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Tuesday, 11 July 2017

Comment by Editor-in-Chief, Robin Bradley

Hey, Harley – leave Ducati alone …

Well, just as we were hoping that the motorcycle parts and accessory market’s softening of the past 12 months (in the United States especially) might be going to stabilize or even reverse itself a tad this year, it looks like underlying economic trends and indicators are starting to blink amber, rather than the green lights we’d been assuming would be the case in 2017.

Many people in the industry have made much about how the primary indicators such as the growth in the number of jobs, relatively low unemployment rates and record numbers of people with jobs has not been creating fiscal “trickle down” to discretionary spending, and it is beginning to look increasingly like they have been right to be concerned.
Throughout the recovery from the 2008 to 2012 banking crisis and the deep, deep recession it triggered, there has been concern about the quality and pay levels of the jobs being created. Leaving aside issues of whether economies should be using prior metrics as the basis for a forward looking analysis of the kind of work that needs to be made available (it isn’t change that is the enemy, it is failing to change that what destroys lives, communities and economies), the actual levels of discretionary disposable income being generated by the kind of 21st century jobs growth seen so far simply hasn’t yet translated into being the driver of economic activity that it should have been.
On both sides of the Atlantic we are seeing levels of unsecured consumer debt climb back to alarming levels. The total consumer debt balance for the first quarter this year in the United States hit $12.73 trillion – that is higher than the $12.68 trillion recorded in the United States for the third quarter of 2008 – and we all know how that movie ended!
In June, in the UK, the Bank of England also started to caution against rising levels of unsecured consumer spending, and in the usual uber-risk averse consumer markets of continental Europe, in Germany especially (a country where debt is regarded as being closer to mortal sin than civic duty), consumer debt is also on the rise and will almost exceed the Eurozone’s June 2010 consumer debt record level within the next 12 months.
While retail spending is still (mostly) growing, for the time being, which is a good thing, if it isn’t being paid for by real wage level growth, growth above the rate of inflation, then it becomes a very bad thing indeed – it becomes something being driven by people’s attempts to keep up with the increasing cost of living in the face of declining real world declines in incomes.

“beware the movie’s sequel”

With growth forecasts being marked down, that is what is starting to happen now. The economic orthodoxy is that a modest level of inflation is a good thing, a necessary side effect of growth, and something that is easily countered by increasing interest rates.
However, that orthodoxy is predicated on the assumption that the corporations who generate the jobs, the growth, the wealth and the government tax incomes needed to pay for welfare, education, health, infrastructure, defence and, yes, meeting the rising costs of public and private debt – unsecured and otherwise - are able to do so.
That in turn is dependent on their ability to access affordable capital – either through the banks, the stock markets or private investment.
The problems start when that flow of capital starts to come under pressure, and those problems have the habit of getting worse real fast if institutions that do the lending are exposed to excessive levels of risk (unsecured consumer debt for example), a slowing of growth, rising interest rates and a return of inflation.
I am afraid to say that this would appear to be exactly the kind of toxic cocktail we could be headed towards again.
Some 10 or 11 years ago I wrote and published a two-page Comment article headed “We are drowning in a sea of debt,” in which I warned against the excessive heat that had built up in the motorcycle aftermarket and the dangers arising from how it was being funded.
I keep meaning to ferret around in our back issue archive to find that article, so I could place when in the timeline of disaster it was that I had called it – some time in 2007 or early 2008 I think.
Now I am not saying that we are “in that place” again, certainly not yet. I am not saying that the laws of inevitable consequences that govern the gravity field that affects debt are an inevitable outcome of where we are right now – not yet anyway.
However, debt is the enemy of performance, and what I think the present mixed signals do behove us all to do in our businesses is to remain risk averse, remain realistic, continue enjoying what we do and investing in our brands and our product lines (the two key elements to determining downturn outcomes), but to do so with the minimum possible exposure to risk, and that means the minimum possible levels of debt.
Which brings me to the point this week – I have one simple message for Harley-Davidson and that is: DON’T DO IT!
As it happens, I think the rumors (accelerated recently by business news provider Reuters) are way off beam. I think, or certainly hope, that there is big fat zero chance that anybody connected with Harley-Davidson would be thinking that splashing something in the order of $1.5 to $2.0 billion on trying to prise Ducati away from the Volkswagen Audi Group (VAG) at this time would be anything other than swallowing a suicide pill - it simply would not end well for either party.
There are dozens of reasons why it would be the dumbest of dumb ideas since King Dumb had his own first dumb idea. It would be akin to hitting every branch of the Dumb Tree on the way down to the big pot of dumb and being basted in dumb sauce.
Not only because of the engineering and competitive pressures that would immediately swamp the Milwaukee balance sheet, but because of the very problem that I have been describing – debt.
Assets, all assets, of all kinds, are currently highly overvalued. From real estate and IP through to equity, bonds and share values – all assets are currently unrealistically overpriced.
This has happened because of a decade of easy money (“quantitative easing”, aka “fiscal stimulus”) and cheap money (record low interest rates). It isn’t necessarily because someone somewhere thought “I know, lets abuse the policies that were designed to get us out of a debt crisis to create another one”, it is simply that those polices have always carried within them the seeds of potential destruction for the very issues they were designed to resolve.
That is a law of inevitable consequence (how, conceivably, can creating debt to resolve debt be sane?), and right now, any corporation which thinks it might be a good idea to leverage themselves in order to buy a business that does something that they themselves lack the competency to do, will be squished by the laws of economic gravity.
Harley has hired Goldman Sachs (aka the ‘Vampire Squid’) to advise them on a possible deal to buy Ducati. VAG is looking for an eye watering EBITDA multiplier of around 15 times the estimated 100m euro that Ducati returned to the VAG balance sheet in their last full financial year (and around 3 times total revenues). In all probability Goldman Sachs are going to not only recommend such a price to Harley but, as any investment bank worth its salt would quite naturally do, avail themselves of the vast profit opportunities that assisting a hapless buyer to facilitate such a deal would yield.
My message to Harley-Davidson is caveat emptor, this is the wrong deal at the wrong time. They should take no notice of whatever Goldman Sachs tell them, pay up the bill they’ve run up so far and walk away.

“the law of inevitable consequence”

If, as appears highly likely, Ducati is on the block despite VAG’s protestations to the contrary, then they should leave it to the likes of KKR, Permira, Indian conglomerate and KTM business partner Bajaj, or former Ducati owner Investindustrial. If the likes of BMW, Honda and even Suzuki have been smart enough to look the other way – then so too should Harley.
The deal that VAG are seeking would mean that they will have doubled their money in their five years of ownership. VAG is being advised by “investment boutique” Evercore, and it is thought that tentative bids are being sought in July, in response the sale prospectus that has been sent to potential suitors; though it is reported than any deal may not be confirmed until towards the end of the year.
Quite apart from seeing acquisition as a quick fix to its own ailing sales, Harley are no doubt eying Ducati’s game changing and much imitated launch of the Scrambler some three years ago as being among the tempting opportunities that Ducati brings to the table (and somewhat the Diavel) and, relatively speaking, in technology terms, a primary point of synergy between the Milwaukee, USA and Bologna, Italy based manufacturers; that and having popular museums, I guess.
Whereas most of the Ducati offer requires design and engineering, electronics and production engineering skills that are way in advance of anything Harley appears to have in its locker, a “scrambler” is essentially a ‘Bobber’ with knobblies. However, if Harley themselves cannot productionize such a simple beast, even by buying in a suitable engine, then they certainly are NOT in a position to own, manage and guide a business that is.
As it happens, in broad terms, seeking solutions down the M&A route is not, in principle, a bad or wrong solution for Harley. I have said many times that they should buy before they get bought. But Ducati? Where’s the institutional memory, and don’t Harley have more than enough Union issues of their own without landing back into another deal in Italy – the mothership of Union regulation and intransigence.
Harley tied to buy Ducati in 2007 before eventually lighting upon MV Agusta in 2008, which, $200m lighter, Harley sold back to the prior owners for one euro a year later. Indeed, Harley had been on the M&A trail for a decade by then. They came within a cigarette paper’s thickness of buying (or “merging” with) KTM in 1998 (a deal ultimately scuppered by divergent cultural perspectives!) and under Richard Teerlink and then Jeffrey L. Bleustein were rumored to have had an informal “first dibs” gentleman’s agreement with Triumph owner John Bloor if or when he ever decided to sell.
Back in that day, such opportunities (with Buell also in the stable) made sense. However, now? With the core business tanking rather than growing inexorably and the market in the United States so soft? Sorry Harley, but you simply are not those guys anymore, and this is simply not the right deal or the right time.
Harley needs to engineer itself out of its present malaise on a self-funded basis, and, corporately, allowing itself to be bought and de-listed would be by far its smartest solution at this time - not adding to its risk and vulnerability at a time when assets are overvalued, money is misleadingly cheap, with growth forecasts down, the ‘Fed’ about to start switching off the easy money, and when the rising tide of consumer debt could be set to sink all boats again.