Harman International is a huge player in the live sound arena, with brands including JBL, Soundcraft, BSS and dbx, but in September it had more in common with the real estate market than it did with the music business. Harman’s high-flying stock soared to $124 per share last April when two private equity companies, Kohlberg Kravis Roberts & Co. (KKR) and Goldman Sachs Group Inc.’s private equity unit, stated that they wanted to take the company private, offering a premium over and above the stock’s stated value, for a total of $8 billion. However, the deal fell apart five months later, with KKR and Goldman Sachs backing out in the wake of the crash of the credit markets last summer, when bad mortgages rolled into repackaged securities began exploding like pipe bombs in portfolios all over the world.
In an analogy that the one to two million American homeowners facing foreclosure would understand, the private equity guys began to feel buyer’s remorse, realizing that they had made a deal to buy at the top of the market. KKR and Goldman Sachs informed Harman that there had been a “ma-terial adverse change” in Harman’s business — the escape clause in the agreement and a charge Harman vigorously denied. Worse, an anonymous source had told the Associated Press that the private equity firms sought to quash the deal over questions about Harman’s financial health, not be-cause of any financing difficulties in a tight credit market.
Wiser Heads Prevail
The dénouement of this drama could have turned out to be complex and ugly. On Wall Street, you don’t just walk away from a deal like this; aside from the money — in this case, a $225 million termination fee (chump change to these guys) and the costs of possible litigation arising from the 24% hit the stock took when the news came out — a banker’s word is his bond, and this puts reputations on the line.
As it turned out, neither side wanted a drawn-out and expensive legal battle, as that would have still called Goldman Sachs’ and KRK’s market wisdom and commitment level into question, as well as Harman’s own reported reluctance to have the “minutiae” of its financials — a term used by an anonymous source in the Wall Street Journal — exposed to any more scrutiny than the SEC requires. So both sides came to an agreement: KKR and Goldman Sachs would purchase $400 million of Harman’s convertible senior notes at $104 per share and hold them for at least one year, and Harman will use these funds to accelerate its stock buy-back program.
It’s a practical solution, but one that leaves a wake. Company founder Sidney Harman called the $400 million settlement “a vote of confidence in our business.” The reality is, it was a face-saver for both sides. Harman shareholders saw their value proposition drop with a thud: The buy-back price is $16 per share less than the $120-per-share the consortium was willing to purchase the company for earlier in the year, reducing Harman’s market capitalization from $8 billion to $5.6 billion. That’s a significant “ouch” in a gyrating stock market.
Harman will more than survive this imbroglio. Regardless of the raised eyebrows caused by KRK and Goldman Sachs’ assertions of “material changes” in Harman’s business fortunes, Harman’s own 10-K disclosures suggest the company was fairly robust, reporting three consecutive years of increased profits, with a total of over $3.5 billion in net sales in fiscal 2007. Pro audio, which makes up 14% of Harman’s revenue, has shown steady increases in both sales and margins. And in terms of margins, it also does not hurt that Harman’s pro audio business is largely based on hardware, selling into a live sound business — the only remaining part of the music business that continues to thrive on hardware. Going forward, the company expects 2008 to be impacted by additional R&D expenditures and the rollout of new “infotainment” products, but those kinds of de-velopmental costs are to be expected with any technology company.
The bulk (70%) of Harman’s revenue comes from sales in the automotive sector, an industry somewhat roiled at the moment between labor unrest and slumping sales. Nonetheless, Harman has a good share of the market for automotive entertainment systems, particularly with speakers.
Still, some questions persist. Harman’s most recent quarter, reported in August, was described by financial pundits as “lackluster,” and revenues of $911 million were about $30 million less than analysts’ expectations. But there’s still nothing obvious that suggests any cratering in the near or long-term future. Harman’s stock has the kind of jagged graph common for tech companies; nonetheless, it has been trading consistently between $80 and $125 a share for three years.
Victim of the Crunch?
This suggests that it was actually the credit crunch that caused the deal to sour. The easy availability of money had fueled two years’ worth of pri-vate equity acquisitions; as soon as the spigot was turned off, a lot of deals suddenly didn’t look as attractive as they once did.
The real significance of this episode to the pro audio industry: It’s another reminder that as more companies in this industry go public, the industry as a whole is that much more vulnerable to the dynamics of larger markets. Nowhere is that more clear than in live touring sound now that publicly traded Live Nation (LYV) and the privately held, but investment-active, AEG Live (via parent company Anschutz Corp.) have become major play-ers in concert production and venue ownership. Expect that kind of market sensitivity to increase going forward, the Harman deal notwithstanding.
(Back when Live Nation’s signing of Madonna was still speculation, CEO Michael Rapino had been coy on the record about the issue during, ironically, a Q&A with Goldman Sachs.)
Contact Dan at ddaley@fohonline.com.
