Friday, 16 January 2009

Company Focus – Harley Davidson – Backing Off the Gas, Checking the Motor & Attracting a Racy Italian to Ride Pillion

As NAIAS progresses at Cobo Hall and US automakers are forced to stoically face the industrial consequences of a deep recession, westwards from Wayne along the western shore of Lake Michigan lies Milwaukee Wisconsin and another legendary American automotive company – Harley Davidson.

Although the deep downturn will ultimately take its toll on revenue and earnings, (FY08 results due next week on Jan 23rd) the company will argue it is better positioned than much of conventional US Auto - able to more effectively temporarily shrink, rationalise operations, seek new synergies and 'ride-out' what for most is a dire retail marketplace.

The Harley Davidson Motor Company presently consists of 5 divisions; though soon to add another with a recent acquisition. As of today, they are: the Group's primary H-D Motorcycle division leading: Parts & Accessories, General Merchandise, another motorcycle Product line named Buell (little known outside the US) and Defence Products. [NB the use of the word 'Motor' as opposed to 'Motorcycle' in its official title, an undoubtedly considered action to provide a broader realm of strategic and operational possibilities].

The H-D Motorcycle division's almost exponential YoY top-line growth has itself been the stuff of legend between 1986 and 2006. The figures below are depicted in an accompanying graph, set against stock-price trend of last 5 years:
1986 $ 216,392
1987 $ 268,821
1988 $ 327,124
1989 $ 409,847
1990 $ 485,255
1991 $ 548,145
1992 $ 662,489
1993 $ 729,183
1994 $ 890,578
1995 $1,038,335
1996 $1,199,163
1997 $1,382,809
1998 $1,595,415
1999 $1,890,932
2000 $2,280,929 (ROIC >20%)
2001 $2,671,314 (ROIC >20%)
2002 $3,161,046 (ROIC >20%)
2003 $3,621,488 (ROIC >20%)
2004 $3,928,232 (ROIC >20%)
2005 $4,183,515 (ROIC >20%)
2006 $4,553,561 (ROIC >20%)
2007 $4,446,637 (ROIC of 26.3%)
2008 $4,055,333 (investment-auto-motives' est)

As we see 2007 posted declined group income, (net revenue -1.3% and declined group net income -10.5%) and so even though running understandably lower, what has been a relatively decent showing for Q1-3 2008 is bound to be hit hard by Q4 figures as consumer confidence continues to falter.

The 20 year growth was impressive indeed, displaying a high acumen to leverage the power of the brand by 'mainstreaming' the HOG cult (during a 20 year period of domestic and international expansion) to create consumer resurgence of the 105 year old brand. (It has since become a text-book case study in industry and academia). The company's historical share-price, even after multiple splits, highlights its general commercial success; even with the 2004 alleged dealership over-shipping and stock price manipulation claims by institutionals regards the ex-CEO's 'timely' stock sale actions

But the previous $40 lows of 2004 look favourable compared to the 33% drop over 2007 and the very heavy 'cliff-drop' since July '08, created as a consequence of the devastating effects of the credit and banking melt-down has affected many consumer focused industrials. Recent prices illustrate the impact of both general industrial investor malaise and specific investor concerns regards what are perceived as the most highly exposed sectors and companies, typically those fashion and credit dependent.

There was some stock-price hold towards the latter part of 2008 as it was presumed that the Asian consumer with possible US-Asian economic de-coupling, would support US exports such as Harley. But it has become evident that (primarily) China's economic contraction aligned with the past 6 month's of strengthening for the US$ has extinguished that previous positive presumption.

Thus the general perception is that of gloom – luxury and leisure goods taking perhaps the hardest hit.

Long recognising that H-D's almost magical commercial formula could be prone to economic and bike fashion trends the company's management have taken steps to allow for the need for product and brand diversification to hedge against a single-dimensional persona. That thinking brought about the aforementioned use of the word 'Motor' in its official name and in 2003 the full acquisition of Buell Motorcycles – a rare US sports-bike maker that uses innovation as a USP – the complete opposite to H-D's classic and unchanged architectures. [Buell is located nearby in Troy Wisconsin originally founded in 1993 by an ex-Harley engineer (Erik Buell) as a Harley-Buell JV (49%:51% respectively].

Thus H-D obtained a (theoretically) strategically important foothold in the complementary (and importantly) globally massive, Sports-bike segment that is effectively owned by the Japanese, so as to philosophically balance and 'hedge' its No.1 ranking in traditional 'Choppers'. That 'hedge' is wise, but after 30 years of Japanese dominance the segment will be hard to conquer. And though Buell was born on the US national track, the likes of Suzuki, Honda and Kawasaki are the undisputed global masters of sports-bike racing for a perceived eternity.

The only real emergence (or rather re-emergence) as opposition has been Ducati in the late 1990s and early 2000s. With PE funding to re-create its engineering ability which gave rise to international competitive success, Ducati became considered the Ferrari of bikes, an Italian inspired, high-minded, deep-pocketed counter-cultural revolt against both the antiquated technology and blue-collar 'HOG' association of Choppers, the boring 'old-man' conventionality of typical Touring bikes like BMWs, and the social stereo-typing of Japanese sports-bike riders as dangerous unthinking adrenalin junkies. Merging yesteryear prestige and modern technology Ducati was born again.

And in its strategic drive for both portfolio diversification and synergy seeking, H-D appears to want to replicate the Ducati 'road to victory' with the $109m acquisition of the essentially lost but not forgotten Italian firm of MV Agusta. Looking to re-capture the long ago but not forgotten glory days of yesteryear.

[MV itself could be regarded as a foster child, previously heavily indebted it was previously sold to Proton (the Malaysian car company) for 70m Euros in December 2004, but by December 2005 Proton sold it back to the Italians for 1 Euro excluding debts, going to the PE firm GEVI SpA. GEVI 're-financed' MV holding 65% share capital, essentially offering basic working capital and gaining from the valuable subsidiary sale of Husqvana to BMW for undisclosed amount. MV still holds Cagiva as subsidiary (which itself has old links to H-D), and interestingly Cagiva as a previous holding company also owned Ducati between 1985-1996 but sold that to the PE firm Texas Pacific Group, which underpinned its aforementioned revival. The twists and turns of the industry!]

But it seems that rather than develop MV Agusta & Cagiva brands itself, possibly readying the company for an LBO/MBO, GEVI SpA preferred to sell outright to Harley-Davidson. Probably done so recognising the 'turning tide' of the premium sports-bike sector, little own portfolio synergy leverage and a timely profit maximising exit from the investment.

From the buyer's perspective, the MV Agusta/Cagiva acquisition provides H-D the benefits of:

1. Additional brands with different European/Italian heritage, cache & leverage (a la Ducati)
2. Abilities to economically synergise Buell with MV-Cagiva (R&D, tech, production, distribution)
3. Ability to, if FX costs prove necessary, assemble Buell bikes in MV-Cagiva plants.
4. Access to a new globally massive bike-market segments - small capacity engines
Of these commercial drivers, items 2 & 4 deserve more attention:

Thus relative to item 2, today H-D's brands and products span a broad spectrum of motorcycle segments from [simplistically] Classic H-D 'big-pot' and 'mid-pot' Choppers & Dressers to Cagiva's 'small-pot' (125cc) / Buell's 'mid-pot' (500cc) / H-D's 'large-pot' 'Naked' – 'Street-fighter' - 'Muscle' upright bikes to Cagiva's & MV's technically conventional yet emotionally connected 'small-pot' and 'mid-pot' sports-bikes to Buell's technically avante garde sports-bike. And most interestingly as of 2009 H-D has introduced a 3-wheeler trike into the range which reflects perhaps the possibility for broader 'motor-vehicle' portfolio ambitions in the mid and longer term time horizon.

H-D could well be creating the foundations and building blocks that provide a fully fledged platform and production strategy akin to the automobile industry, perhaps best illustrated over the last decade by VW's use of sensitively adapted platforms for Skoda, SEAT, VW and Audi. What H-D cannot afford to do is simply badge-engineer a plethora of me-too products as GM has done for decades and so suffered by. H-D management will need to sensitively handle the balance of scale economies vs product integrity.

And relative to item 4, the decision to enter the small capacity engine market opens up literally a new world of opportunity given the millions of 125cc (& <125cc>125cc variants siblings) sold throughout Asia (esp China, India) and growing trends in the rest of the world in a bid amongst bikers and previous non-bikers to combat increasingly high mobility costs and inconvenience, whether that be conventional cars gridlocked in cities or on highways or indeed increasingly expensive and unreliable public transport if infact available.

Moving into the premium end of the 125cc segment with plausible brands and product architectures provides opportunity to create a complete portfolio of 125cc variants and in due course the possibility to procure other OEM engines in the 100cc-250cc range to extend product/brand appeal.

There are a plethora of Asian manufacturers in this sector with nationally indigenous and export popularity, but none have the cache of the racy Italians or racy American. And, although it has been a painful process negotiating with the Indian authorities regards H-D's import and domestic assembly intentions – in all probability due to what the Indian's see as a threat to their own motorcycle industry, from a Bajaj 125 to a Royal Enfield Classic - there must be a way of both the US and Indian industries benefiting mutually from eachother, as previously proven by the Indian-Japanese Bike JV's of Hero-Honda and TVS-Suzuki (which now appear to be seperating and so leaving a possible IPR vacuum for the Indians), and as witnessed with India's automotive JV's.

Finally, looking as far out as the 4 wheeled car world, investment-auto-motives believes that H-D, if it hasn't already, should undertake an exercise to see how it could enter and exploit the quickly changing small car market by naturally 'walking up' beyond its present (to be honest rather poor) trike offering by re-conceptualising that and using that base to consider a fully fledge lightweight 4-wheeler...after all HOG's do have 4 legs!
Add to the business mix H-D's desire to maintain a well-cultivated eco-reputation (ie efforts to expel old ground-contamination from an assembly plant) aligned to the need to consider the emergence and role of eco-technologies (ie electric motors and even hybrid motors), and the strategic possibilities for the company appear endless.

To be candid, investment-auto-motives suspects that Harley Davidson Motor Company considers the in-roads made to date with Buell as somewhat disappointing, realising the pain of organic growth of what in industry terms is a new start-up. So given the size of the global sports-bike market and so has decided to understandably add another string to its bow with MV.

The trick will be to expediantly execute the innate potential (visible and invisible) that resides as a result of the M&A. Reading between the lines of H-D's actions, ambitious but achievable plans appear to have been drafted; ones that use the strategic technology, production and retail foundations logically created by the MV Agusta acquisition.

H-D has been here before back in the 1970s having to alter its traditional business model to befit chnaged times. investment-auto-motives hopes it learned the lessons of the past to enable a return to strong global growth using the new 'dual path' commercial ideology that has emerged once the enforced hiatus of the present economic watershed has expectantly passed in 2010 or so.