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Martin Schwartz of Dorel Industries: Schwinning bet

Dorel's product line was a hodgepodge of youth-geared brands until a 2004 deal brought it the way-cool Schwinn Sting-Ray bike -- and made its CEO look like a hero.

How could Martin Schwartz have known that a retro-looking kid's bicycle -- chopper-style handlebars, banana seat, coaster brakes -- would put his family company on the trendy youth-market map?

Over 43 years Montreal-based Dorel Industries had built a portfolio of solid but unsensational youth-focused brands, including Cosco kids' furniture and Safety 1st child car seats.

Yet CEO Schwartz, 56, had tried in vain to get either Wall Street or Bay Street to take much notice. Dorel's share price had logged respectable, if unspectacular, gains since the company's 1987 IPO, essentially keeping pace with the market; its price-earnings ratio stayed in single digits.

But in February 2004, Schwartz spent $310 million to buy Madison, Wisconsin­based Pacific Cycle. Immediately, Dorel became the possessor of such major brands as Mongoose, Roadmaster and Schwinn, making it the top U.S. bike supplier.

What's more, the deal came with an unexpected bonus: Schwinn's Sting-Ray bicycle, one of the hottest gifts of the 2004 holiday season. Dorel sold a half million Sting-Rays between April 2004 and December 31, at a retail price of $180. The company's revenues jumped 45 percent last year, to $1.7 billion, and earnings soared 35 percent, to $100 million.

The markets hopped onto the Sting-Ray phenomenon. Dorel's share price rose nearly 20 percent in the 12 months following the Pacific Cycle purchase, although it has retreated some since the end of the holiday season. (The company, whose sales are mostly in the U.S., is listed on Nasdaq and the Toronto Stock Exchange.)

Schwartz's father, the late Leo Schwartz, founded the company in 1962 to produce crib pads and mattresses. The son initially went his own way: Deciding that his engineering studies at Montreal's McGill University "were not for me," he joined brother-in-law Jeff Segel in 1969 to start Ridgewood Industries, which manufactured ready-to-assemble furniture. In 1987 the two family enterprises merged into Dorel, which went public later that year.

Schwartz, who has been running Dorel since 1993, is proud that the company is still a family business. Segel is executive vice president of sales and marketing, and Schwartz's younger brothers Jeffrey and Alan are CFO and executive vice president of operations, respectively.

Ian Zaffino, an analyst at Oppenheimer & Co. who started covering Dorel in February, sees the family's involvement -- they own 17.8 percent of the equity and exercise 55.6 percent voting control -- as a plus. "They are very focused on the share price," says Zaffino, who initially rated the company a buy at $35.04, with a $45 price target. In late March it traded at about $33, approximately ten times projected 2005 earnings.

But the market still seems unimpressed, worrying that rising commodity prices and interest costs may limit future earnings growth. Dorel's $1.1 billion in market capitalization represents a discount of 35 percent to its 2004 sales, which it projects will increase by 5 to 10 percent this year.

Schwartz recently discussed Dorel's situation with Institutional Investor Assistant Managing Editor Jeffrey Kutler.

Institutional Investor: Why the low price-earnings multiple and the struggle to get the attention of analysts?

Schwartz: We feel we've been underappreciated because the market doesn't have a good peer comparison. In our ready-to-assemble business, for example, we are No. 2 in North America behind [privately held, Archbold, Ohio­based] Sauder Woodworking Co. and have always been profitable, but No. 3 and No. 4 [Lamar, Missouri­based O'Sullivan Industries and Jamestown, New York­based Bush Industries] have had financial problems, so people assume we're in a lousy industry and don't give us credit for our performance. Bikes, it's true, is not a great industry, but someone has to be the best, and Pacific is the best by far.

How do you explain the Sting-Ray phenomenon?

It was covered in all the major media. A lot of the people who write these stories and watch the trends grew up in the 1960s and '70s, when that type of model, with the high handlebars and banana seat, dominated the bicycle market. People remembered that.

Was it just a fad based on nostalgia?

On the publicity side, yes. But when the kids between seven and 17 saw the bicycle itself at Wal-Mart or Toys "R" Us, that was the big thing that created the demand.

Were the production lines ready?

The demand came out of left field, and our suppliers in China weren't ready for it at first. Early last year prices of steel and other raw materials were rising, and they had to cope with shortages. But we worked our way through that.

What's your acquisition strategy?

It has changed over the years. Originally, we wanted to grow in the U.S. and looked for companies with growth potential. We didn't discount prospects that were in poor shape, if we thought we could turn them around quickly. Our first was [Columbus, Indiana­based] Cosco [in 1988], a decent but not greatly profitable juvenile products company that was twice as large as we were at the time. A couple years later, in 1990, we bought [Wright City, Missouri­based] Charleswood Corp., which for all intents and purposes was bankrupt, and that helped us grow in ready-to-assemble furniture. We turned it around very quickly and made a few similar deals after that. But the last few, including Pacific Cycle, were larger, profitable companies that were accretive to earnings very shortly after the acquisition.

Is there a common thread running through Dorel's products?

People ask us, "Are you a holding company or a conglomerate?" We're neither. We are a consumer products company in the areas of juvenile products, home furnishings and bicycles. They are similar in the sense that they share a single distribution network and take advantage of our strong ties to the major retailers. The size and strength of Dorel allows us to save money on services and commodities across the enterprise.

Were bicycles a major departure?

They are consumer products. All our bikes are made in Asia, and we know how to do business there -- we've been there for 25 years.

How big are you in China?

We have an office in China and a few people there who work in quality control, inspection and sourcing. But we don't own any factories there. We are, in many cases, the major customer of the factories we use, which gives us effective control.

Are you looking to diversify further?

We wouldn't be afraid to go into other consumer products -- they wouldn't be things we have no idea about, but there are other, related products that would certainly fit. Then again, our growth philosophy isn't just [to make] acquisitions. We also look for internal growth, and we've done that successfully as well.

Wal-Mart is known for driving a very hard bargain with suppliers. What's your relationship with the company?

They are definitely tough, but we've done very well with them and have an excellent relationship. When you make a deal with Wal-Mart, they stick to it and are fair. We've both made a lot of money on our products over the years. Dorel has had a presence in Bentonville, Arkansas, where Wal-Mart is based, since the early 1990s. We were one of the first suppliers with a foothold there, because we believe that it's important to be close to our customers. That operation is now 35 people in sales and marketing, product design and inventory management -- all servicing Wal-Mart full time, with the intention of making the buyer's life easier. We have the same types of relationships, including a physical presence, with other major retailers, including Kmart, Target and Toys "R" Us.

Are you cooperating with Wal-Mart's desire for suppliers to use radio-frequency identification tags for inventory tracking?

As one of their top suppliers, we are among the early ones working with them on RFID. We have a team working on that. There is still a lot of confusion. One question is whether you put it on a product that sells for 99 cents, for example. We'll probably be doing bicycles, because they are higher-ticket items, first.

Do you expect to keep making acquisitions at a steady pace -- or have you felt the need to take a breather?

We're very happy with the Pacific Cycle situation -- it was one we swallowed very easily. We are not constantly saying that we have to acquire. We're still growing internally, and there are plenty of things we can fix to make the company better. The last several acquisitions have been opportunity-based, but there are M&A bankers who have a shopping list, and we say, "Bring us something interesting, and we'll take a look."

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