Description

OVERVIEW
Steiner Leisure (STNR) provides spa services and skin- and hair- care products on board cruise ships worldwide. Its services include massage, aromatherapy treatments, seaweed wraps, saunas, steam rooms, aerobic exercise, hair styling, manicures, and pedicures. In addition, the company sells premium-priced personal-care products primarily in connection with the company's services, and also through third-party land-based salons and retail markets. The company serves 104 cruise ships representing 26 cruise lines including Carnival, Royal Caribbean, Princess, and Celebrity (Source: Morningstar.com).

Steiner Leisure was formed in the Bahamas as an international business company in 1995 and is the successor to Steiner Group Limited, a family-owned business founded in 1934 in the United Kingdom.

DRIVERS OF DEMAND FOR SPA SERVICES
Cruise travelers rate "being pampered" highly among their reasons for selecting cruise travel and Steiner, operating under contract in facilities on board approximately 100 ships, is there to satisfy that need. In addition, North American passenger cruise travel, owing to increased industry capacity and price competition, can be expected to grow at rates above the historical 8.9% CAGR (Source: Cruise Line International Association; 1970-1999 period).

One Steiner partner, Carnival Cruise Lines, is in the process of a multi-year capital investment program totaling over $5 billion across each of its brands. Other competitors are following suit.

Notwithstanding the competition in "outsourced cruise based spa services", Steiner is a clear industry leader and will likely benefit from continued strong cruise occupancy levels (spa sessions per cruise) and the growth in the number cruise ships worldwide (ships under contract).

As a result of these factors, I expect Steiner revenues to grow revenues in the 10-15% range (the low end of its historical experience) during the coming five years, and to taper off at around the 8-10% level beyond that time frame.

STEINER OPERATIONS
With regard to contracts with cruise lines, Steiner typically negotiates agreements with terms ranging from one to six years. Agreements are cancelable under certain circumstances by the cruise operators with limited prior notice. According to the company, since 1996 no cruise line agreement had been terminated prior to expiration. In October 2000 the company was notified that its contract with Norwegian Cruise Lines would not be renewed upon expiration at year-end 2000.

In exchange for the right to offer services aboard ships cruise lines bill customers and retain a percentage of the gross receipt. Most contracts also contain minimum payment arrangements obligating Steiner to pay minimum annual amounts per ship regardless of the volume of business done.

I'd expect expiring contracts to be renegotiated at less favorable terms to Steiner simply given the knowledge and power cruise operators have concerning contract profitability. In light of this risk, Steiner’s ability to diversify its business portfolio is key to its long-term growth and profitability.

NEW BUSINESS INITIATIVES
In addition to running spas on board ships, the company has backward integrated into training spa service providers by acquiring accredited training institutes. These institutes collect fees for training service providers to work for Steiner.

The company has also beefed up its emphasis on its beauty product line and has spent significantly on redesigning packaging and refining formulations. This spending has had a dramatic impact on operating margins during the past quarters but will hopefully pay off as a stable source of recurring revenues. Current marketing of these products is focused on spa customers but will likely be broadened in the future.

The company has also begun development of a land based luxury health spa business line. The Elemis at Aladdin Resorts and Casino, a 32,000 square foot facility in Los Vegas, is expected to debut in October 2001.

The company has also taken it upon itself to get involved in designing spa and gymnasium space on board newly constructed ships. This work, though likely to contribute little to operating income, helps solidify relationships with cruise lines and, hopefully, will improve an already solid contract retention rate.


STEINER FINANCIAL & VALUATION REVIEW
Revenue (2000) $161.8
Average Revenue Growth (5yr) 25%
Average Operating Margin (4yr)* 16%
Tax Rate ** 5%

Cash & Equivalents (9/30/00) $36.8
Debts (9/30/00) 0
Shares (Diluted) 15.6 million

Estimated Incremental Working Cap 10%
Estimated Incremental Cap Ex 5%

Share Price (3/30) $16.50
Earnings (2000) $1.50
Equity Market Cap $273.5 million
P/E 11.0X

* Operating margins prior to 1996, given that revenues were less than half the
current level at that time, are not reflective of margin levels going forward
and were excluded from the calculation of an average.

** The company, as a Bahamian Corporation, pays little US income tax.

Plugging the assumptions provided above into a rudimentary DCF model, and assuming a 10% discount rate, the value of the business can be reasonably estimated at $27-$33 (assuming 10%-15% revenue and operating income growth over the next five years and no growth thereafter).

In addition to a flow based valuation methodology, one might consider what this company could be worth in an acquisition. That analysis is beyond the scope of this work, but one could see how an existing cruise operator, management, or a beauty products company might find interest in owning the business. Estee Lauder and Avon, both in the beauty products business, currently trade at P/E's of 31x and 21x...significant premiums to STNR.

Management also seems to be shareholder friendly and has bought back shares when they have deemed them cheap. In fact, during the 1/2000 - 3/2001 period, the company purchased 849,400 shares at an average price of $15.14.

WHAT COULD GO WRONG
1. Cruise operators might decide to outsource less of their spa operations, limiting the growth of this market.

2. Steiner's relationship with key partners, particularly Carnival, might deteriorate resulting in a loss of contracts.

3. Cruise passenger demand growth might not pan out as expected or passengers might purchase fewer spa visits.

4. New business initiatives might fail.

CONCLUSIONS
Steiner is a well-managed company positioned in a market that is experiencing strong growth. It has a sterling balance sheet, and has maintained solid levels of profitability and growth while financing investments in new business areas.

I expect shares to appreciate substantially over the coming years given the solid outlook for growth and pristine balance sheet.

Catalyst

Execution of the business plans and continued strong growth.