Wednesday, February 4, 2009

Buffett Invests in Harley Davidson

As many of you know, I'm an avid Warren Buffett follower, so I was interested to read that Buffett agreed to buy $300 million of debt issued by Harley Davidson (NYSE: HOG) yesterday.

(Note: many people use Buffett and Berkshire interchangably, as if he makes every decision at the company he runs. While I am sure this is not true, I often use the two interchangably as well, so whenever you see me mentioning Buffett and Berkshire in the same entry, assume I'm referring to Berkshire Hathaway in all cases unless I specify otherwise. I promise to try to be more precise in the future.)

Harley announced that it was selling $600 million of senior unsecured debt to two investors: Berkshire Hathaway (Buffett's company), and Davis Advisors, LP, which is Harley's biggest shareholder. According to an article I read, Buffett hasn't invested any other money in Harley besides this purchase. The notes are a pretty sweet deal. Though unsecured, they are senior in the capital structure which means they get paid pretty quickly if the company goes bankrupt. I am not sure what Harley's capital structure looks like, but being that Berkshire bought the notes, I'm willing to bet that Buffett or someone at BRK took a good look at it and feels there is a good chance the notes will be repaid when they mature in 2014. The best part of the deal? They pay FIFTEEN PERCENT INTEREST. So for lending Harley $300 million now, Buffett will collect a check for $45 million each year for the next five years. That's a total of $225 million in interest, plus the return of his original principal.

Harley plans to use the money for its consumer lending unit, ie to lend money to people so that they can afford to buy its motorcycles. I don't follow the company too closely, but apparently it is in the midst of a turnaround plan.

The stock jumped something like 15% yesterday on the news that Buffett was "investing" in the company. I noticed it fell about 7% today. I think it's pretty crazy when people view Berkshire buying preferred stock (as he did recently with Goldman Sachs) or loaning money via a debt purchase as some kind of an endorsement from Buffett that the company's equity is undervalued. If he thought Harley was undervalued, he could have bought the entire company, which has a market cap of only about $3 billion compared with Berkshire's $30 billion pile of cash. But he didn't. Instead he chose to lend them money for a relatively short period of time at a high interest rate. Being one of the few people with $30B cash in hand during a financial crisis helps Buffett to get some very favorable investment opportunities. 

I noticed that Moody's poured icewater on the announcement by immediately downgrading Harley Davidson Funding Corp., which is the fundraising arm of Harley's consumer finance unit. This will make it more expensive for the unit to raise money, which is not a good thing. Though Moody's does not directly come out and say it, it appears that the new $600M of debt was the catalyst for the downgrade.

In any event, I assume Buffett did his homework on this one and in the end he will get his 15% per year. 

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