SRAM opens up

Monday, 16 May 2011

Component maker SRAM has announced it is going to float on a US stock exchange, that its current owners are selling the business and new shareholders will be able to buy a slice of the company.

When a company does this it has to give comprehensive information in a prospectus so that investors can get a picture of what they might be buying in to. This document runs to hundreds of hundreds of pages and it’s mostly a dull read. But here are some snippets worth sharing:

  • SRAM operates in a part of the sector it describes as “mid to high-end bikes, ranging in price from $300 to over $10,000” and adds “we believe this is the highest margin segment of the bicycle component market“.
  • They reckon bike prices will go up as new technology appears. My interpretation is that they will aim to sell power meters and more carbon wheels with a “normal” race bike.
  • Sales in 2010 exceeded US$500 million.
  • Profits were US$50 million for the same year.
  • The balance sheet shows a significant amount of debt, some US$227 million.
  • The company spent US$40.6 million on sales and marketing last year.
  • The spend on product development was US$37.2 million with 280 people involved in this area of the business.

SRAM locations

  • SRAM employs 2,200 people across 15 facilities around the world.
  • Note the careful mix of locations with several low tax bases evident.
  • SRAM say “We currently do not offer an electronic drivetrain system“.
  • The company has about 550 patents.
  • Amongst the potential risks to the company’s outlook are product recalls but also the chance of a high profile product failure from a sponsored team, ie a fluffed gear change in the Tour de France.
  • Another identified risk is the UCI, whereby product approval and regulations are concerned.
  • Zipp wheels are described as “ultra-premium priced“, reassuring for investors perhaps but it’s a nice euphemism, no?

SRAM view

  • That’s SRAM’s view of the bike market, with the company supplying both bike shops and bicycle companies like Giant and Trek.
  • SRAM sees the bike market growing and they want a larger share of this expanding market.
  • Boss Stanley Day took home $514,395 last year.

Summary
Reading between the lines SRAM is frequently saying, in a discreet way, “we make juicy margins” and “there’s not much competition in this market”. Given all this, you might prefer to invest in the shares rather than buy some components but as ever, buyer beware.

Oliver May 16, 2011 at 6:26 pm

Fascinating post, thanks. Interesting that the company has $227 million in debt and only $50 million in profit a year. Will take a while to pay back. Slightly staggering that the equivalent of 10% of the profit are going to the c.e.o. What’s the sense in that? (Let’s not mention fairness…)
No wonder they want more money… They need it to survive!

And to think how susceptible to a highly publicized component failure this company is; it already happened! Some have even argued that a sRam crankset cost Mr. Schleck nothing less than the Tour de France.! Though I am sure their stuff (made by cheap labor in the far east it seems) works well under average strain, I doubt this episode in the Tour certainly made anybody want to rush out and buy their products….

marek May 16, 2011 at 6:36 pm

500k / 50 MM != 10% Try 1% :)

Q May 16, 2011 at 6:39 pm

That’s 1% of the profit, not 10%. I just calculated that the CEO of my current employer took home about 2% of the company’s profit last year, making 1% seem like a relative bargain. I’m going to guess that the number goes up over time after the IPO.

It does seem like quite a lot of debt. I’m wondering how much of the cash they get from the IPO they are planning to use to retire debt.

The Inner Ring May 16, 2011 at 6:41 pm

Oliver: it has recently refinanced the debt and even got a lower interest rate. Plus if the stockmarket sale goes ahead it will have more cash to pay down the debt. The company has used debt as its form of capital to grow, now it will use shares as well. The debt is big but very manageable and not a danger. Plus note Day’s pay deal is just over 1% of the 2010 profits, not 10%. Fairness is a subjective issue but note he owns a lot of the business and founded it so his real wealth is not the income, it’s the stake in the business.

Readers shouldn’t worry about this company’s financial future, it’s pretty solid.

KingKongnito May 16, 2011 at 7:00 pm

Wut? ~$500,000 is 1% of $50 million, and if that was the whole income to mr Day from SRAM, inculding bonuses, options etc. it seems like a very modest salary for the CEO of an american company with ~2200 employees.

$227 million in debt with $50 million profit is very healthy, and the debt could be paid back in very short time if desired. I have personally about the same debt/income ratio , but that is my income which is supposed to cover all my expenses. The $50 million is profit and is even after the interest expenses on the debt is payed.

Do you have a short position in the sRam stock Oliver?

CD May 16, 2011 at 7:01 pm

Juicy margins? Less than 10% net income margin is not so juicy.

Touriste-Routier May 16, 2011 at 7:26 pm

CD- profitability and margins are two different business metrics. A 10% net profit on a manufactured good is a respectable profit. I am sure their gross margins are reasonably healthy; in terms of materials and labor, it probably doesn’t cost much more to produce high end components than it does lower end components. The difference is in volume, R&D, and marketing.

Oliver May 16, 2011 at 7:41 pm

Sorry about the percentage mistake! My bad. And no, I’m not “shorting” Sram. Couldn’t afford to buy one of their chains, so playing the market is not an option…. It probably would not be a good idea anyway with my math ;-)
I still think that in terms of debt and exposure — i.e., the risk of a well publicized mishap — this isn’t a great bet. Obviously they are going public because they need a cash influx to pay that debt. Seems like this is a race to really gain a lot of market share quickly and really dominate the market.

Tom May 16, 2011 at 7:55 pm

Re the debt component, companies are typically assessed on a debt-to-ebitda basis, i.e debt divided by “earnings before interest tax depreciation and amortisation”. Given that debt-to-netincome (proft?) is about 4.5x, I can tell you that the company is by no means overly indebted, and in fact (without having seen the numbers) could most likely carry another 50-100mn with ease. It’s all about ROE…

Champs May 16, 2011 at 8:00 pm

To me it’s an (ahem) Red flag that they spend more on sales & marketing than research & development.

What technological advances are on the horizon could possibly justify an ever-inflating bubble for carbon wonderbikes? At current trends, it would not be hyperbole to suggest that premium mass-market models (to say nothing of the Cervelo R5ca) will be “priced like a new car” before decade’s end.

Vandalay May 16, 2011 at 9:06 pm

Champs, I am not surprised by the minimal r&d. You would be shocked to know that most of the major bike manufacturers spend about 2 percent or less on r&d. Believe it, it’s true. Figure 10 percent on sales and marketing and 13 percent on administrative expenses. Gross margins for most of the big bike brands are around 40 percent. So figure that 3k carbon wonder frame costs your dealer around 1600

Vandalay May 16, 2011 at 9:17 pm

So 1600 cost and they spent 32 total dollars on r&d, ha probably not what they want you to believe based on the marketing campaigns!

Touriste-Routier May 16, 2011 at 10:29 pm

Vandalay- I think you are missing a few things in your explanation. The large component manufacturers typically do not sell directly to retailers. They have original equipment (OEM) sales to the bike brands and aftermarket sales to distributors.

The bike manufacturers may sell direct to dealers or through distributors, but a $3000 MSRP frame would typically cost a dealer more than $1600. 47% margins on frames & bikes is rare (25 – 40% available margin @ MSRP is more likely). 50% margins on clothing and accessories is typical @ MSRP. But margins for retailers are a separate set of stats than those for the manufacturer, whose margins are dictated by the cost they sell their good for at wholesale; it has nothing to do with the final sales price.

Champs- in large sales driven firms one should expect Sales & Marketing expenses to well outspend R&D. R&D is usually confined to a discreet lab, whereas sales and marketing needs to be a global endeavor. In smaller engineering driven firms, R&D is typically a larger portion of the budget.

Birillo May 16, 2011 at 10:34 pm

Don’t forget that a fair chunk of the marketing budget goes towards sponsoring professional cycling teams that we get to watch for free. SRAM, their shareholders, and cycling fans all share the benefit. I’m not complaining.

Vandalay May 16, 2011 at 10:55 pm

Agreed , I may be off in my overall calculations but I have seen financials and r&d for a bike brand doing 500m in sales is only 10m in total. That was the point I was trying to make, for all the marketing hype the overall expense for r&d is not all that much relative to sales, although 10m is a good amount of cash to spend developing new technology it’s a very small part of the picture.

MK May 17, 2011 at 4:12 am

Interesting
This backs up what many have said for years. One Company in Taiwan is making frames and bikes for multiple brands.

In the document SRAM state that “no bicycle company representing 10%” of revenue. However you will note further in the document there are two cuctomers (In Taiwan I assume based on the figures) who represent “greater than 10% of total revenues”.

This means someone in Taiwan is making multiple frames for someone and selling them built with SRAM components! No massive secret and I’m sure we could easily figure it out!

Gillis May 17, 2011 at 5:33 am

I think its important to mention that Sram owns all (or most) of its manufacturing facilities. It shows they are invested in their product and the future. It also allows them flexibility in production during lean years that others may not afford.

Also, as far risks related to high profile product failures, I find that worthless. F1 cars blow engines all the time, and you don’t see Mercedes dropping sales from it. Mechanicals happen, its a fact of life. I’d bet they happen more often in the pro ranks than you hear about. Franks mis-shift was just the worst possible scenario. Regardless, I don’t see it as a risk to their sales because most of they’re sales are from OEM spec on lower-end bikes, and those people don’t care what happened to anyone named Schleck.

Igor May 17, 2011 at 6:06 am

… off topic a bit, but @MK yes there are 4~5 manufacturers in Taiwan that, between them, are building 80% of the medium to high end bikes in the world e.g. Giant, Merida, Ideal, Hodaka and Fairly.

Back on topic, how do you think this will affect SRAM’s goals of providing product to the medium to high end markets?

My personnel view is that their product is always a little susceptible to issues however currently, with the greatest marketing machine in the industry, they are able to gloss over issues that would kill other brands. To avoid risk, will it not drive them to mass market and e-bikes? What are the potential effect of this change on the company and product they make?

The Inner Ring May 17, 2011 at 8:10 am

MK: yes, as Igor says there are a couple of large OEM companies like Merida and Giant.

Gillis: well it’s a risk to the company’s profits but they list every risk possible, it’s not “three most likely disasters” but an exercise in caution.

Igor: note they say the high end area is where the big margins are, they will continue to exploit this, indeed I think they’ll focus on the ultra high end with Quarq, Zipp and more.

Note for all the marketing spend, this covers everything from team sponsorship to magazine adverts. It’s actually not that expensive to back a team, you can supply 100-150 groupsets for free and you get to back the squad, throw in, say, $200,000 and you’ll have the name on the jersey and more.

Aleko May 18, 2011 at 12:33 am

Absolutely fascinating article! I am a finance professor and a cyclist it is absolutely amazing to see both discussed with such detail and understanding.

As related to the debt levels of SRAM – it is optimal to have (some) debt in the capital structure! It reduces taxes and may improve the monitoring of the firm. The relevant ratios are not Debt to profit but rather debt to equity(or value) and interest coverage (=annual interest expense/earnings). I have not looked in detail at the prospectus but 227 MM does not seem excessive for a company of that size at all. If the IPO is even marginally successful they may have to lever up rather than down.

James Martinez September 4, 2011 at 4:46 pm

I am working on bicycle business and I think this brand could have a great potential. But they are taking a wrong decisions which can reduce the speed of their evolution. They are growing on the OEM market (asembling factories and brands which subcontracts production) but they are still very weak on the after market market where profit is bigger. Growing in the OEM will help them to grow in the AM but this is not enought. They need to take right decisions for the both markets. As example, in my market (Spain) where bycicle business is very important they made a big mistake some years ago when they bought Rock Shox as they decided to keep Rock Shox distributor and refuce the market leader one (Sram distributor). Nowadays Sram would lead the Spanish after market but their decision was so bad that their market now in this important market is nothing (less 3 million). This year they decided to pick a new distributor in Spain and although they improve they left again (for second time) the best outside…On this market Sram will not arrive over 5 million turn over in the AM next years when they could get double quick and very easy with a right decision. And same situation in other European countries!! It is strange because if you are in the market you know well who is the best. It is clear they do not care of AM or they need better people to manage it…Or Perhaps they are only focus on the OEM but I am not sure if this is the best goal for this business evolution.
Furthermore, their main competitors are developping electronic components; Shimano ones are sold in the market already from 3 years on the very high range but this year arriving to the lower ranges. Probably, this is the reason they try to get money in the stock market; to developpe it “jumping” already pattents of the other big transmision makers (Shimano & Campagnolo). Sram is lucky due Campagnolo is “lazy” (typical Italian company) or they are wrongly managed but it is also true Campagnolo electronic pattents can help them grow also on the MTB market where they are not yet present (could it be creating another brand as they did with Fulcrum on the wheels???)
I am not a stock professional and not too good with numbers like the other comments I read here but my bicycle business experience can shoulder them.
As a conclusion, Sram can grow due there is only a real leader (Shimano) who controls main share of the market and take from them is not a hard job…but also Sram has to take care competitors (product developpment basicly electronic) and improve a lot their after market policy. This company potential is very big but always following right strategies.

Igor September 5, 2011 at 5:42 am

@James Martinez, i don’t believe the real money for these big component suppliers is selling product in the aftermarket, sure they have increased profits, however much of those profits are eaten up by the distributors and quantities are way down.
Last week SRAM gave information on their supposed reason for going public “http://www.bicycleretailer.com/news/newsDetail/5877.html”. They’ve spent the last few years building the ‘SRAM’ name, and downplaying the names they got through acquisition. With the information from the article attached and the building of their personnel brand, I believe they really view Shimano as the only big gun in the market and see it as ripe for the picking!!

Pierre Lebrec October 9, 2011 at 4:35 pm

I am totally agree with Martinez; to compete Shimano, Sram needs a global policy. Both together is the key to succeed; OEM&AM. Campagnolo demostrate just one does not work well but it is clear Sram is the best position to pick some share of Shimano. Time talks.

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