Last week we spoke about the impact of interest rates on consolidation. While a low rate environment certainly provides incentive to companies to grow through mergers and acquisitions, good deals are good deals in both high and low interest rate environments. There is a financial component that drives consolidation but there is a strategic component as well. Consolidation in the entire automotive aftermarket industry will likely continue due to both components. Prolonged increases in interest rates may have an impact on valuations over the medium term but likely not a significant impact immediately.
When considering growth by acquisition, a lot of time is spent identifying and quantifying synergies. Synergies are advantages that come about through the integration of two companies that, individually, the two companies would be unable to achieve. There are three common types of synergies: revenue, cost, and financial.
Revenue Synergies
A revenue synergy is when, as a result of an acquisition, the combined company is able to generate more sales than the two companies would be able to separately. For example, consider LKQ and Keystone. Prior to LKQ’s acquisition of Keystone, LKQ sold primarily used parts. Keystone sold primarily aftermarket parts. However, in the combined company, LKQ could leverage its existing distribution network and sales force to sell more aftermarket parts into the industry than Keystone could sell as a stand-alone organization. Similarly, when a major consolidator acquires a smaller competitor, the consolidator often is able to leverage existing client relations to drive more sales into the new location than the stand-alone operator was able to on its own.
Revenue synergies can create very attractive economics for both buyer and seller. A savvy seller can command a substantial premium when the revenue synergy that the selling company provides is unique to the buyer. Conversely, a savvy buyer can often easily justify paying a substantial premium confident that the increase in revenues post close will offset the additional consideration provided to the seller.
Cost Synergies
Cost synergies refer to the opportunity, as a result of an acquisition, for the combined company to reduce costs more than the two companies would be able to do individually. Again, take the LKQ – Keystone deal as an example. When LKQ acquired Keystone, LKQ could distribute aftermarket parts through its existing distribution network. LKQ was able to eliminate significant costs associated with delivery trucks, fuel, insurance and delivery drivers. LKQ was also able combine warehouses and eliminate redundant storage expenses. Redundant management overhead was eliminated as well, further reducing expenses. As a result of the LKQ – Keystone acquisition, LKQ’s overall cost of doing business dropped while its sales increased. This is often referred to as developing economies of scale. In collision repair another example of cost synergies is when a larger group is able to negotiate lower prices or improved payment terms with vendors such as paint companies because they buying more products and services.
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