My Due Dilligence on Harley-Davidson (HOG)

When reading the book ”You can be a Stock Market Genius” by Joel Greenblatt, I recently learned that there are numerous special situations in which big profits are awaiting the patient and observant investor. As explained in the biggest chapter of the book, one category of special situations that can reveal an unique investment opportunity are spin-offs. In the analysis below, I will explain why I believe Harley-Davidson (HOG) to be one of these special investment opportunities. Please notice at first that most spin-offs are done to create shareholder value, that is, investors find it difficult to value one share price for a company that consists of multiple companies and therefore investments. Management mostly finds that the shareholders value can be increased by separating the businesses, therefore providing more clarity to the market and more value towards the shareholders (e.g. management due to their incentive schemes). The facts are overwhelming. Stocks of spinoff companies, and even shares of the parent companies that do the spinning off, significantly and consistenly outperform the market averages.

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1. INTRODUCTION

I refer to the Harley-Davidson website and their Wikipedia for a thorough read on what Harley-Davidson is and what they stand for as a company. For clarity, I assume from now on the reader is accustomed to the business model and general company information of Harley-Davidson. Since the purpose of this blog is investment related, we focus on the investment related information. First, we notice several interesting points that highlight the potential value investing in Harley-Davidson (HOG):

• The stock trades at $36.40 (at the time of writing), with a 52-week range of (32.13 – 52.06). This indicates that HOG trades towards the lower end of their 52-week range and may indicate that HOG is undervalued relatively to their own price history.
• The PE-ratio (price to earnings) ratio is currently 8.73. For comparison, the PE-ratio of Tesla is 212.41 while the PE-ratio of the S&P500 is 25.57. This means that relatively towards the broader market, HOG is priced lower which may indicate that HOG is currently undervalued.
• With a stock price of $36.40, and given the fact that HOG has 153.569M shares outstanding, this leads towards a marketcap of he market cap $5.52B.
• HOG has a dividend of $0.1575 quarterly, which adds up to $0.63 yearly, or a dividend yield of 1.73%.
• According to Yahoo Finance, we notice that HOG has total cash of $1.08B, which is approximately $7.01 cash per share. This returns you 19.25% (7.01/36.40) of your investment in cash.
• For the 2018-2022 period, HOG has positive FCF’s (Free cash flow), has net debt and has remained profitable which shows the constant performs of the company.
• Harley-Davidson is currently implementing its 2021-2025 strategic plan (The Hardwire). The company is focused on reigniting the spirit of Harley-Davidson and returning to winning, delivering the timeless pursuit of adventure and freedom for the soul for riders around the world.
• The historical return for holding HOG stock has been -10.60% (1Yr) and -39.60% (5Yr) showing a clear downward trend.
• The P/S ratio is 1.13, showing that investors are investing $1.13 for every $1 the company earns in revenue. For comparison the P/S ratio of Apple is 7.88.
• The book value per share is $16.63, which leads to a P/B ratio of 2.18. Value investors often consider stocks with a P/B ratio under 3.0.

Concludingly, the above analysis shows that Harley-Davidson is attractively valued based upon various statistics and valuation techniques. There is, however, one last gem to be discovered in our investment analysis.

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2. THE LIVEWIRE SPIN-OFF

Harley-Davidson has a electric motorcycle business unit (Livewire) that is planned to go public in a recent deal. This means that Livewire is the first publicly traded EV motorcycle company in the US. The combined company is expected to have an enterprise value of approximately $1.77 billion and post-money equity value (= marketcap) of approximately $2.31 billion at closing. Investors are able to then buy shares in the newly formed company, while Harley-Davidson still remains in control of 74% of Livewire stock. Given the fact that even Dr. Michael Burry recently has taken up a position in the stock, we examine this deal a little further. We further notice that according to their own figures, Livewire has an annual 2021 revenue of $33M. Livewire, given their valuation of roughly $2B and their sales of $33M in 2021. When comparing this to various other EV companies, we note that:

• Rivian has a marketcap of $35.866B. Sales 2021 of 55 million.
• Nio has a marketcap of $40.43B. Sales 2021 of 5.68 million.
• Lucid has a marketcap of $38.141B. Sales 2021 of 27 million.
• Tesla has a marketcap of $1.081T. Sales 2021 of $53B.

1) Livewire has a higher revenue for their valuation, or put differently, Livewire has a lower valuation for their revenue compared to other EV companies. If the valuation of Livewire would be similar to that of other EV companies, the valuation of Livewire would be multiples higher than the $2B stated in the recent accouncement.

2) According to the Livewire investor presentation, the company projects $1B revenue between 2025 and 2026. This higher revenue could eventually lead to a higher valuation.

3) The $2.3B recent valuation of Livewire, and the 74% stake of HOG in Livewire leads to a potential ownership of (74% x 2.3B  =) $1.7B for Harley-Davidson. For conservative purposes, we round this number to $1.5B. The total number of shares outstanding for Harley-Davidson is 153.569M, which means that the 74% ownership of Livewire constitutes to around $9.7 per share of Harley-Davidson.

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3. THE INSIDERS

In ”You can be a Stock Market Genius” we find further explanation:

”Insider participation is one of the key areas to look for when picking and choosing between spinoffs. Are the managers of the new spinoff incentivized along the same lines as shareholders? Will they receive a large part of their potential compensation in stock?”

Simply put, when insiders benefits to the same extent as you the shareholder, their incentives are in line with yours (e.g. they too want a higher share price).

1) From the Livewire investor presentation, we notice that Jochen Zeitz (CEO of Harley-Davidson) and Gina Goetter (CFO of Harley-Davidson) will become the CEO and CFO of Livewire, respectively. Please notice from the 74% ownership, that a higher share price of Livewire would eventually lead to a higher share price of Harley-Davidson, and therefore the incentives of management are clearly aligned to that of the shareholders of both companies.

2) According to their latest SEC filing on April 1st, we notice several executive compensation plans. We highlight several significant developments:

• Proposal 4: We are seeking shareholder approval for an amendment (the “Plan Amendment”) to the Harley-Davidson, Inc. 2020 Incentive Stock Plan (the “2020 Plan”) to increase the authorized number of shares of our common stock by 3.3 million, bringing the total number of shares authorized under the 2020 Plan since its adoption to 8.7 million.
• Proposal 5: We are seeking shareholder approval for an Aspirational Incentive Plan (the “AIP”) authorizing the grant to our President and Chief Executive Officer and a small group of other executive leaders of up to 3.0 million aspirational performance shares or performance share units (“Performance Shares”) relating to our common stock, contingent upon achievement of specific stock price thresholds.
• The CEO has given up $600.000 in base salary in order to receive stock options with strike prices between $45 and $65. In addition, the letter agreement provides that Mr. Zeitz will be eligible to participate in our long-term incentive plan and will receive an equity award consisting of RSUs with a target value of $6.0 million as of the grant date of February 9, 2022 and an award of options to purchase 500,000 shares of our common stock, which we have called the WIN stock options. The Board elected to grant the WIN stock options rather than performance share units as the long-term performance component of Mr. Zeitz’s new compensation terms to provide a focused incentive to increase shareholder value.

Concludingly, we notice a significant increase in various performance shares, restricted shares, short-term incentive plans, stock options and long term incentive plans for the insiders of the company. For the exact SEC filing and handout, I refer to the Seeking Alpha link above as the document is too extensive to go through in full detail. We note, however, that various incentive plans have a strike price above $45 and even above $70, as well as stock options that allow management to buy additional shares. Combining these findings with the fact that incentives of Livewire are aligned with the incentives of the Harley-Davidson board, we notice that insiders in both the spinoff as the parent that spinsoff the company are highly aligned towards increased shareholder value, even more so compared to other periods.

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4. CONCLUSION

Combining our due dilligence above, we arrive at the following outtakes:

• Harley- Davidson currently has a stock price of $36.40 – $7.01 in cash per share = $29.39 (i.e. investors only pay $29 dollars for the entire business of Harley-Davidson)
• Harley-Davidson has a business division that is likely to spinoff in Q2 2022 in which it will hold a 74% stake, currently valued at $9.7 per share. The spinoff company is undervalued relatively to its peers. If the spinoff company is to be valued compared to its peers, this would value the spinoff company even more than the entire business of Harley-Davidson (i.e. investors could buy Harley-Davidson shares for the spinoff company and receive the entire Harley-Davidson company for free). At a $10B valuation ($20B), this would mean a value of $48.5 ($97) of Livewire per share of Harley-Davidson.
• Management has strong incentives to increase shareholder value for both Livewire and Harley Davidson. Incentives are structured above the $70 per share region.
• Revenues and therefore valuation of the spinoff company is expected to increase exponentially as Livewire is the first publicly traded EV motorcycle company.
• Even when all of the above would seem trivial, Harley-Davidson is undervalued and remains a value buy based upon its own principals. You would even reap some nice dividends rewards of 1.73$.

Simple math and logic, combined with the skill to think indepently and think correctly are the only skills an investor needs. At the current price and situation, this seems to be the perfect specific situation that Joel Greenblatt described in his book.

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You can read up on the entire blogpost at the link below: https://eurykleiainvestments.com/blog/my-due-dilligence-on-harley-davidson/