Microsoft and Harman to Tussle on Car Dashboards

Nov. 18 (Bloomberg) -- The automotive sector is replete with low-margin and no-margin enterprises that have excelled mainly -- from a financial perspective -- at eliciting groans of frustration from their shareholders.Towering above this crowd of unfortunates are a few outstanding performers, and at the top of that small group is Harman International Industries Inc., a maker of premium sound and information systems featured in BMW, Mercedes, Porsche, Lexus and other luxury automobiles.
Since its founding in 1953, Harman has contended with formidable stereo and electronics manufacturers. Now it faces new competition from mighty Microsoft Corp., which makes no secret of its intention to extend its dominance in computing from home and office to car.
Of the 476 publicly held U.S. companies with a market capitalization of more than $5 billion, Harman is the 10th best- performing stock over the last year, up 99.8 percent. During the last five years, Harman shares have averaged a 64 percent annual increase, far surpassing all relevant indexes.
For the last five years, by contrast, Bloomberg's Auto Parts/Equipment Index of 27 large suppliers lost an average 1.3 percent in price annually. In the last year, the index is up 12 percent, including reinvested dividends.
Earnings Growth
The most striking feature of Harman's financial performance has to be its earnings growth. In an era of unprecedented cost cutting, supplier consolidation and price deflation of new vehicles, Harman since 1999 has achieved average net-income growth of 135 percent annually.
Much of that increase may be attributed to Harman's ability to command premium prices for its Harman/Kardon, JBL, Mark Levinson, Becker and other car stereo brands, which often come equipped in luxury models with premium prices.
Significantly, Harman sits at the forefront of a digital revolution in vehicle information and sound systems. Stereos, navigation systems, car phones, DVD players and other devices typically have been connected by wiring harnesses and controlled mechanically. That's all changing, as physical connectors give way to integrated systems, rich with software programs.
Just as personal computers have needed operating systems like Microsoft Windows and XP to control software programs, cars increasingly need them, too.
Dashboard Duel
In the past three weeks, Harman's stock price jumped 13 percent following the Oct. 27 announcement that it intended to buy privately held QNX Software Systems Ltd. of Ottawa, Canada, for $138 million in cash. QNX makes the Neutrino operating system used by Harman and other automotive electronics manufacturers like Delphi Corp.
``QNIX represents absolute dependability, it's recognized universally as the ideal means of integrating infotainment applications in the vehicle,'' said Sidney Harman, 86, the company's chairman and co-founder.
Microsoft, which recently announced an alliance with Fiat, intends to battle QNIX and, therefore, Harman, for its dominant position in vehicle dashboards. ``Microsoft hasn't got the traction it wants because they've basically got a PC operating system,'' said Harman. Microsoft calls its system Windows Automotive.
Harman Has Delivered
With QNX now belonging to Harman, Microsoft may be able to approach competitors to Harman in car stereos that buy Neutrino and sell Windows Automotive as a substitute.
Harman's chairman doesn't believe his company is vulnerable. ``Of course the possibility is there to drop QNIX,'' he said. ``Nothing of significance has been lost in part because our assurances of an intellectual firewall we've set up to protect QNIX clients from us.''
Meantime, new opportunities are opening abroad.
``The Asian vehicle market is critical to us,'' he said, ``and I'm very optimistic that it will begin to occur, and within the next six months.''
As for the booming price of Harman's shares, which already have exceeded the expectations of the most optimistic equity analysts, he said: ``What you're seeing is a company that six years ago laid out a schematic of what it was going to do and has delivered quarter after quarter.''
Of the seven equity analysts who follow Harman, five rate the stock as a ``buy'' and two recommend ``hold.'' Yesterday, Moody's raised its outlook to ``positive'' on $375 million of Harman unsecured debt, rated Baa3, citing rising profit margins and other factors.
Safety Enhancements
Automobiles are coming loaded with more and more electronic features, such as Bluetooth. That's a wireless protocol that allows hands-free operation of a cell phone through a vehicle's audio system, a safety and convenience enhancement.
Saab is developing a ``workload manager'' that can figure out when a driver is too busy braking or turning to answer the phone safely, and switches incoming calls to voicemail.
Harman International shareholders are reaping prodigious rewards for their company's success at keeping itself at the center of digital technology inside vehicles. As Microsoft raises its sites, that success will be tougher to maintain.
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