Sour Notes for the Harman Buyout
Harman International (HAR) is a classic growth company, a leading maker of audio products that many believe are on the verge of catching on around the world.
So why are private equity buyers reportedly reconsidering their purchase of Harman, announced in April? Kohlberg Kravis Roberts and a Goldman Sachs (GS) private equity fund have reportedly soured on the $8 billion deal, the Wall Street Journal reported Sept. 21 citing unidentified sources.
By midday on Sept. 21, Harman's stock had plunged 19% to $91 per share. Its private equity buyers had offered $120 per share earlier this year.
The buyers aren't giving reasons for their concerns at this point. Perhaps it has to do with the recent disruptions to the credit markets, which have made it harder to finance risky buyout deals.
However, other, larger deals announced before the credit crunch are still on track. The Journal reports one source said "buyers have come across new information that makes them less sanguine about the deal."
That might indicate frustration with Harman's recent results. Because while analysts say Harman's growth prospects are mostly intact, a quarterly earnings report last month disturbed many investors. Fourth-quarter earnings of 93 cents per share were way below analysts' estimates of $1.22 per share.
Harman makes audio, video and electronic devices. Its brands include JBL, Infinity, Lexicon and Mark Levinson. But its most promising product may be fiber optic networks now being installed in luxury cars. The idea is to link Harman's sophisticated audio equipment with navigation devices, phones, air conditioning and other controls all through one interface.
Many German carmakers are already customers. Hyundai (HYNDF), Peugeot (PEUP.PA), and Chrysler are also making plans to include Harman systems in their vehicles.
Standard & Poor's equity analyst James Peters wrote last month that Harman's "original equipment manufacturing pipeline for the automotive segment is booked through 2008 and is nearly full for 2009." A "surge in revenue [is] expected over the next few years," Roberts W. Baird analyst David Leiker wrote last month. Already, he said, Harman has "substantial" free cash flow — estimated at more than $500 million in 2007-08 — "with essentially no debt."
Analysts blamed the weak results last quarter on a few different factors. Revenue was hurt by the delayed launch of a new line of cars from Mercedes Benz and "increased competition in the market for multimedia devices," Leiker said.
Also, profit margins declined as Harman invested in new products and lines of business. Harman will launch five or six major programs each year for the next three years, spending a total $1.2 billion on new business, Leiker notes.
Research and development costs should continue to rise. Also, Peters expects Harman's quick growth rate to slow in future years, but higher revenues should allow for wider profit margins. (Standard & Poor's, like BusinessWeek, is a unit of the McGraw-Hill Companies. Baird makes a market in Harman shares.)
It's not clear whether KKR and Goldman Sachs simply want to re-negotiate the deal or if they will indeed walk away from it.
If the deal does fall apart, the would-be buyers may need to pay a $225 million termination fee. Also, Wall Street would lose the chance to experiment with a new kind of private equity deal. The Harman buyout deal unusually allow current public investors to hold onto a 27% stake in the company once it's taken private.