Despite Rumors, Harley-Davidson (HOG) Makes a Poor LBO Candidate - Barclays
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Shares of Harley-Davidson (NYSE: HOG) surged 20% last Friday on unsubstantiated rumors private equity firm KKR was interested in taking the company private. Slow holiday trading perpetuated the upside action. When trading re-opened Tuesday reality set in that a deal was unlikely and shares fell nearly 11%. Shares of HOG are shedding another 1.4% Wednesday in part as Barclays analyst Felicia Hendrix said the iconic motorcycle maker is not an ideal LBO candidate.
Hendrix said Harley-Davidson is a poor LBO candidate for two reasons:reasons:
- covenants on the motor company (H-D) and HDFS limit the amount of debt that can be put on either entity; and
- H-D may not produce enough cash flow to delever within an adequate private equity time horizon to generate an acceptable return.
With the stock trading at 10.7x 2017E EPS, the analyst said they can understand how stories like Friday's come to the surface, however unlikely.
The analyst said their analysis shows that at $43, HOG could produce an adequate IRR for a PE firm (at least 20% in Year 5), assume a reasonable amount of sponsor equity (40%) and leverage 4.6x, and most importantly, not trigger HDFS covenants. The problme is, this "breakeven" is 11.1% below yesterday's close, 20.7% lower than Friday's high and 8.2% below the 6/23 (pre-Brexit) close. "We do not believe the HOG Board would consider that level given it's also at a 15.7% discount to the $51 consensus price target," the analyst said.
Hendrix added that any analysis of a LBO needs to recognize that HDFS' cross collateralization significantly limits the amount of debt an LBO would put on H-D. Per Harley- Davidson's financial statements, there are operating and financial covenants on the motor company (H-D) and HDFS which state that the consolidated debt to equity ratio of HDFS cannot exceed 10.0 to 1.0 at the end of any fiscal quarter. Further, the ratio of the motor company's consolidated debt to its consolidated debt and equity (all excluding HDFS debt) cannot exceed 0.65 to 1.0 at the end of any fiscal quarter. Currently, HOG and HDFS are in compliance with these covenants. However, leverage above 4.6x OpCo's LTM EBITDA would breach these covenants and could limit HDFS' access to the commercial paper market which is important to its motorcycle lending business.
The firm retaliated an Equalweight rating and price target of $49 on HOG.
For an analyst ratings summary and ratings history on Harley-Davidson click here. For more ratings news on Harley-Davidson click here.
Shares of Harley-Davidson closed at $48.37 yesterday.
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