|indinvestor on Yahoo! posted an interesting Barrons article that required several Yahoo posts. Since SI has a larger size and a better looking format, I'll cut-paste the entire article here.|
Ticket to Ride
Harman International has bet big on auto "infortainment" systems. Now comes the payoff
By JIM MCTAGUE
First it was the kids. Now the darned car is talking back, correcting your speech and giving you driving directions. Welcome to the age of the intelligent automobile. Digital technologies such as voice recognition, navigation and tracking, and remote diagnosis are beginning to revolutionize passenger vehicles, laying the groundwork for what may be the next new thing in consumer electronics. And few folks are more ready than audio pioneer Sidney Harman. "I bet the company on it," he declares.
Harman International Industries has spent close to $800 million since fiscal 1996 retooling to produce "infotainment systems", primarily for luxury-car manufacturers BMW, Mercedes, Audi and Porsche. The company's signature system combines audio, video, navigation, voice recognition and telephone delivery into a single, space-saving unit embedded in the dashboard and operated by a control panel tucked between the driver's and passenger's seats. Harman's all-in-one design enables the system to be integrated more easily with a vehicle's other digital components.
So far, Harman, the company's 84-year-old executive chairman, appears to be winning his bet. The company expects to earn $3 a share in the fiscal year ending June 30, 2003, notwithstanding a seven-to-ten-cent hit from the effects of the dock workers' strike in California. Sidney Harman predicts another 25% jump in earnings in fiscal '04, and for several years thereafter.
Last year Harman International netted $57.5 million, or $1.70 a share, on $1.83 billion in sales. But the company generated about $4 a share in cash flow, before depreciation and other charges.
Harman International's robust results and rosy prospects have not gone unnoticed by investors. Despite a setback earlier this year, the company's stock has rallied sharply, tacking on more than 20 points since August, to a recent high of 62.95. Yet, if earnings pile up as Harman expects, it's not hard to imagine the stock trading between 80 and 100 within two years.
This forecast depends largely on sustained sales of luxury cars -- no sure thing in a wobbly global economy. Harman International would stand to lose about 15 cents a share in earnings for each million-unit decline in its customers' production. Yet, Harman notes that the BMWs and Mercedes of the world have not had to resort to zero-percent financing and other buyer incentives. "These are companies with real legs," he says.
Harman, the son of a hearing-aid salesman, co-founded Harman International with a fellow engineer, Bernard Kardon, in 1953. Three years later Kardon sold his stake in the young hi-fi manufacturer to Harman, who sold the company to Beatrice Foods for $100 million when he joined the Carter administration as an assistant commerce secretary in 1977. During this time, Harman also met his wife Jane, a long-time Democratic Congresswoman for California.
Harman bought back Harman International in 1980, for $50 million, and later told the Washington Post there are two ways to get rich: "One is to sell your company to Beatrice Foods. The other is to buy it back."
Today Harman International remains best known for its high-end audio systems, marketed under names such as Harman Kardon, JBL, Infinity and Mark Levinson. Indeed, the consumer systems group accounted for 77% of fiscal 2002 sales. The company also manufactures audio equipment for concert halls and movie theaters.
Sidney Harman does not foresee dramatic growth in the consumer market, because of weak economies around the world, and standard-setting disagreements that have slowed sales of high-definition televisions. "Consumer electronics is a tough place to make money for everybody, with no exception," he says. But there's plenty of sizzle in automotive systems, and Harman predicts the original equipment market soon will represent about 65% of the company's sales. BMW uses Harman International's system in its revolutionary iDrive control system, found in the super-luxurious 745 model. A mouse controls the iDrive's 700-plus functions, although frequently used features can be activated by spoken command. Some European legislators, alarmed by the number of auto accidents caused by cell-phone users, are considering making voice-activated systems compulsory.
Some older BMW customers have been turned off by the iDrive's complexity. "Why design a car for twenty-year-olds that only 50-year-olds can afford?" one critic recently lamented. Nevertheless, sales of the 745 line are up more than 40% this year, and BMW credits Harman International's gadgetry with helping it attract more youthful buyers.
In the past two years automakers have been stuffing their newer luxury models with digital technologies such as voice recognition, surround sound and remote diagnostics. Eventually such features, known as "telematics", will become standard in most new cars -- a trend that bodes well for Harman. Past product cycles, at least, have played out this way. Electric starters first appeared in the 1911 Cadillac. Chrysler first offered cruise control in 1958.
Navigation systems could be the next wave. Currently they are factory-installed in about 300,000 new cars, less than 1% of annual production in the U.S. Experts predict demand will snowball, however, as more people become familiar with the technology, and prices drop from a current $2,000 per unit to perhaps $500. Frank Forkin, a partner at JD Powers & Associates, says 90% of people who have used a car navigation system would recommend it to someone else. And 60% of users say they would not buy a new car without one.
German automakers are Harman International's biggest customers; DaimlerChrysler accounted for 21% of fiscal '02 sales. But European cars are not the only showcase for the company's inventions. Toyota uses the Mark Levinson brand in its luxury Lexus model. Ford dealers soon will offer Harman's navigation systems as a dealer-installed option. And DaimlerChrysler will use a Harman infotainment system in one of its Dodge truck lines beginning in 2004.
Harman International had expected the hefty capital expenditures of recent years to begin bearing fruit in fiscal 2003. So far, that forecast is right on track. Net sales for the September quarter were $490.8 million, a 23% increase over year-ago results, while net income of $9.8 million was almost double last year's profits. Consumer sales, including home entertainment and automotive sales, were $390 million, up 33%, while sales to automotive customers alone jumped 48% in the quarter.
Despite its recent success, Harman is not alone in promoting telematics. Scores of companies, from cellphone makers to Microsoft, want a slice of this lucrative market. Other big players include Germany's Siemens and Bosch; Johnson Controls, Motorola and Delco, in the U.S., and Japan's Pioneer Electronics, Hitachi, and Denzo.
Sidney Harman believes he has a four-to-five-year lead on the competition, and expresses surprise that none of the industry's bigger players has sought to buy him out. While he is not eager to sell the company, he will do what benefits shareholders, he says.
Thanks to its strong balance sheet, at least, Harman has the wherewithal to keep pace with its peers. Long-term debt, net of cash, stood at $358 million as of Sept. 30, and accounted for 49% of total capital.
BMW's iDrive system incorporates Harman's "telematic" technology. Maggie Blagrove, editor of the London-based Telematics Update, likens the current state of the industry to the cellphone market of five years ago. "We're looking for something major -- a killer application that will create massive demand for the services," she says.
These days most digital technology is sold to commercial fleets, not consumers, she notes, although Siemens will announce some new partnerships with the auto industry in coming weeks. Forkin, of JD Powers, claims the Japanese navigation systems are faster and more user-friendly than offerings by Harman International, Bosch and Siemens.
Still, Harman stands by his product, pointing to the company's biggest coup to date -- a partnership with Mercedes, announced last year. The carmaker had invited Siemens and Bosch to develop a telematics system for its E-Class cars, but Harman International's partnership ultimately got the nod.
The Mercedes pact validated money manager T. Rowe Price's long-time investment in Harman International. As of Sept. 30, the firm owned 2.6 million of the company's 32 million shares, enough to retain its status as Harman's International largest holder, despite the sale of roughly 500,000 shares earlier this year. "The fact that an American company was able to put its product in German cars tells me that Harman's strategy has succeeded and their investment should start to pay off," says T. Rowe Price analyst Curt Organt. "We are in the early stages of that payoff."
Automakers are famous for squeezing their suppliers, however, and that, he adds, is Harman International's "biggest long-term risk." But Harman says the new, high-tech manufacturing plants the company built in the past five years will enable it to lower costs to its customers continuously, while securing Harman International's margins. Thanks to digital manufacturing processes, these plants can produce multiple products simultaneously, and retool at low cost.
T. Rowe Price money manager Joe Milano, who oversaw his company's original investment in Harman International in 1998, notes that manufacturers of high-value-added products are less likely to be squeezed for cost concessions. "The good news for Harman International is that its product is differentiated, even among its competitors," he says.
Sidney Harman is Harman International's second-largest shareholder, with 2.5 million shares. But Milano praises the company's bench strength, including Vice Chairman and CEO Bernard Girod, 60, who runs Harman International's day-to-day affairs. President and COO Gregory Stapleton, 56, is viewed as the brains behind the automobile-equipment initiative. Harman fully expects telematics to "graduate" from class to mass, and not just because of declining costs. "There is a real appetite for these systems," he says.
If Harman International can feed the beast faster and better than its competitors, investors are likely to sustain their hearty appetite for the company's shares.