Friday, 29 April 2011

Company Focus - Indian Motorcycles – 'Sweet-Spot' Timing from PE to Trade, as Polaris Adds Industrial Mass.

Indian Motorcycles is a prime example of a once legendary brand which having suffered historic atrophy is seen as a proposition for a 'renaissance recovery'. Depending upon the complexity of the situation such propositions will be viewed as target acquisitions for private equity, ripe for business re-evaluation and resuscitation, exited via Secondary Market sale, an MBO or ideally bought-over by a synergistic trade-buyer. The trade buyer seeking to typically eliminate the nascent 3rd party competition and by adding a new brand broaden their own portfolio, market-base and sales potential.

Such is the case with Indian Motorcycles.

Indian Motorcycles then sits as a minnow inside centre of a large and complex commercial bike world, its approximate annual output of 1000 bikes is dwarfed by H-D's 23,000.

A century ago that picture was reversed, established in 1901 it was far bigger than H-D up until WW1, their rankings reversed from the 1920s onwards until today, though with a few resurge years such as 1940. The prime models of Chief (v-twin engine), Scout (v-twin) and Four (IL4).

The last 80 years has seen various attempts at recapturing that early success, merged into duPont Motors, sold to Ralph B Rogers for light-bike focus, sold onto Brockhouse Engineering which re-badged imported Royal Enfields in the 1950, sold to the UK's AMC in 1960 (not related to US AMC automobiles), the name 'adopted' by entrepreneur Floyd Clymer in 1962 to produce mopeds and 2 big bikes, the name allegedly sold to an LA lawyer in 1970 who had products produced in Taiwan until 1977, thereafter brand ownership disputes until 1998. The Indian name was given to an amalgam of firms headed by the California Motorcycle Co which began Gilroy CA production of a new Chief model in 1999, a Scout in 2001 but liquidated in 2003.

Such false-starts and re-starts all too typical with 'renaissance brands', the 'fits & starts' of commercial activity typically generated by an imbalance of new 'personality' owner ambitions set against an unrealistic heavy-headwind situational context.

However, when purchased by a PE firm with sensitivity to its history, philosophy and can re-mould and pass-on the regenerated small enterprise to a distinctly large, well-aligned company, it will offer a far better chance of success; if handled with care and attention given the new structural foundations in place.

Indian Motorcycles has now entered this phase of maturation, having been essentially yet again re-formed in 2006 with the majority-ownership of the London-based PE firm Stellican Ltd, and now recently sold onto Polaris Industries on 19.04.2011. Polaris manufactures of utility, leisure and defence-sector off-road vehicles, typically comprising of Quad-bikes / ATVs, 2WD / 4WD / 6WD buggies, 'Neighbourhood Vehicles' and Snowmobiles, having extracted from water-based vessels after a brief stint. Polaris also critically owns Victory Motorcycles.

Victory bikes are retro-styled large and medium-sized cruisers designed to compete directly against the monolith that is H-D. Its model range consists of 'Tourer' and 'Cruiser' variants – the latter large and medium – with effectively 3 trim levels: EightBall 'Base', Standard & 'Ness' Premium, the latter reflecting a co-branding the well respected 'Arlen Ness' bike builders; altogether offering 18 different bike variants.

Stellican describes itself as specialising in 'distressed situations', 'value situations' & 'special situations' related to old-economy businesses, although it has explored alternative arenas such as sports entertainment, with Italy being prime territory. Its focus however seems to be the regeneration of legendary names from whom which the lustre has faded. A good previous example of how it seeks to create value being the re-unification of nameplate and build-capability for the legendary wooden boat builders Chris-Craft, the American equal of the classic Riva; done so by buying the name from Rupert Murdoch's NewsCorp (see previous essay) (which also highlights the the subtle brand-capture and hold role which appears to NewsCorp play).

Stellican states its (very typical) PE investment criteria as seeking:

- Leading market share.
- Good brand, franchise or reputation, whether current or past.
- Solid asset backing, including preferably non-core assets.
- Potential to increase earnings and return on capital employed.
- Actual or potential high cash generation.
- Strong management team.

[NB These strengths then offer various PE plays in re-shaping a company, especially so where non-core assets can be disposed to re-invest back into the company, or the funds from which can be re-deployed elsewhere by a PE firm, or useful to repay client repayment demands without sacrificing core growth capital or associated yields. This part of general Balance Sheet restructuring. The other facets are self-explanatory].

Extracting such internal value will have been part & parcel of the purchase and sale of Indian Motorcycles, given that it started production afresh in 2006 at what appears a Stellican funded site in Kings Mountain, North Carolina site. This physical asset then 'returned to pasture' with the company's sale to Polaris Industries and transferal of Indian tooling and inventory to its own Spirit Lake, Iowa site. Thus then able to either re-deploy or sell the Kings Mountain site.

From an external perspective, re-deploy appearing the better option given the site's somewhat remote 'captive' location, low regional labour costs promoting high-manual content, sub-assembly activities for dispatch to Chris-Craft Industries.

But what of the Indian Motorcycle back-story?

Stellican would have noted that Victory Motorcycles had been established in 1998 with aim of gaining headway into the massive sales success and so notional market development created by the demographic and geographic reach of Harley-Davidson. That growth story was still robust in 2006, a decade into the sales boom, though obviously prior to the 2008 financial crash. Victory then was eager to replicate Harley success but knowingly lacked the pedigree, instead seeking to invent itself as neo-classical, very much in the retro-vain of the period. Yet it still lacked Harley authenticity, a trait that Stellican saw as able to effectively arbitrage with the Indian nameplate.

Thus Stellican (like so the many others previously) saw Indian as the perfect, centrally positioned renaissance brand, with endemic history it had greater authenticity than the neo-classical offerings from Polaris or indeed the Japanese, and as such a more plausible up-scale alternative to Harley for both new and migratory middle-aged bikers.

The emergence of the middle-aged, white-collar, motorcycle rider in the late 1990s, inflated the market for expensive, accessory-laden 'Weekend-Toy' motorcycles across the US, UK, Europe with latterly uptake in EM regions. Whilst a few of this new crop of 21st century 'suburban cowboys' were drawn to superbike territory, emulating the hero status of real-life GP and TT riders, the vast majority bought cruiser bikes. These less dangerous, more practical and crucially far more conspicuous when parked outside the pub / bar; the ordering of a soft-drink little more than a conversation starter to highlight the beast sat outside.

Nine times in ten, that beast was/is a 'HOG', the nickname for a Harley-Davidson apparent in its stock ticker. And so true to the tenants of deep consumer-psychology that middle aged Sunday rider believes himself (or increasingly herself) to be part of a counter-culture motor-cycle tribe with anthology spanning from the silver-screen's Easy Rider to 'Hells Angels' chapters that live on the outlaw fringes to the idea of a Springsteen-esque 'Steel-Town Joe', all this supposed 'Socking it to the Man' repaid by the 9-5 escapism of the 'Sturgis' bike festival – the veritable bikers Mecca - though don't dare mention those "damned A'rabs" and the price of gas!

Such is the H-D social cult that has flourished in the good times and bad; the economic waves well ridden by H-D's executives over the decades though obviously assisted by its near monopoly of the market . The times of economic woe only paradoxically add to the anti-hero persona even if bike sales for the company tend to heavily flag under the fluttering stars and stripes at a dealership, as seen over 2008-9.

It is within this world of Cruisers, Soft-Tails and Hard-Tails that that Indian Motorcycles has been fighting for recognition and market-share, a world almost unto itself, well apart from that of BMW's ownership of sensible Tourers, Enduro-bikes & Enduro-Hybrids, KTM's Paris-Dakar roots, Honda's ownership of 'Lazy-Bikers' with GoldWing and supply to the police and services fleets, and at extremes wholly separate from Honda's and Suzuki's ownership of the sports-bike market, even if H-D markets Sportster and Cafe-Racer types, given that its Buell brand was created for patriotic performance but discontinued since 2009 (along with H-D's sale of MV Augusta).

As if not hard enough for Indian to combat a heavily re-focused H-D alone with its market grasp, the Japanese VM's product lines periodically see cruiser-bike introductions which vary from mimicking H-D to alternative characters. Furthermore other once legendary brands have been reborn, from British Triumph in the mid 1990s building well beyond its Bonneville associations, to very recently the re-appearance of the 1920s Brough Superior – as ridden by Lawrence of Arabia - at the very top of the market and hand-built to order. Royal Enfield having become entrenched a basic transport in India for decades has sought to re-ignite its own Retro-British look & feel with models like its olive green Military Bullet for export back into the West. And to add yet further complexity and competition for Indian Motorcycles is the smaller but high value custom / “kustom” branch of the market, where cruisers are specified and built on a bespoke basis by dedicated firms of modern craftsmen akin to the origins of Arlen Ness, seeking similarly to make their name through high-value clients and projects.

[NB there is also the self-builder operating out of home garage, shed or even front room, inspired by bike magazines, the efforts of these individuals and clubs feeding back to influence the mainstream, though of only cultural interest to Indian Motorcycles, since these people are typically the antithesis of the luxury market that Indian seeks].

For the management at Polaris Industries all this is very familiar territory, before and since the creation of Victory Motorcycles back in 1998 and adoption of the (father-sons) Ness names to boost the upstarts credibility.

However creating market traction for itself has been a problem and the use of the Ness name on a brand that offers value-pricing ('spec-for-spec') against H-D (as exemplified by its 'Bobber' model which sits $3,500 or so under) is intrinsically confusing, and so undermines brand integrity, even if on paper the amalgam looks positive and as a central part of its own top-spec model-lines.

Through exploitation of the Polaris distribution-base Victory Motorcycles has had notionally broad US reach and international presence in major cities. However its marketing platform and client presentation leaves much to be desired. Typically co-located with Polaris retailers for both pragmatic and apparent synergistic reasons - given the corollary of off-road & on-road leisure pursuits – this set-up reflects in the sub-divisional organisation of Polaris Industries more than the ideal shop window. The probable effect of shared space retailing is that Victory Bikes is seen as an 'add-on' to Polaris and thus unable to stand-alone. Though it might appear otherwise to the internal perspective with need to keep tight budget control, clean-chromed stylised boulevard cruiser bikes and dirt-machines, no matter how able and toy-like, do not make for good showroom partners, sending-out distinctly different messages, even if the central idea of cross-selling appears appealing and has indeed enjoyed success to date.

Thus Victory whilst probably successful in rural areas with dual-use clients, has been unable to present itself with the same high degree of professionalism as Harley-Davidson, when indeed it must appear to be superior in terms of urban street presence, window display and customer service. The need to improve marketplace presentation then is a driving force in combining Victory and Indian nameplates, the two (unlike quads & buggies) able to stand side by side the urban/suburban bike showroom.

This headwind in creating a costly dealership network was no doubt was part of Stellican's rational for exiting from Indian Motorcycles, recognising the need to find a new and able 'steward' for the century-old marque. And beyond distribution and retail, Stellican would have noted the high engineering development costs required to make Indian truly superior to Harley-Davidson.

Biker web-forums state that Stellican noted the quality problems that the older 'Gilroy Indians' suffered using Taiwan sourced-parts early-on in its ownership, and sought to address this issue as part of its re-build of the Indian brand reputation. This done by creating the manufacturing base in Kings Mountain, North Carolina, and approving specific but basic re-engineering projects to improve product quality as part of the quality march beyond the H-D benchmark, which could then prove itself as worthy in the low-volume niche luxury sector - the only tenable re-start point (esp for a PE firm) where all important levels of unit margin could theoretically speak for itself. However, its does appear that the level of 1999 product re-engineering has been quite low over the last 10 years, directed at the powertrain of the Chief model, Stellican very probably seeking to both cure the major engineering / specification problems whilst simultaneously maximise company profitability so as to create an attractive vehicle for full or partial exit.

The attraction of Victory Motorcycles for Polaris was to obviously create a second motorcycle business that could sit above H-D, just as Victory Motorcycles sits below. Thus with the idea of creating lower and upper pricing boundaries for H-D, and in time, the intent to eat its way into that massive middle-ground that H-D occupies.

Thus it seems probable that beyond the costs of ideally creating an all-new dealership network - with web-linked BTO assistance, but still invariably required - Polaris Industries must also maintain the march of product quality; both undoubtedly costly exercise s. The overhead operating costs of Indian can now however be reduced as – depending upon internal cost-centre accounting methods used – it is able to share its backroom operating and administrative costs within the Polaris empire, this cost-saving providing for incoming cashflow to be directed at product development and retail development, though realistically it probably only offers small room for such manouvres, the majority of funding very probably born from Polaris with greater access to investment capital than would be the case for Indian or Victory separately – though latterly plausible when the 2 siblings have been better merged.

investment-auto-motives sees the Stellican sale of Indian to Polaris as at a 'sweet-spot' moment. June sees the end of the Federal Reserve's Quantitative Easing measures, which pumped so much liquidity into Wall Street to both prop-up the banks, re-generate the investment markets and provide cash for activity-based (rather than asset-bubble) commercial lending. Having seen phases 1 & 2 completed the White House wants to see the liquidity trickle-through into the real economy, ie US industry, which having been through re-structuring, cost-abatement and created savings-cushions where possible has used such in-house cash for acquisitions and seeks to access low-cost bank borrowing to finance new-era expansion plans.

Polaris Industries then in buying Indian Motorcycles exemplifies itself as a constituent part of the crucial pillar in the US administration's desire to see a 'productivity push' economic recovery, one in which US products and associated services like Victory & Indian can ride the global bow-wave that Harley-Davidson created...selling a piece of ideological free-spirited, but high priced, Americana to the world.

It was that very free-wheeling spirit that the infamous writer Hunter S Thompson sought in the mid 1970s when he wrote his counter-culture classic 'Fear & Loathing in Las Vegas", a booze and drug-fuelled adventure into the Nevada desert as cover-journalist for the Mint 400 desert race (since revived)...

“I bought a beer and watched the bikes checking in. Many 405 Husquavarnas...many Yamahas, Kawasakis, a few 500 Triumphs, Maicos, here and there a CZ, a Pursang...No Hogs in this league, not even a Sportster”.

Whilst such literary overtones of H-D's absence might live in Victory's & Indian's fantasy, the fact is that they were created, revived and now sit pillion together with the direct intent to wallow within Hog territory. But perhaps not uncoincidentally, Victory's 'Vegas' models give an impression to Polaris executives that H-D cannot stay forever the grand-daddy of cruisers.

But, in the meantime, in the motorcycling world of 'Urban Cowboys', Polaris still needs to find a strategy that provides an “Indian Victory”. Their strategic and operational unification will prove undoubtedly advantageous, yet whilst the road ahead will be tough, it does offer much once western economies have re-bounded and eastern luxury-toy consumers seek the non-obvious.

However, one is clear...the Hog will be first at both troughs, so Polaris will need to identify exactly how it can configure and espouse its 'lower and upper' marques. 70% of the Polaris share-holding is held by the US institutionals, a community now seeking greater governance and possibly semi-supervisory input given the performance boost many pensions funds require. Though Polaris management are aligned with its 7% share-hold, the instututionals should seek greater transparency in both strategy formulation and operational execution than has been the case in the past.

In the meantime, shareholders and management alike will be overjoyed at the 21% stock-price leap that Polaris saw on 20.04.2011 (a week after the Indian purchase) when management announced that its FY2011 dividend of $5.53 would beat analysts expectations of $4.87, the share-price hit $110.28, the highest peak since 1987. Whether the announcement was made 'optimistically' to assist stock-favour and thus assist MarketCap valuation and so strategic funding remains to be seen, but the interest in Polaris' future from the capital markets is obviously palpable, given its place in the 're-making of America'.

“Roast the Hog” might well be a motivational saying in Spirit Lake, but beyond surveying Hog territory as it has done Polaris must create its own territories which accord with the mentalities and aspirations of specific client types. Moreover it must better understand the Hog's psyche, its strengths and weaknesses, and that will take some doing, given its own recent 're-centering' and its undoubted self-analysis. That an imperative so as to build its own on-road divisional tribe and its own 'H-D counter-culture'.

That appears to have started in Victory with the 2010 CORE concept bike implicitly taking the brand in the direction of 'naked elegance' using the archetype Bobber-build mentality as its new centre of philosophical gravity created by an ex-BMW (Designworks CA) bike designer. That leaves Indian as the more flamboyant heavily-bodied sibling.

This model for aesthetics then well matches the tenants of respective 'lower & upper' basic business models which sees the relativity of basic production costs echoed in Victory and Indian pricing points and so unit margins

As for a suitable signature tune for Polaris's newly expanded motorcycle division, the antidote and antithesis to H-D's links with Steppenwolf's “Born to be Wild” or “The Pusher” could well be Rufus Wainright's..."Ain't Heavy"

“The road is Long...”.