We initiated a position in Harman International (NYSE:HAR), a leading provider of in-car software solutions for infotainment, high-end audio and telematics with annual revenues of approximately $7 billion. Harman may be better known to many of you through their brand named audio divisions serving automotive, high end consumer and professional markets under the Harman/Kardon, JBL, Mark Levinson and Bang & Olufsen brands.
We have known Harman for many years, and have taken advantage of market fears and misunderstanding about Harman as an automotive exposed stock to initiate a position. Harman has sold off from almost $150 per share in May 2015, to the current price in the mid-$70’s as the Street has grown concerned about the current auto cycle approaching ‘peak’ levels. Investors, based on a primacy of the income statement mentality, have sold the stock off to approximately 10x FY2017(June) EPS, in line with most auto suppliers. However, despite roughly 70% of Harman’s revenue coming from automobiles, we think Harman can continue to grow revenues and compound earnings at double digit rates for at least the next several years. This revenue growth, in our opinion, is more secular than cyclical, as automakers accelerate both the penetration and functionality of infotainment and telematics across their vehicle fleet. Harman has historically served the higher end luxury automakers—BMW, Mercedes and VW—who were early adopters due to the price point of more luxury vehicles. However, Harman has developed a scalable platform that will accelerate adoption through the mid and low range of vehicle fleets. Indeed, Harman has won significant business with GM, Fiat Chrysler, Subaru, Hyundai and even Geely in China. We further believe, as has been stated by
Harman and demonstrated with win rates, that Harman’s systems will be an enabler of Apple, Google and Baidu automotive products and not a competitive offering, as Harman’s software will be the platform to access these offerings, while providing the safety and security features necessary in an automotive environment. Indeed, it is our speculation that at ‘only’ a $5 billion market cap, Harman would make a nice acquisition for any of these larger players.
Beyond infotainment, Harman has increased its offerings in its home audio lineup, and is now entering high end earphone markets. Even more exciting is Harman’s new Connected Car division, which incorporates its recent Symphony Telca and Red Bend acquisitions, which enable ‘over-the-air’ software updates for any connected device, whether a car, or perhaps a turbine or a dishwasher, and thus is an emerging leader in the nascent ‘Internet-of-things’ space. This division now has over $735 million in revenues and 15% EBITDA margins, with mid-teens revenue growth and 20% EBITDA margin targets.
We believe Harman is a compelling addition to the portfolio as it meets all three tenets of our investing philosophy. From a creditworthiness standpoint, Harman has a strong balance sheet with a 21.5% Debt to Capital Ratio, made up of approximately $1.0 billion in debt and $438 million in cash. Harman refinanced its senior debt in 2015 into two tranches, $390 million due in 2022 at a rate of 2% and $400 million due in 2025 at 4.15%, providing long -term maturities at low rates. Debt to expected FY16 EBITDA is .74. Harman is returning excess cash to shareholders with a dividend yield of about 2% and has $463 million remaining on its share repurchase authorization; it is looking to step up repurchases on current share price weakness.
Harman has compounded book value growth over the trailing 5 years at 18.2%, when adding back dividends. More importantly, we see Harman well positioned to continue this growth as it has a $23 billion backlog, revenue growth estimated at 14% for 2016 and likely double digit over the next few years, and continued margin expansion driven by price mix and sales leverage. At our average purchase cost of $77, Harman offers over 30% upside to our mid-case NAV of $100, and as such we look to continue to build the position size opportunistically on market weakness.
From the Third Avenue Value Fund 1st quarter 2016 letter. Continue Reading »