Born to be leveraged

Harley LBO: Could Henry Kravis handle a hog? Harley-Davidson’s shares revved up on talk of a leveraged buyout, and Kravis’ firm, Kohlberg Kravis Roberts, was one name mentioned. The iconic motorcycle maker can absorb plenty more debt, though the price tag and the cyclical nature of the business mean a deal would be no easy ride.

Harley has roared back to life, overtaking frets about its aging customer profile and younger bikers opting for rival brands like Ducati. At around $28 apiece, Harley’s shares are more than triple their recession low, including the 6 percent bounce they got on the takeover speculation. Figure any deal would require a premium of at least 30 percent, and the implied equity valuation would be about $8.5 billion.

The company is expected by analysts to generate Ebitda of $950 million in 2011. Set aside Harley’s financing arm debt and its $1.7 billion of cash, and that would put the enterprise value at a multiple of a little more than 5.8 times Ebitda. Even though consumers are still weighed down by debt and the economy is only sputtering back, the valuation is a bit rich but not unreasonable for the times. Private equity firms also have a knack for improving established but languishing brands, so might see fresh ways to make Harley’s bottom line grow faster.

Of course, any Harley buyer would scrutinise the financial services arm, which is used to extend credit to the Milwaukee manufacturer’s enthusiasts. It had $5.1 billion of receivables at the end of last year, which shouldn’t be counted in Harley’s net debt. Care would be needed to avoid trashing its ability to fund itself.

But, there seems to be plenty of room to gear up. Only $600 million of Harley’s $5.7 billion of debt is in the operating company, according to Wells Fargo estimates. For leveraged buyouts, depending on the deal, banks are starting to stretch to debt multiples of 5.5 times Ebitda. At that admittedly toppy ratio, KKR, or another private equity buyer, would need to stump up about $3.9 billion of equity, or 46 percent of the price tag -- also at the top end of recent-vintage deals.

This base-case scenario would make any buyout a rough ride. But, even though Kravis is a good bit older than the average Harley buyer, the idea of his firm cruising off with the company isn’t entirely hog-wild.