to me that if you’re wealthy you get better service from everybody, except maybe from the phone company.

Jim: Thank you for that analysis of the social condition. But this firm in particular has long had a reputation for being prominent in the money management field with its private asset management group. Then there are its mutual funds, including Guardian, Genesis and Partners.

Put it all together, and Neuberger Berman manages about $56 billion. But as you said, the firm is renowned for being contrarian insofar as it doesn’t jump on the latest fad or engage in momentum investing. It’s a value player that looks for stocks it thinks are underpriced relative to their prospects--often, stocks disliked by most investors.

Mike: The firm sure believes in its own stock: The vast majority of the shares have been held by partners and employees. Neuberger Berman was started in 1939, but it went public only about 14 months ago.

Jim: And the stock has risen steadily ever since, even though the firm’s mutual funds were a mixed bag last year. And while earnings at the private asset management group rose 10% from the previous year, earnings at the mutual fund unit fell about 10%.

Mike: It’s not a wash, though. To give our readers an idea of the importance of the private asset management division, the group accounted for less than 40% of Neuberger Berman’s assets but kicked in 60% of its profit.

Jim: I believe investors bid this stock higher in large part because, as tech stocks and other high-growth stocks were flaming out last year, Neuberger Berman’s reputation for finding undervalued stocks again became appreciated.

Mike: There’s another reason. I think the stock nearly tripled last year in part on takeover hopes: A number of other U.S. asset-management companies were snapped up by foreign financial firms. I suspect Neuberger Berman was on everybody’s wish list. Some investors bet on the firm getting bought.

But it now behooves us to ask: With the stock already up so much, has the company been priced out of the market?

Jim: You mean in terms of being acquired?

Mike: Either in terms of our readers buying some shares or an outfit such as a big European bank buying the whole company.

Jim: I doubt the company can be taken out if insiders own most of the stock.

Mike: You don’t think someone could make the insiders an offer they couldn’t refuse?

Jim: It’s always possible.

Mike: In the meantime, the fact that relatively few Neuberger Berman shares are trading publicly is another reason the stock has rallied: This isn’t a very “liquid” stock, meaning trading volume is pretty modest most days. A little demand can push the price a lot.

Jim: Well, that can cut both ways. It might mean the stock is more vulnerable to a steep dive on bad news. In any case, is it worth buying now, given how much the price has surged and the fact that the company’s earnings growth has been rather modest?

Mike: I say no.

Jim: I say no, too. Neuberger Berman is a great operation. I’ve always been a fan of its mutual funds and of its investing philosophy. In a recent interview, one of its senior partners explained how they look for stocks of companies with growing earnings, strong balance sheets and managements that are shareholder-focused. And, of course, they like low price-to-earnings multiples.

Mike: Classic value investing.

Jim: Yep, Neuberger Berman managers are always scouring for stocks trading at 50% to 80% of what they believe the company is really worth, per share--or will be worth. But in terms of Neuberger Berman’s own stock . . .

Mike: It doesn’t qualify under the firm’s own investment rules.

Jim: No, it doesn’t. The shares are trading for about 25 times the company’s expected per-share earnings this year. That isn’t astronomical on its face, but I think you’d still be overpaying.

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Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment. Either can also be reached at Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.