Court affidavit outlines Deric “Tuna” McGuire’s rise to head of Pagans motorcycle club.
PROVIDENCE, R.I. — For almost a year, state and federal agents wiretapped the many different telephones used by a Burrillville man, capturing, they say, his recruitment to lead a new Rhode Island chapter of the Pagans outlaw motorcycle gang and documenting his illegal drug enterprise.
Hundreds of transcribed pages of recorded conversations between Deric “Tuna” McGuire and his associates were unsealed Tuesday as part of the state police’s Operation Patched Out investigation, which in May led to more than 50 people arrested.
The recorded conversations are part of a 1,274-page affidavit that supported dozens of searches of homes, cars and motorcycles when scores of agents swept across northern Rhode Island making arrests.
Much of the affidavit centers on the 33-year-old McGuire, depicted as not just a motorcycle gang leader but the head of a Woonsocket-based drug operation.
McGuire is being held without bail and faces more than 220 counts of narcotics and weapons charges. His lawyer Christopher Millea declined comment on Tuesday.
The affidavit, which shines a light on the sometimes violent world of rival biker gangs, alleges that McGuire, a former member of the Thug Riders motorcycle gang, was by last summer looking to join the Pagans.
At the same time Keith Richter, the purported leader of a New Jersey-area Pagans club — who the New York Times reported in 1998 had served prison time for plotting a killing — was looking to expand into Rhode Island.
Richter, with ambitions of becoming the Pagan’s national leader, took a liking to McGuire because he had committed “violent acts” in the past against members of the Hell’s Angels, the Pagans’ historic nemesis.
Richter, also known as “Conan,” “was attempting to recruit and expand the Pagans motorcycle club and establish a Rhode Island chapter with Deric S. McGuire as the chapter president,” says the affidavit.
McGuire took a “mandatory trip” to Elizabeth, New Jersey, last December to meet with members of the Pagans. Then he returned to Rhode Island and faced the doldrums of normal life — like plowing out a hospital parking lot, a responsibility Richter seemed to have a hard time understanding in one recorded conversation.
McGuire: “I got this hospital over here, so I didn’t even … get to [go] home or nothin’ ”.
Richter: “You’re in the hospital?”
McGuire: “No I was sanding, plowing, all kinds of …”
Richter: “Oh, okay.”
In February of this year, Richter ordered all new prospective Pagan members to a meeting in New Jersey on March 3: “Everybody got to go down on bikes to get patched.”
But there was a delay. It wasn’t until March 24, the affidavit reads, that McGuire and several former Thug Riders officially became Pagans.
Agents also had McGuire under surveillance and on Saturday, April 14, state police detectives watched as McGuire wearing the patch and colors of a Pagans motorcycle club member, drove his black Harley Davidson on to the property of the “newly established” Pagans clubhouse at 91 Mason St., Woonsocket, formerly the home of the Thug Riders.
The taped conversations reveal McGuire arranging meetings to sell drugs to associates out of the club house, with periodic visits to his “stash house” at 1 Lake Drive, Woonsocket, where he kept pounds of marijuana and cocaine.
Agents wiretapped at least seven different cell phones that McGuire used. Because he did not have to present actual identification to buy them, he could be creative in coming up with subscriber names. Among his aliases: Donald Trump, Bruce Wayne and Hillary Clinton.
The affidavit outlines how the state police investigation into illegal biker activity began in February 2017 when a confidential source told detectives that members of the Thug Riders were drug dealing and that tensions were growing among Rhode Island’s many motorcycle clubs.
That tension boiled over on April 8, 2017. State chapters of the Outlaws and the Thug Riders scheduled social events on that same day at their clubhouses — less than a mile apart from each other in Woonsocket. The annual Outlaws party also drew members of various other motorcycle clubs.
Before the day was over, members of the Thug Riders were making slow, intimidating drive-bys on their bikes in front of the Outlaws’ clubhouse at 19 Fabien St. as well as the Hells Angels’ clubhouse on Messer Street, in Providence.
Members of the Hells Angels gave chase, catching one of the Thug Riders, knocking him off his bike and throwing him through a house window on Valley Street, the affidavit says.
It was the threat of more violence, the state police have said, that prompted them and federal agents to move when they did in May.
Focus for Harley-Davidson has been on declining interest from consumers and cost headwinds from raw materials – there are bigger pitfalls on the balance sheet.
The Financial Services business has grown exponentially over the past several years. By my estimate, half of all Harley-Davidson sales are financed by HDFS.
Rather than securitize and sell loans (as they did in the past), HDFS has been retaining these loans on the balance sheet. An increase in defaults could cause major losses.
With that said, liquidating receivables would drive the company to a net cash balance. The company is not as levered as many investors believe.
The dramatic saga of Harley-Davidson (HOG) has been well documented: declining interest in the bikes from the younger generation, poor choices on model design and pricing, higher raw material costs, and the Trump/European Union tariff entanglement have all made major headlines. All of those concerns are valid and very important to the long-term story on revenue and unit sales. However, the financial arm – run via Harley-Davidson Financial Services – does not get much press. Over the past several years, the company has moved away from selling loans it has originated, retaining all the risk of default on its balance sheet. While this has been a boost to operating income, it could bring problems down the line. Further, with it likely now that nearly half of all motorcycle sales are financed through HDFS (and more including third party lenders), there is risk that demand could collapse significantly if credit dries up.
Business Overview, Dynamics Of Harley-Davidson
Before touching on the Financial Services segment, I wanted to touch on the history of Harley-Davidson a bit. More than a century old, Harley-Davidson has built a reputation on building distinctive, quality motorcycles. Emphasis is placed on cruiser and touring models, both of which utilize high displacement engines (600-1900cc) with a focus on styling and rider comfort, respectively. While that sounds like a great niche to those outside the motorcycle industry, simply put these bulky, expensive bikes do not resonate with the millennial generation. Yamaha (OTCPK:YAMCY), Honda (HMC), Suzuki (OTCPK:SZKMY), and Kawasaki have run circles around the company in the 18-34 age demographic. While the company has retained market share within the large bike segment, that piece of the business continues to stall. Meanwhile, Asian manufacturers that are exposed to cheaper, smaller engine bikes that have broader appeal to current buyers. Harley-Davidson has stubbornly refused to address the market, and likely made a mistake moving away from the Buell brand at the end of the Great Recession.
This isn’t a new situation, and is in fact eerily similar to the Harley-Davidson bankruptcy scare back in the early 1980’s. While the company does not have the same manufacturing defect problems today that it had then, it has the same stubbornness in not bringing new innovative models to market that customers want. If the company ever hopes to achieve meaningful growth again, management has to think long and hard whether it wants to remain stubborn on its niche market focus. Back in the 1980’s, the company took an innovative approach to fixing its issues: cultivating its brand. It redesigned its stores, encouraging the Harley-Davidson dealer network to focus on comradery versus just being a sales outlet. It created networking events, founding the Harley Owners Group, where bike owners could meet up to deepen the love for the Harley-Davidson brand. The marketing chief at the time said that “The sale begins after the sale”. Focus of late appears to be on manufacturing cost improvements – not continuing to nurture brand cache.
This is a mistake in my view. While at the end of the day the company has to put out great motorcycles, much of the money being made at Harley-Davidson isn’t from physical bike sales. While Parts & Accessories, Licensing and General Merchandise only contribute a little more than 20% of overall revenue, they contribute vastly more to overall profit. Assuming 25% operating margins for those products (not outlandish at all for these marked up products) and it isn’t hard to back into 40%+ operating profit contribution from sales other than new motorcycles. This dynamic is likely a large reason why Harley-Davidson has been unwilling to disclose profit contribution from these kinds of sales in the past.
Financial Services Segment – Risky Exposure?
If we turn back the clock all the way to 2002, Harley-Davidson sold 263,000 motorcycles; it sold 241,000 in 2017. Sales are basically flat once considering the elimination of the manufacture of the Buell Motorcycle brand, a product Harley-Davidson once used as an introductory starter bike that it hoped would cultivate eventual Harley-Davidson buyers. Like sales, total pre-tax operating income was also similar despite the: income from operations came in at $885mm in 2002, with Harley-Davidson reporting $863mm in 2017. However, a major difference has been the elevated importance of Harley-Davidson Financial Services (“HDFS”) to earnings. In 2002, the Financial Services segment generated 11.8% of total company income. Last year, it was 30%. This has heightened the risk profile.
HDFS finances and services loans on wholesale inventory (loans to independent Harley-Davidson dealers) and makes retail consumer loans to aid consumers in purchasing a motorcycle. Today, the subsidiary principally operates in the United States and Canada, but that does not mean the portfolio is small. In-house (“captive”) dealer financing is incredibly commonplace, with pretty much every major automotive manufacturer having a financing subsidiary. It helps make the sales process clean and reduces the risk of a potential loan snafu causing the loss of a sale. At the end of Q1 2018, Harley-Davidson had $7,317mm in gross finance receivables outstanding; more than 80% of that is consumer loans. To offset, it only held a $182mm provision for credit losses, so excessive credit losses could have meaningful impact on results. While default rates have been low, more than one billion in receivables ($1,141mm) within the credit portfolio are self-described by Harley-Davidson as sub-prime loans (less than 640 FICO). Today, more than 4% of loans are more than 30 days past due. Even a small shift in expected default rates could cause hundreds of millions of dollars in losses. I’m surprised to see Harley-Davidson retaining so many of loans, especially when the market, in its never-ending quest for yield, would definitely be interested in large HDFS loan securitizations. Doing so significantly lowers risk by shifting the impact of default onto buyers.
Perhaps more importantly, financing remains an incredibly important driver of sales. While the percentage of sales that utilize HDFS is not disclosed in company filings, motorcycle loans run off very quickly. Single monthly mortality rates have ranged between 200-250bps when they were disclosed. If that holds true today, the average HDFS loan is in force for just three years, meaning more than $2,000mm in loans run off the retained portfolio in any given year. With finance receivables holding steady above $7,000mm since 2015, HDFS has to have been financing north of $2,000mm of new consumer loans each and every year. Given current reported annual motorcycle sales revenue at Harley-Davidson, it is highly likely that around half of all sales are financed by just HDFS – never mind including third party lenders. Perhaps that is not surprising given we are talking about bikes with MSRPs north of $20,000/year, but after all these are discretionary purchases. When push comes to shove and other bills need to get paid, walking away from that HDFS loan looks mighty appealing versus defaulting on a home or car. In 2008, losses were relatively moderate – but the portfolio was less than a third of the size. I spoke about the shift in treatment towards loan retention – that is a pretty recent change. Harley Davidson, prior to the Great Recession, was in the habit of selling its consumer loans in securitizations. In 2006 and 2007, the company sold nearly $5,000mm of these kinds of loans through these transactions.
HDFS is also reliant on financial institutions. Unlike banks, it has no source of liquidity other than other lenders that are willing to extend HDFS credit. The recent downdraft in the company’s stock price, weak demand for company products, rising LIBOR, and myriad factors all could pressure spread: the rate banks are willing to lend to HDFS and the rate on the loans HDFS can feasibly charge without impacting product demand. HDFS needs to remain competitive because these loans provide a substantial amount of operating income at Harley-Davidson – it cannot afford to lose all that juicy interest income that drove 30% of pre-tax operating income last year. While investors might focus on manufacturing cost cutting initiatives, a more important place to look might be the refinancing of HDFS credit facilities.
Harley-Davidson has begun to retain more risk on its balance sheet, becoming increasingly reliant on that sweet interest income as per unit profit margins fall in the Motorcycles business. Given the continued pressure on the base business, it is likely that management will continue to rely on Financial Services to keep earnings elevated. On the bright side, what some investors view as a levered company – $5,981mm in debt in Q1 2018 – actually could run at a net cash balance. If Harley-Davidson elected to monetize its finance receivables, it could settle all of its outstanding debt if those loans sold at par. That is big – so long as Harley-Davidson customers keep making their payments. In my view, a major securitization sale as a strong positive in driving interest in the stock with smaller investors, with the added benefit that Harley-Davidson could still strip off some income from those loans from the servicing rights.