Making sense of private equity in the collision aftermarket

Aug. 25, 2014
Private equity firms are taking profits because the time is ripe in the automotive aftermarket to make extraordinary returns.

Sixteen years ago, David Roberts and his partner, Matthew Ohrnstein, founded Caliber Collision with the intention of developing a premier consolidator of the collision repair industry. Over a period of 8 years as Caliber’s Chairman, Roberts helped lead the initial capital raises and the acquisition of its first 37 shops. Now a leading investment banker in the Automotive Services industry with FOCUS Investment Banking, Roberts has a unique 20-year perspective on the industry. In a previous article, Roberts examined recent consolidation developments and their impact on the industry. In this article, Roberts examines the role of Private Equity Groups and tries to help us make sense of the dramatic developments involving these PEGS and their activities in the Automotive Aftermarket.

In the last two weeks, the news has been full of private equity activity in the automotive aftermarkets of collision repair (sales of Service King and ABRA), autoparts (Blackstone buying Alliance Autoparts) and refinish markets (Carlyle IPO for Axalta).  What’s up with all this activity?

It’s all about the money, of course.  Private equity groups (PEGs) are taking profits because the time is ripe. The fundamental thing to understand about private equity is that their sole reason for existence is to realize profits for their investors.  They aren’t building a legacy for their kids, solving world hunger or investing for the next century.  So when there’s an opportunity to harvest their investment (realize a liquidity event) at a return that is substantially above their targeted return, they do so.

Most private equity groups invest on behalf of their own investors, usually pension funds, sovereign equity funds (think oil rich countries like Qatar and Norway) and high net worth individuals. There are some very large private equity groups such as Carlyle and Blackstone thatare publicly traded firms which gives ordinary mortals the opportunity to invest as well. Investors in thse publicly traded firms are looking to the PEG to produce a continuing stream of realized liquidity events that better determine the underlying values of its assets. For example, while Carlyle sold a large portion of its investment in Service King, it retained a significant portion as well. And now the price paid for their majority position increases the value for the retained portion — and also improves their stock price. 

So when Carlyle sold Service King, it was just doing what smart money always does, take extraordinary profits when they can.  And that’s what Palladium did in selling ABRA to Hellman & Friedman. And that is what Carlyle is doing with an IPO for Axalta.

Carlyle’s estimated return on Service King was 4x their original investment in less than 2 years. That’s an annualized return of more than 100 percent. Palladium has been invested in ABRA for a little over 3 years. If they make 5x on their original investment, they too have realized better than a 100 percent IRR. Most PEGs are thrilled with 30 percent IRRs.

So why are Blackstone and H&F entering the fray? Can they expect 100 percent annual returns? Unlikely but the opportunities to realize 30 percent IRRs seem widespread so both large and medium size PEGS will find the space attractive compared to other opportunities.

Hasn’t all the easy money been made?

Consider the following:

·      The top four consolidators collectively generate less than $2.5 billion in revenues, less than 7 percent of total industry revenues of $31 billion.

·      Lowes and Home Depot generate more than 45 percent of all home improvement revenues. CVS and Walgreens generate almost 40% of the US drugstore/sundry business. 

·      If the collision repair industry continues to consolidate to 45 percent of total revenues, there is more than $10 billion in additional revenue to be consolidated by investors entering the business today. That is an excellent opportunity for large and medium size PEGs to invest over the next 3-5 years.

·      And now the risks seem lower. Just because Palladium and Carlyle have reaped the benefits of investing early doesn’t mean investing today is inherently more risky than investing 2-4 years ago. In fact, now it’s probably less risky.  Management is getting better and better. Processes are improving, insurers are referring more work. Capital is still very inexpensive.

But challenges remain.

·      Experienced shop level managers and technicians are still in short supply. 

·      Training is improving but the pool of qualified candidates is limited and the price of labor is being bid up in some markets. 

·      Permits to open new locations in many urban areas are difficult to obtain. 

·      Insurers may begin to become more wary of referring too much business to any one consolidator in the future.

The continuing private equity involvement means continuing change for: 

·      The Industry: We expect the industry to continue consolidating for years to come. The benefits of larger scale enterprises in this industry are little different from many others where consumers, payors and capital providers all reap the rewards.·      Consolidators and Larger MSOs: Well capitalized consolidators and larger MSOs are expected to continue to gain market share as well.  With the huge capital pools of Blackstone, Hellman & Friedman and OMERS and the public currency of Boyd/Gerber, the financing capabilities of Service King, ABRA, Caliber and Gerber are nearly unlimited.  Their growth is more likely to be constrained by integration and management capacities than capital.

·      Dealers: Those dealers with body shops should continue to make market share gains as vehicle complexity and certification requirements grow.  The continuing investments in technology required to work with aluminum, composites and increasingly integrated vehicle systems are expected to give well-capitalized dealers first shot at retaining the repairs of these new vehicles.

·      Insurerrs: While large insurers are still making big gains from directing more repairs to fewer providers. They may be nervous about concentration of repairs with fewer providers. However, most insurers are continuing to narrow their DRP networks. Observing the excellent performance of GEICO with its extremely limited DRP network, every insurer is looking to gain more control over the cost and timing of repairs. State Farm’s Loss Adjustment Expenses to oversee more than 10,000 shops in its DRP networks are probably 4 times GEICO’s costs to service just twice as many insureds. This leaves GEICO will more margin which it spends on more marketing and gains more market share.

·      Vendors: As vendors facea decreasing number of customers as the number of shops continues to shrink, they will continue to experience their own consolidation.  We expect this will result in continued pressure on margins but may conversely allow some stronger vendors to lock in large customers with national reach.

What does the accelerating involvement of private equity groups mean for acquisition activity and pricing?
·      We expect there will be more capital chasing more acquisitions.  Acquisition prices, already at all-time highs should continue to be robust for the best MSOs.

·      We are seeing more MSOs engage with potential buyers through intermediaries. Following the successful example of ABRA, Service King and Caliber in achieving very attractive valuations by using an intermediary to create competition among multiple bidders, more and more MSOs are doing the same thing.

·      Smaller PEGS are actively looking to buy and invest in regional and single market MSOs. Those PEGS with less than $5 billion under management are looking for candidates they can back that will either grow into substantial regional operations or become candidates for sale to the big consolidators.

·      We expect an increasing number of MSOs and single shop operators will choose to sell out to consolidators or other MSOs.  Like the smart PEGs, operators who have been looking for an ideal time to realize a liquidity event expect to find ready buyers.

·      Those MSOs and single shop operators seeking to grow are likely to find it more expensive as they have to compete with consolidators and larger MSOs. This will change their growth strategies.

·      Life for single shop operators, already under pressure, will most likely become tougher as their larger competitors gain the benefits of scale, more DRP referrals and better purchasing, cheaper capital for new investment and more attractive stable environments for employees.

Subscribe to ABRN and receive articles like this every month…absolutely free. Click here

Sponsored Recommendations

Best Body Shop and the 360-Degree-Concept

Spanesi ‘360-Degree-Concept’ Enables Kansas Body Shop to Complete High-Quality Repairs

ADAS Applications: What They Are & What They Do

Learn how ADAS utilizes sensors such as radar, sonar, lidar and cameras to perceive the world around the vehicle, and either provide critical information to the driver or take...

Banking on Bigger Profits with a Heavy-Duty Truck Paint Booth

The addition of a heavy-duty paint booth for oversized trucks & vehicles can open the door to new or expanded service opportunities.

Boosting Your Shop's Bottom Line with an Extended Height Paint Booths

Discover how the investment in an extended-height paint booth is a game-changer for most collision shops with this Free Guide.