A Sound Investment

This company offers a stealth monopoly on the sound and entertainment systems being integrated in everything from stadiums, cars, homes and headphones. This makes it an attractive acquisition target.

One of the great “ah ha” moments in my learning curve of stock investing was realizing many of the great well-known brands I see and use in everyday life are owned by a parent company I barely knew or heard little about. Obvious examples are in the food and fashion industry, where companies put out multiple lines of similar products to hit all tiers of price points and demographics; think early days of Gap (GPS) running the gamut from Old Navy up to Banana Republic. Or Hormel (HRL) maker of spam, now proud owner of organic Applegate Farms.

This taught me to dig deeper and look for other companies who have a stealth monopoly on a category. A few years ago I discovered the maker of sound and entertainment equipment, essentially a technology company, which was sneakily integrating its way into much of my daily life. After a recent pullback it looks like a sound investment ready to hit new high notes.

Harman International (HAR) was once a tightly held family company focused simply on high end audio components such as speakers. As the elders died off (sorry, it happens) new management has leveraged the name to make acquisitions, expand the product line and became more shareholder friendly.

Harman now manufactures and installs audio, lighting and electronic systems for stadiums, movie and home theaters. It also has mobile applications and accessories such as earbuds and noise cancelling headphones under the Harman/Kardon and JBL brands. These are all solid business lines, displaying good double digit growth and solid profit margins. The result is a stock that gained some 300% from 2012 to its recent peak of $150 in April of 2015 giving it a $8.7 billion market capitalization. I don’t throw this out as an idle statistic but as a potentially important catalyst. The most exciting and scalable growth potential comes from the automotive industry.

Driven to Dominate

One of the main drivers, pun intended, has been its domination as the Original Equipment Manufacturer (OEM) for the installation of audio/information systems in automobiles. Harman is well positioned to benefit as cars becoming large mobile “internet of things” device.

Harman’s recent acquisition of Bang & Olufsen Automotive car audio business cements its position as the de facto monopoly supplier for sound and software systems in cars that range from Ford (F) to BMW.

The most recent car sales data was the strongest in over a decade. Harman systems are now standard equipment in nearly 80% of new cars and over 90% for high end autos priced over $60,000. Harman’s hand-in-glove relationship not only gives direct exposure to auto sales but also leverage for higher profit margins.

Which in turn makes it a very attractive acquisition target. As everyone from Google to Apple to Uber push into the auto industry through software platforms and self-driving cars it might make sense to own the main component maker to create efficiencies of vertical integration. The above mentioned $8.7 billion market cap could command a 20% premium and still best easily digestible by one the larger companies.

From a technical standpoint the chart is showing a nice bull flag forming above support after the gap higher following a strong earnings report two weeks ago. This is healthy consolidation which should lead to a new leg higher.

HAR Chart 8.22.16

I’m suggesting buying calls. Specifically;

-Buy January 85 calls for $5.50 a contract

HAR Order 8.22.16

I think this offers a great risk/reward. My expectations are shares make a new high above $100 by the end of the year which would give the calls a minimum value of over $15 or nearly a 300% gain. That’s music to my ears.

— Steve Smith

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About the Author: Steve Smith