Hog Wild for a Buyout?

March 18, 2010

Cross-posted from today’s NYT.

Could Henry Kravis handle a hog? Harley-Davidson’s shares revved up this week on talk of a leveraged buyout, and Mr. Kravis’ firm, Kohlberg Kravis Roberts, was one name mentioned. The iconic motorcycle maker can absorb plenty more debt, but the price tag and the cyclical nature of the business mean a deal would be no easy ride.

Harley has roared back to life. At around $28 apiece, Harley’s shares are more than triple their recession low, including Tuesday’s 6 percent bounce. Figure any deal would require a premium of at least 30 percent, and the implied equity valuation would be about $8.5 billion.

The company is expected by analysts to generate earnings before interest, tax, depreciation and amortization (EBITDA) of $950 million in 2011. Strip out Harley’s financing arm for simplicity and adjust for its $1.7 billion of cash, and that price tag would peg its enterprise value at a little more than 5.8 times EBITDA.* Rich, yes, but not outrageous.

Of course, any Harley buyer would scrutinize the financial services unit, which is used to extend credit to the Milwaukee manufacturer’s customers. It had $5.1 billion of receivables at the end of last year, and heavy borrowing at the parent company would risk trashing the finance arm’s ability to fund itself.

But with careful structuring, there seems to be room to gear up. Only $600 million of Harley’s $5.7 billion of debt relates to the manufacturing part of the business, according to Wells Fargo estimates. For leveraged buyouts, depending on the deal, banks are starting to stretch to debt multiples of 5.5 times EBITDA.

Putting such high leverage on a business as cyclical as Harley’s could turn it into the next Simmons, yet banks are slowly but surely loosening underwriting standards for buyouts. Anyway, at that multiple, KKR or another private equity buyer could borrow some $4.6 billion, meaning they’d need to throw in about $3.9 billion of equity or 46 percent of the total price — a big but feasible sum.

This back-of-the-envelope scenario suggests any buyout would run close to the limits. But the idea of Mr. Kravis or another buyout baron cruising off with Harley isn’t entirely hog-wild. But just because a deal can be done doesn’t mean it should be.


*The presence of Harley’s finance company means the valuation isn’t straightfoward. Multiple analysts told me that, from a buyout shop’s perspective, you’d ignore the finance company debt (=$5.1 billion of total debt at 12/31 of $5.7 billion) as it’s backed by receivables. So we have market cap = $6.6 billion, debt = $600 million, cash = $1.7 billion….EV (6.6 + .6 – 1.7) = $5.5 billion, or 5.8x ’11 consensus EBITDA of $950 million.

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A Harley is such a huge expense that only Hollywood stars buy one with cash. Since everyone else gets a loan and a hog is a completely discretionary purchase, sales should be a good indicator of whether or not Joe Public really is serious about reducing his debt load. Paying many thousands of dollars for a machine that, in much of the U.S., sits unused in a garage for half the year would not seem to be the act of a cautious consumer. We’ll see.

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