In 1948, a radio repairman named Leo Fender took a piece of ash, bolted on a length of maple and attached an electronic transducer.
You know the rest, even if you don't know you know the rest.
You've heard it — in the guitar riffs of Buddy Holly, Jimi Hendrix, George Harrison, Keith Richards, Eric Clapton, Pete Townshend, Bruce Springsteen, Mark Knopfler, Kurt Cobain and on and on.
It's the sound of a Fender electric guitar. Fender's company, now known as the Fender Musical Instruments Corp., is the world's largest maker of guitars. Its Stratocaster, which made its debut in 1954, is still a top seller. For many, the Strat's cutting tone and sexy, double-cutaway curves mean rock 'n' roll.
But this heart of rock isn't beating quite the way it once did. Like many other U.S. manufacturers, Fender is struggling to hold on to what it's got in a tight economy. Sales and profits are down this year.
A Strat, after all, is what economists call a consumer discretionary item — a nonessential.
More than macroeconomics, however, is at work here. Fender, based in Scottsdale, Ariz., is also being buffeted by powerful forces on Wall Street.
A private investment firm, Weston Presidio, controls nearly half of the company and has been looking for an exit. It pushed to take Fender public in March, to howls in the guitar-o-sphere that Fender was selling out. But, to Fender's embarrassment, investors balked. They were worried about the lofty price and, even more, about how Fender can keep growing.
And that, really, is the crux of the matter. Times have changed, and so has music. In the 1950s, '60s and '70s, electric guitars powered rock and pop. Today, turntable rigs, drum machines and sampler synthesizers drive music like hip-hop. Electric guitars, huge as they are, have lost some of their old magic in this era of Jay-Z, Kanye West and “The Voice.”
Games like Guitar Hero have helped underpin sales, but teenagers who once might have hankered after guitars now get by making music on laptops. It's worth remembering that the accordion was once the most popular instrument in America.
Granted, Fender is such a powerful brand that it can ride out the lean times. But sales of all kinds of musical instruments plunged during the recession, and they still haven't recovered fully. Sales of all instruments in the United States totaled $6.5 billion last year, down roughly 13 percent from their peak in 2005, according to Music Trades, which tracks the industry.
Many of the guitars that are selling these days are cheap ones made in places like China — ones that cost a small fraction of, say, a $1,599 Fender Artist “Eric Clapton” Strat. Fender has been making its own line of inexpensive guitars overseas for years, but the question is how the company can keep growing and compete profitably in a fast-moving, global marketplace. Its margins are already under pressure.
“What possible niche is left unexploited by Fender?” asks Jeffrey Bronchick, founder of Cove Street Capital, an investment advisory firm in El Segundo, Calif., and the owner of some 40 guitars, including four Fenders.
Another big player on the American music scene, Guitar Center, has already had financial strains. Like Fender, Guitar Center, the world's largest chain of instrument retailers, is also involved with private equity. It's controlled by Bain Capital, Mitt Romney's old firm.
Analysts say Guitar Center is crucial to Fender, accounting for roughly a sixth of Fender's sales — and the ties between the two run deep. Fender's chief executive, Larry Thomas, used to be the chief of Guitar Center. He sold the company to Bain at the top of the market in 2007 for $2.1 billion, including debt.
Guitar Center has been losing money since. Moody's issued a junk rating of B2 on Guitar Center's debt in October 2007, and has since downgraded the company two more times, most recently in November 2010, to Caa1.
The change in American music is evident on West 48th Street — the “Music Row” of Manhattan. The block just east of Times Square was once home to dozens of music stores, practice studios and instrument repair shops. It was the place to go to buy a Fender in New York.
Now Music Row is being hollowed out by high rents and competition on the Web. Even Sam Ash, which has been there since the 1920s, is moving to West 34th Street.
Fender, too, has had to contend with changing tastes and markets. Once it looked like the Pan Am of guitars, a storied name that might simply vanish. Leo Fender sold his company to CBS for $13 million in 1965, but Fender struggled in the ensuing years to maintain its identity inside a big corporation. Analysts said that Fender, under pressure to meet quarterly earnings numbers, made a series of cost cuts that caused quality to suffer and sales to nosedive.
Yamaha of Japan, meanwhile, began grabbing market share with inexpensive, high-quality guitars. In 1980, the problems came to a head when Fender posted a $10 million loss on only $40 million in sales.
“In 1970, nobody wanted a Yamaha musical instrument, but by 1980 they were beginning to dominate, along with many other Japanese companies,” says Bill Mendello, the former chief of Fender and today a member of its board. “And they were, frankly, better made and a lot cheaper than U.S. manufacturing.”
In the 1980s, Mendello, then a top executive in CBS' musical instruments division, and Bill Shultz, then president of Fender, developed a plan to save Fender. To make it happen, they had to take on William Paley, the feared chairman of CBS. Their plan called for CBS to invest heavily — about $50 million over five years — in Fender and to revamp marketing. Paley signed off.
Back in the black
But three years into the plan, Paley was out and new management decided to sell the music division. With Fender losing money, there were few buyers. CBS considered liquidating the company. Instead, Schultz and Mendello engineered a $12.5 million leveraged buyout. Before long, Fender was back in the black.
Fender gradually clawed its way back up in the '80s and '90s, beefing up quality, training and oversight, and, for the first time, starting to manufacture guitars internationally, especially in Japan and South Korea. Restoring quality was crucial, Mendello says. Artists like Clapton, who had modified his Strat “Blackie,” were impressed with Fender's craftsmanship. Leo Fender died in 1991 at the age of 82; in 2001, Weston swooped in, buying a 43 percent stake of Fender for $58 million.
Mendello says the recent recession was tougher on Fender than past downturns.
“Fender and the whole music industry got hit pretty hard,” he says. “People were afraid to buy anything or do anything. They didn't know if they'd have a job.”
Many in the industry praise Fender for branching out into other areas, including making and selling steel-string acoustic guitars and cutting deals with various other brands like Gretsch guitars and drums and Sabian cymbals. But one of the biggest competitors for new Fender guitars is old Fender guitars. Many players believe — rightly or wrongly — that the Fenders of the 1950s, the '60s and even the '70s, when analysts say quality suffered, have a special something. A vintage Fender won't make a novice sound like a Hendrix. But many pros say that at their level, the equipment matters. Prices of vintage Fenders have soared accordingly.
Rick Barrio Dill, the bassist for the soul and rock band Vintage Trouble, was frantic when his customized Fender Reissue Precision bass guitar was stolen while his group was touring with the Cranberries in May. Playing another brand was out of the question.
“It put a feeling in my stomach like someone had just died — I was a complete wreck,” Dill remembers.
He alerted his fans via Twitter, and before long the story reached the Gibson Guitar Corp., Fender's big competitor, which offered a replacement. Dill turned it down. Then Fender made a similar offer — and Dill pounced.
“I kind of bleed Fender,” he says.
He, too, is chasing vintage Fenders. He bought a 1969 Tobacco Sunburst Fender Jazz Bass in 1999 for $1,200 and sold it four years later for $2,500. “I'm trying to buy the exact bass now, and it's selling for $6,500 or $7,000,” he says.
Duff McKagan, the former bassist for Guns N' Roses and Velvet Revolver, grew up listening to Led Zeppelin, Aerosmith and the Clash. He used to drop by the Guitar Center branch on Hollywood's Sunset Strip, when that company was independent, and dream about buying a Fender bass.
“I'm sure they got sick and tired of me coming in,” McKagan says. He still plays the 1985 Fender Jazz Special he bought after Guns N' Roses landed its first record deal. He can attest to the durability of Fenders. Once he tried to imitate Paul Simonon of the Clash by smashing his bass at the end of a show.
“I took a full swing and brought it down on this metal grate stage — and nothing happened,” McKagan recalls. After 20 or so tries, one shard of wood came loose. “That was enough for me,” he says, adding that he never tried to smash a Fender again.
The next step
Such testimonials aside, the question is where Fender will go from here. It has been hurt by the economic slump in Europe, a region that accounts for 27 percent of net sales, and the situation there could hang over Fender for years.
The company has also been criticized by Wall Street analysts for acquiring the Kaman Music Corp., a distributor of musical instruments and accessories, in 2008 for $117 million. The company, which it renamed KMC Music, is a low-margin business and has squeezed Fender's overall profit margins.
Fender filed to go public in an initial stock offering in March, in a deal that would have valued the company at as much as $396 million. That is a pittance by Facebook standards. But the price was high for a company of Fender's size.
Bankers and investors scoffed. Fender, they said, was trying to go public as a “growth” company when its sales were declining.
“It made no sense,” says Arnold Ursaner, president of CJS Securities in White Plains, N.Y.
The talk on Wall Street was that Weston Presidio was pushing to sell at a high price. Weston executives declined to comment.
“They saw a window and said let's try to hit it and maybe no one will pay attention to the negative sales trends,” Ursaner says. “It was banking at its worst.”
In documents filed in connection with the proposed initial public offering, Fender outlined avenues that it contended would bolster growth, such as sales to emerging markets like China and India, the addition of more licensing and co-branding deals, and strategic acquisitions.
Bronchick, the analyst, speculates that investment bankers didn't wanted to take the offer at such a high valuation.
“Nobody wants to be embarrassed like Facebook,” he says.
At Fender, Mendello doesn't rule out a future public offering. Fender might try again sooner rather than later, because about $237 million of its $246 million in long-term debt will be due in 2014.
Mendello, who owns 4.8 percent of Fender, says he isn't looking to cash out personally. Neither are the company's other shareholders, he says.
“I love Fender — it's the greatest company in the world,” he says. “We're here for the long-term, and we're going to do what's right for Fender.”