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JP Morgan Deal Case Study 2012 - BMW and Harley Davidson

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JP Morgan Case Study Competition 2012

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Potential Acquisition of Harley-Davidson by BMW AG Case Study- The Deal 2012

12OverviewMotorcycle IndustryBrief Profile BMW AGBrief Profile Harley Davidson

Slide 3 - 5Deal RationaleKey Issues to consider while acquiring Harley Davidson7Valuation drivers of Harley Davidson8Valuation Summary15Bidding Strategy and Deal Structure

199 - 14 Valuation MethodologiesDCF Including SynergiesMarket MultiplesComparable Transactions

16- 18Credit Worthiness of BMW AGKMV ModelCredit Metrics Analysis

Merits and Demerits of Valuation Methodologies used 23 - 24Accretion Dilution Analysis

20Evaluation of Alternatives

226Value Creation Analysis

21Appendix25Agenda2Industry Analysis- MotorcyclesIndustry OverviewGlobal motorcycles sales stagnated between 2006 and 2010 but volume sales increased during the same periodTotal global motorcycle revenues in 2010: $63 billion The market is expected to grow at a CAGR of 6% for the period between 2010 and 2015

European market : CAGR @ 3.3% Asia-Pacific markets: CAGRs @ 6.5%, between 2010 and 2015

Global market segmentation, by region 10Global market value 2006-2010

Five Forces Analysis3*Source:: Datamonitor Industry report October 2011Brief Profile BMW AGBMW AG - AcquirerGoals and ObjectivesMission : To be the worlds leading provider of premium products and premium services for individual mobility.

Key Pillars of Strategy : Growth Shaping the future Profitability Access to technology and customersBusiness PortfolioBMW AG headquartered in Munich, Germany manufactures and sells luxury cars and motorcycles worldwide. It owns and produces theMINImarque, and is the parent company ofRolls-Royce. BMW produces motorcycles underBMW MotorradandHusqvarnabrands.In 2010, the BMW group produced 1,481,253 automobiles and 112,271 motorcycles across all its brands.Recent Investments Investments in new products and in the expansion of international production network -around 3.7 billion (2011). Investment company BMW i Ventures set up in February 2011 for assessing strategic investments in innovative mobility service providersAcquired 15 entities of the ING Car Lease Group (ICL Group)4*Source: BMW AG annual report and company websiteBrief Profile Harley DavidsonHarley Davidson- Potential TargetGoals and ObjectivesStrategy :Sustain a loyalbrand communityactive through clubs, events, and a museum.

Harley-Davidson motorcycles have a distinctive design and exhaust note and is known for the tradition of heavy customization

Business PortfolioHarley-Davidson Motor Company, produces heavyweight motorcycles and a complete line of motorcycle parts, accessories and general merchandise.

Harley-Davidson Financial Services provides motorcycle financing to Harley-Davidson dealers and customers in the U.S. and CanadaFig: Distribution of Sales (in millions) by regionFig: Distribution of Sales (in millions) by product lines

5*Source: Harley Davidson annual report and company website6Harley Davidson will help BMW AG to reach out to the American market Deal RationaleMarket ExpansionCost synergiesAddition of new product lines to existing product portfolioHarley Davidson currently has a 55.7% of the US market and BMW Motorcycle is a relatively small player. BMW can leverage the existing dealer and distribution network of Harley in the US to bolster its own salesSimilarly, Harley Davidson will have a foray into the European market where BMW AG has a strong presenceAmongst the 5 segments of the total heavyweight motorcycle market, BMW is present in 3 of them (Sport Bikes, Touring, Street Bikes) and Dirt Bikes (through Husqvarna) It does not have a presence in the popular Cruiser segment where Harley Davidson is a major playerBy acquiring Harley Davidson, it can expand its portfolio to be a major player in this categoryWith a successful merger, BMW AG can exploit the existing product development practices of Harley Davidson and apply them to their own stableBoth companies can realize cost synergies and product developmentFinancial IssuesBusiness IssuesHow much market expansion can be achieved by the acquisition of Harley Davidson?What is the shareholding pattern of Harley Davidson? Is it highly fragmented or are there few shareholders with high stake?Are the values and employee culture of both the companies compatible with each other?Is the acquisition of Harley Davidson in line with long term goals of BMW AG?Should BMW AG retain top management team of Harley Davidson?What would be the competitors reaction?Would there be any regulatory issues in this acquisition?

Marketing IssuesWhat would be the effect on the brand equity of BMW AG?What will be the brand strategy in markets where brands of both these companies are competing with each other?How would the advertising campaigns of BMW AG be affected by inclusion of new brands in its portfolio?

Operational IssuesWhat are the existing distributional channels of Harley Davidson and how can they be utilized most efficiently after the acquisition?What would be the effect on relationships of existing key suppliers & customers of both BMW AG and Harley Davidson ?How much operational costs can be reduced by increased operational efficiency due to economies of scale achieved through the acquisition of Harley Davidson?What would be the revenue growth rate for next 10 years and terminal growth rate of Harley Davidson?How much premium above the share price should be given while deciding the bid price?What would be the acquisition structure? Would BMW AG purchase assets or stocks of Harley Davidson?What would be the payment structure? Would BMW AG pay in cash or its stock?How would the transaction be funded?What would be the effect on credit rating of BMW AG if large amount of debt is taken to finance the acquisition?If cash position of BMW AG worsens due to this acquisition, what would be its effect on future dividend policy of BMW AG?Key issues to consider as part of acquisition of Harley DavidsonM&A Issues

7Source: Team AnalysisRevenueEarningsValuation Drivers Harley Davidson Valuation Drivers

8Volume growth in different regionsHarley-Davidson has a very small market share in Europe. On the other hand, BMW is a very big name in Europe with a large market share and vast distribution networks. This will help Harley in expanding its sales in the European regionAs the European crisis comes to an end, spending on cult brands like Harley shall revive and thus boost Harleys sales.Also, the last few years have seen a good growth in the womens segment bikes.

EBITDA Margin of Harley-Davidson is about 12% as compared to 18% for BMWProductivity of Harley is expected to increase with time when acquired by BMWWith time, due to cost synergies, EBITDA margin for Harley Davidson is expected to increase to 14% in the base case scenarioIt is expected to increase to 16% in the best case scenarioApart from distribution network and cost synergies, other synergies expected are in product development and R&D.

Three Primary Valuation Methodologies DCFThis methodology values a company as sum of its free cash flows over a forecasted period and the terminal value at the end of forecast periodMarket MultiplesValues a target company by referencing key financial ratios of peer group companies.Transaction ComparableValues a target company by referencing M&A transaction multiple paid in recent times by companies involving business operations of similar nature, size and similar M&A motives40%20%40%Range of share price for target companyContribution to Final Value RangeHarley Davidson Valuation

9The Market Multiples method is applicable for a non-strategic buyer. It does not account for the premium a strategic buyer would pay. Hence we assigned a lesser weightage to this method.10Best Case ScenarioSales Growth Rates EBIT Growth RatesFirst 3 Years5.0%First 3 Years12%-13.5%4-6 Years 6.0%-8.0%4-6 Years13.5%-15%6-10 Years 8.0%-10.0%6-10 Years15%-16%Firm Value 9224Equity Value 8224Price Per Share 35.52Assumptions:-Global motorcycle industry growth consideredOperating Margin due to synergies improved to 16%Sales Synergies increase to 10%Scenario Analysis : Changing growth ratesMetrics used in DCFWACC9.71%Perpetual Growth1.50%Debt1000.01# of Shares231.519Detailed calculations are furnished in appendixKey pointers to growth ratesRevenue growth rates assumed includes the price mix growth and the volume mix growth rates by region. Price mix is the major driver of the revenue growthPerpetual growth rate does not exceed the average long term growth of the groups individual geographical segment Worst Case ScenarioSales Growth Rates EBIT Growth RatesFirst 3 Years6.0%First 3 Years12%4-6 Years 6.0%4-6 Years12%6-10 Years 6.0%6-10 Years12%Firm Value 6711Equity Value 5711Price Per Share 24.67Assumptions:-Global motorcycle industry growth consideredSynergies not realized Base Case ScenarioSales Growth Rates EBIT Growth RatesFirst 3 Years3.0%-4.0%First 3 Years12%-12.5%4-6 Years 4.0%-6.5%4-6 Years12.5%-13.5%6-10 Years 6.5%-8.0%6-10 Years13.5%-14.0%Firm Value 7968Equity Value 6968Price Per Share 30.10Assumptions:-Operating Margin due to synergies improved to 14%Sales Synergies increase to 8%DCF Valuation - Share price ranges from $24.67 $35.52

5.435.42Harley Davidson Valuation

Assumptions and FindingsWe have assumed a 10% shift in all the four parameters and have evaluated the share price variation and have found the following resultsHarley Davidsons Share price is most susceptible to change in EBIT(which is due to change in operational efficiency) As Harley Davidson is already pursuing operational efficiency drives, the share prices are expected to rise due to increase in marginsShare price

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