Monday, October 1, 2007

Financial Times of London on the Harman Purchase Debacle

Harman International: sources see little evidence of MAC being triggered

by Yana Morris and Ed Mullane in New York
Published: September 24 2007 04:14 Last updated: September 24 2007 04:14

Rumors circulating suggesting that Harman International, the high-end audio supplier, has seen a meaningful deterioration in its operating performance that could lead to a triggering of a Material Adverse Effect Clause (MAC) are unsubstantiated, a large shareholder said on Friday.

A second large shareholder agreed saying he has found little evidence supporting claims by Kohlberg Kravis & Roberts (KKR) and Goldman Sachs that Harman’s revenue or earnings have changed in such away as to allow them to walk away from the transaction.

Earlier on Friday, Harman announced that it was informed by KKR and GS Capital Partners that they no longer intended to complete the acquisition of the Washington DC-based high-fidelity audio products developer, under Material and Adverse Clause (MAC). Harman disagreed that a MAC had been triggered.

However, a source familiar with the situation said KKR and GS were growing worried about Harman’s deteriorating financial performance which he suspects gave them a reason to test MAC’s performance in this deal.

Still, according to Harman’s merger agreement, a MAC could only be triggered if “a material adverse effect on or with respect to the business, results of operation or financial condition of the company and its subsidiaries taken as a whole that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger”. However, the MAC cannot be applied under deterioration in the auto industry or general market conditions.

A third shareholder said Goldman Sachs’ undisclosed commitment to provide up to USD 4bn in equity financing on the deal was another reason why the bank agreed with KKR to back out of the deal to reduce its exposure to Harman in volatile credit market conditions. Harman’s weakening fundamentals would have impaired Goldman’s ability to syndicate the LBO-related debt.

In addition, the source said that while Harman committed to providing all the necessary financing information to banks to secure financing, there was some disagreement over technical financial information that was provided by Harman to KKR and GS. The source would not elaborate any further.

A third shareholder who claimed he was briefed by sources close to the deal said Goldman Sachs was apparently referring to a breach of specific conditions that were attached to the financing agreement.

Both equity commitment details and terms of the underwritten financing were never released to the market with KKR and Goldman Sachs today declining to comment on this matter.
Market chatter started early this morning focused around a Mercedes contract that might have fallen apart that could trigger MAC. However, Harman did not make any release supporting such a claim, and checks with company insiders proved there was no change to the outstanding contract with the auto marker.

On 15, 2007, following its fourth quarter earnings release, David Leiker of Robert W. Baird & Co wrote that Harman missed revenue and gross margin projections citing shortfalls stemming from the delayed launched of the Mercedes C-Class, increased competition from multimedia devices and higher costs ahead of new businesses being launched during the next two to three years. While Harman’s grew revenue by 6%, it was 7% short of Leiker’s estimate. Harman has been one of the fastest growing companies in the auto-supply space for over a decade.

Harman’s earnings results were viewed by some as being unclear in its most recently reported quarter. However, looking past the non-recurring expenses and the slow ramp on the new Mercedes line, the results are better than they first appear, a fourth shareholder said.

Currently, all LBO deals are under review, said a lawyer who specializes in working with PE firms. Each deal is being evaluated with PE firms carefully calculating the cost they can get out of a transaction, with the reverse breakup fee and whether the particular circumstances support a strong or weak argument that a MAC has occurred in a particular merger agreement, he added.

An industry banker said transactions that are being levered 8x EBITDA are simply going to be tough to get financed, although each transaction will be evaluated on its own merits. According to one shareholde’rs analysis, Harman’s leverage would be just at the 8x level, with the deal sponsor committing 43% to 45% in equity.

Harman’s stock dropped 21% during regular trading hours, dropping another 6% in after-hours trading.