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It's not the time to test-drive a Harley buyout

Harley-Davidson has a great ticker symbol: HOG .

Lately, though, the company has been more of a dog. A Harley is hardly something you have to own so when the economy teeters on the edge of ruin, sales dry up pretty fast, profits follow and so does the share price, which is a third of what it was 3½ years ago.

But it's perking up now on speculation that Harley is the subject of an imminent leveraged buyout.

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Anything is possible, and it may well be true, but one thing is clear to me: It's easy to look at a long-term stock chart that shows HOG was once worth $75 (U.S.) and fantasize about it getting there again quickly.

But, take a look at the nature of the business and you might have some doubts. Harley-Davidson was as much a beneficiary of the great era of easy credit as it is now a victim.

I am not a leveraged buyout expert by any means but if I were kicking tires with an LBO in mind I'd start by looking for a strong brand name because that implies fat profit margins and stability. Harley has both. It's been around for a century, it has a strong identity and everyone knows what it stands for.

It also usually earns healthy margins and returns on equity. In 2004, a good year, the net margin was 18 per cent of revenues, which is excellent for a manufacturer.

Of course, if you borrow loads of money to buy a company, you want it to ooze cash so you can pay the debt off quickly.

Harley can do that. In fact, last year, despite falling profits, cash flow was up for reasons I'll get to later.

Another important feature would be opportunities to improve profitability.

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Harley has those too, and in fact has already started to implement them by cutting staff and getting rid of product lines that don't fit in well, like the Buell motorcycle brand.

One thing I would not want to do is use debt to pay a lot for a business that's still shrinking, and Harley-Davidson is doing just that.

Revenue in 2009 was down by almost a quarter from a year earlier.

More importantly, motorcycle shipments were down even more: 2008 was not a great year but 2009 was worse, with annual shipments dropping by almost 30 per cent.

Fourth-quarter sales were down by more than half year over year.

And the depressing trend is alive and well this year, with sales expected to be down between 5 and 10 per cent.

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Is it just a matter of time before they return to where they were when the stock was $75 or even $60? You tell me.

One of the interesting items in Harley-Davidson's financial statements relates to securitizations.

Like many car and motorbike manufacturers, Harley-Davidson offers credit to buyers. It does it in spades actually.

And it usually securitizes the loans it offers, meaning it sells them to fixed-income investors like pension funds. One reason cash flow was up last year despite lower profits was such sales.

In 2007, proceeds from securitizations were $2.4-billion on revenue of $5.7-billion. By 2008 that had shrunk to $470-million, meaning Harley-Davidson was left holding a lot of debt it couldn't offload, which helped lead to a $120-million loss in the finance segment last year.

It appears to me that, befitting the age, consumers were buying Harleys with lots of borrowed money. The securitization and finance business was growing faster than anything over the past couple of decades.

If you think the era of easy money is over, you have to assume that Harley-Davidson's sales will get crimped.

I can't say for sure by how much but easily enough that with the stock trading at $28.35 yesterday, investors should not think of $40 or more per share as realistic any time soon.

It's a great company and the stock might well be cheap. There are bright spots, like international sales. But the bread and butter business might be reverting to the proverbial mean.

And even if an LBO is in the works, it might not be that rich for investors.


From best to worst?

America's love affair with debt is plain to see in Harley-Davidson's results, which peaked in 2006. Now that debt is a four-letter word, its 2009 results may be closer to typical.










Gross profit





Financial service profit





Op profit










Cash flow from ops (net income)










Cash from investing





Note: All figures in the table represent thousands of dollars

Source: company reports

Fabrice Taylor, Chartered Financial Analyst, is a principal in Capital Ideas Research and writes the blog

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