K2’s purchase of Ride, announced on July 22 and expected to close within 100 days, is as close as we’ll ever get to a capstone on consolidation.

We all were intellectually aware of consolidation, but this makes you aware in your gut. Burton and K2 now control an estimated 65 percent of the United States snowboard hardgoods market. Add Salomon and Rossignol and the number jumps to north of 75 percent.

The number-two, independent, snowboard-only brand in North America is now Sims.

So what’s the deal all about, what does this mean for the industry, and how is K2 going to manage its five snowboard brands (K2, Morrow, Ride, 5150, and Liquid) so each has the best chance to grow?

The DealK2 is buying the common stock of Ride. That is, it’s buying the whole company–not just the assets like in the Morrow deal and so many other snowboard deals.

So it gets all the assets and all the liabilities, known and unknown. If a two-year-old Ride binding blows up, somebody is hurt, and Ride is sued, K2 will be responsible. In an asset-only deal, it typically wouldn’t be–which is one reason asset deals are often popular.

Ride’s stock will be acquired in exchange for K2 common stock. Ride shareholders will receive K2 shares “with an approximate value of one dollar for each share of Ride stock owned.”

Given the number of Ride shares outstanding, that means a purchase price of around 14.3-million dollars.

Both boards of directors have approved the deal. One of the reasons it will take so long to close is that Ride shareholders have to approve the deal as well. The deal is being structured so it’s tax free to Ride’s shareholders. Ride’s directors have already agreed to vote their shares in favor of the deal.

To get Ride from the July 22 agreement date to closing, K2 has agreed to extend two-million in interim financing to Ride in exchange of a promissory note that can be converted into Ride stock. The note’s initial interest rate is eight percent. That rate increases one percent every 180 days up to a maximum of eighteen percent on the unpaid portion of the note and any accrued interest, however the notes is payable in full on November 19, 1999.

The note is convertible by K2 at any time into Ride’s cumulative convertible preferred stock and is automatically converted under certain circumstances if the merger agreement between K2 and Ride is terminated. K2 would get one share of the convertible preferred stock for each dollar that is still owed from the principal and unpaid interest of the note.

If somebody else buys Ride, or agrees to buy ride, before the note is repaid or converted, K2 can demand to be paid in cash for up to a year based on the price of Ride’s stock (which could go up if a better deal comes along).

Ride, as a public company, has an obligation to consider any better offers. This note is structured not only to give Ride working capital to get it through the period until closing, but to make it less likely that any such deal will come along. If the deal with K2 closes, there’s nothing but intercompany debt that gets eliminated in consolidation.

The transaction will be accounted for as a purchase rather than a pooling, and now I’ve put my foot in it because I have to explain the difference and why it matters.

An Asset-Only DealFirst, if you buy assets, you assign values to the assets based on what they are really worth.

So if you’re buying accounts receivable worth 100,000 dollars in orders, but know that you won’t be able to collect perhaps 15,000 dollars of it, you’d “allocate” 85,000 dollars of the purchase price to those receivables.

After you’ve allocated as much of the purchase price as you can to the assets, the rest is allocated to goodwill. Goodwill sits on your balance sheet and has to be amoized (taken as an expense some at a time) over a period of many years, but isn’t deductible for tax purposes. In addition, no bank ever thinks goodwill is worth anything when considering whether or not to lend the company money.

Allocation of purchase price in an asset deal also has a major impact on who pays what tax when the deal closes, but since the Ride purchase isn’t an asset deal, we’ll skip that. You’re welcome.

Pooling DealsA pooling is a straight exchange of stock where the values on the two companies’ balance sheets are added up. No goodwill is created. No assets are written up or down, and there’s no allocation of purchase price. The only adjustments are the netting out of any inter-company amounts (amounts the two companies owe each other).

K2 is buying Ride’s stock with its stock, but it’s not a pooling because Ride shareholders are getting a certain value per each share of Ride stock they own–not just K2 shares. It’s a purchase.

A Look At The NumbersOnce K2 knows exactly how many shares it’s exchanging for Ride, and the market price of those shares at closing, it will know how many dollars it paid for Ride.

It’s buying Ride’s equity, a balance-sheet number. At March 31, that number was 16.1-million dollars. It’s probably lower now, perhaps even around 14.3-million dollars.

To the extent that the purchase price is higher or lower than Ride’s actual equity at closing, other balance-sheet items can be adjusted to reflect fair market values.

To the extent that those adjustments don’t account for the difference between Ride’s equity and K2’s purchase price, goodwill is adjusted. It looks in this case like the purchase price will end up being somewhere close to Ride’s equity, so adjustments should be minor.

So what’s the deal worth anyway? The easy answer is that it’s worth the approximately 14.3-million dollars in K2 stock Ride shareholders are receiving. That’s not a bad answer, but let’s go a little further, keeping in mind that there’s rarely a “right” answer when you value companies.

Ride’s March 31, 1999 balance sheet showed 32-million dollars in assets and sixteen-million dollars in liabilities. K2 gets all those as part of the purchase. The assets include 8.5-million dollars in goodwill and 5.4-million dollars for Ride’s factory and equipment.

If I were K2 trying to figure out the value of Ride, I’d call the goodwill zero. I’d write down the plant and equipment. How much would depend on what I was going to use the factory for.

Let’s say K2 cuts the value of the factory in half, making the realizable value of the Ride assets around twenty-million dollars. The liabilities, as usual, are all real.

Let’s say that K2 could liquidate the assets and liabilities tomorrow for twenty-million dollars and sixteen-million dollars, respectively. It doesn’t work that way of course, but if it did K2 would have four-million in the bank. So, they would have paid stock worth 14.3-million less four-million in net assets, or 10.3-million dollars basically for Ride’s trade name and order book.

But you can’t realize the value of that trade name and order book unless you operate the business. To do that, you have to invest a certain amount of permanent working capital. Ride didn’t have any. That’s why they had to sell.

My guesstimate, depending on the expense reductions K2 can find to reduce overall operating costs, is that K2 is going to have to invest maybe more than ten-million dollars in Ride in additional to the four-million dollars in net assets that’s already in there.

At a minimum, Ride’s bank (owed 8.5-million according to the March 31 SEC filing) will want to be paid off once the deal is completed–as will certain unsecured creditors who have been waiting a long time for their money.

K2, therefore, may look at its cost to buy Ride as not only the value of the equity it gave up, but as the additional capital it will have to invest to normalize the balance sheet–perhaps more than 24-million dollars in total.

If Ride had been capitalized normally, that whole amount, and probably more, would have accrued to Ride’s shareholders. But K2’s offer was based on what it would cost it not only to buy, but also to operate Ride–regardless of whether it went to the Ride shareholders or not.

So, was it a good deal?K2 got a very good deal. Did Ride shareholders get screwed? Not given the alternative. My sense is that Ride’s management found the buyer to whom Ride has the most value.

Furthermore, Ride’s balance sheet and recent public information suggest that cash-flow issues were severe enough that scenarios where shareholders got less than one dollar per share were possible. Like a whole lot less. Like the big goose egg.

Industry ImpactThe strategic line between the niche players and the big companies are as clearly drawn as you could ever expect to see. If any single action can be said to mark the end of snowboarding’s consolidation phase, this deal is it.

Ride and Morrow are gone as independent snowboard companies. To Forum, Sims, Palmer, Never Summer, Option, and just maybe a few other brands, this could be an huge opportunity–depending on retailers’ perception of the deal. Some retailers who were prepared to buy Ride may be put off by the idea of buying “another K2 brand.”

Because of this deal, specialty brands might find it easier to identify a niche and maybe grow a little. But they won’t have the economies of scale, distribution leverage, and marketing dollars they need to chase the big players. And as independent companies, they probably never will.

Then there’s Burton with something like 45 percent of the U.S. unit market share and 40 percent of dollar market share–at least when it comes to snowboards. It alone has the cachet of a niche brand, but on an international scale, and the leverage of a large company. Ain’t nothing to analyze there. My guess is that Burton management is thrilled with this deal.

Some retailers will likely put up some resistance to putting more eggs in the K2 basket. But if the consumer wants Ride boards, and K2 offers good terms, prices, service, quality, and promotion, the retailers will pretty much get over it. They have before.

The complete programs from Morrow and Ride are likely to improve as a result of being part of a larger, financially stable organization. And it’s likely that K2 will produce some boards in China at pricepoints retailers aren’t going to be able to live without.

K2’s DecisionsK2’s opportunistic purchase of Morrow (it was too good a deal to turn down) seems to have transformed itself into a strategy with the purchase of Ride. Of course, we don’t know exactly what that strategy is yet.

K2 now has five snowboard brands, with K2, Morrow, Ride, Liquid and 5150. How do they get positioned against each other?

I’d make K2 the ski-shop brand. I’d retain Brad Steward (between movies, of course) to consult on repositioning Morrow as the quirky brand it used to be. Liquid would be for the mass-market channel, and Ride for specialty shops–but with a more mainstream profile and higher volume than Morrow. I have no idea what to do with 5150. Whatever the positioning decisions are, it will be interesting to see if all five brands survive.

Managing five brands against each other is hard. One of former Ride President Bob Hall’s first pronouncements on becoming CEO of Ride was that the company had too many brands. He proceeded to reduce the number. Of course, some of the brands he eliminateed creditors who have been waiting a long time for their money.

K2, therefore, may look at its cost to buy Ride as not only the value of the equity it gave up, but as the additional capital it will have to invest to normalize the balance sheet–perhaps more than 24-million dollars in total.

If Ride had been capitalized normally, that whole amount, and probably more, would have accrued to Ride’s shareholders. But K2’s offer was based on what it would cost it not only to buy, but also to operate Ride–regardless of whether it went to the Ride shareholders or not.

So, was it a good deal?K2 got a very good deal. Did Ride shareholders get screwed? Not given the alternative. My sense is that Ride’s management found the buyer to whom Ride has the most value.

Furthermore, Ride’s balance sheet and recent public information suggest that cash-flow issues were severe enough that scenarios where shareholders got less than one dollar per share were possible. Like a whole lot less. Like the big goose egg.

Industry ImpactThe strategic line between the niche players and the big companies are as clearly drawn as you could ever expect to see. If any single action can be said to mark the end of snowboarding’s consolidation phase, this deal is it.

Ride and Morrow are gone as independent snowboard companies. To Forum, Sims, Palmer, Never Summer, Option, and just maybe a few other brands, this could be an huge opportunity–depending on retailers’ perception of the deal. Some retailers who were prepared to buy Ride may be put off by the idea of buying “another K2 brand.”

Because of this deal, specialty brands might find it easier to identify a niche and maybe grow a little. But they won’t have the economies of scale, distribution leverage, and marketing dollars they need to chase the big players. And as independent companies, they probably never will.

Then there’s Burton with something like 45 percent of the U.S. unit market share and 40 percent of dollar market share–at least when it comes to snowboards. It alone has the cachet of a niche brand, but on an international scale, and the leverage of a large company. Ain’t nothing to analyze there. My guess is that Burton management is thrilled with this deal.

Some retailers will likely put up some resistance to putting more eggs in the K2 basket. But if the consumer wants Ride boards, and K2 offers good terms, prices, service, quality, and promotion, the retailers will pretty much get over it. They have before.

The complete programs from Morrow and Ride are likely to improve as a result of being part of a larger, financially stable organization. And it’s likely that K2 will produce some boards in China at pricepoints retailers aren’t going to be able to live without.

K2’s DecisionsK2’s opportunistic purchase of Morrow (it was too good a deal to turn down) seems to have transformed itself into a strategy with the purchase of Ride. Of course, we don’t know exactly what that strategy is yet.

K2 now has five snowboard brands, with K2, Morrow, Ride, Liquid and 5150. How do they get positioned against each other?

I’d make K2 the ski-shop brand. I’d retain Brad Steward (between movies, of course) to consult on repositioning Morrow as the quirky brand it used to be. Liquid would be for the mass-market channel, and Ride for specialty shops–but with a more mainstream profile and higher volume than Morrow. I have no idea what to do with 5150. Whatever the positioning decisions are, it will be interesting to see if all five brands survive.

Managing five brands against each other is hard. One of former Ride President Bob Hall’s first pronouncements on becoming CEO of Ride was that the company had too many brands. He proceeded to reduce the number. Of course, some of the brands he eliminated didn’t have enough volume to justify the required advertising and promotional expenditures–K2 probably doesn’t face that. Still, there are some obvious conflicts as K2 works to restructure its organization to manage the five brands.

For instance, you just know that the financial guys at K2 are sharpening their knives to slice expenses and walking around muttering stuff about synergies. And certainly they don’t need two warehouses, credit departments, computer systems, or purchasing departments.

Maybe they don’t need two factories.

Yet maintaining brand integrity means keeping sales and marketing separate. Will they have separate customer-service departments with people dedicated to brands, or will the temptation to have one group that answers the phone “snowboard customer service” win out?

Will all the invoices the retailers receive look the same except for the brand name? How many brands will be made in the same factory?

In a thousand ways, none of which by itself probably matters, the identity of the brands can be subverted in the perfectly reasonable pursuit of operational efficiencies.

I’m not saying it will happen, but making sure it doesn’t is a hell of a challenge. It’s not easy to be passionate about five brands at once.––––––––––––––––––––––

Jeff Harbaugh works with action-sports companies in transition. As always, his views do not necessarily reflect those of SNOWboarding Business. Reach him at: (206) 232-3138, or by e-mail at: jaharbaugh@compuserve.com nated didn’t have enough volume to justify the required advertising and promotional expenditures–K2 probably doesn’t face that. Still, there are some obvious conflicts as K2 works to restructure its organization to manage the five brands.

For instance, you just know that the financial guys at K2 are sharpening their knives to slice expenses and walking around muttering stuff about synergies. And certainly they don’t need two warehouses, credit departments, computer systems, or purchasing departments.

Maybe they don’t need two factories.

Yet maintaining brand integrity means keeping sales and marketing separate. Will they have separate customer-service departments with people dedicated to brands, or will the temptation to have one group that answers the phone “snowboard customer service” win out?

Will all the invoices the retailers receive look the same except for the brand name? How many brands will be made in the same factory?

In a thousand ways, none of which by itself probably matters, the identity of the brands can be subverted in the perfectly reasonable pursuit of operational efficiencies.

I’m not saying it will happen, but making sure it doesn’t is a hell of a challenge. It’s not easy to be passionate about five brands at once.––––––––––––––––––––––

Jeff Harbaugh works with action-sports companies in transition. As always, his views do not necessarily reflect those of SNOWboarding Business. Reach him at: (206) 232-3138, or by e-mail at: jaharbaugh@compuserve.com