When Midas reported its 2011 Q2 results, management was quite candid with respect to its disappointment surrounding the stock price. Following the settlement of Midas’ European arbitration and Q2 earnings, management announced that its board would conduct a review of potential strategic and financial alternatives, including, but not limited to a possible sale, merger or other business combination. Since then, the shares have risen approximately 30 percent versus a +2 percent gain for the Russell 2000 (as of 12/14/11).
In mid-December, GAMCO Asset Management (15.4 percent holder, although including other vehicles Gabelli owns 24.4 percent) sent Midas a proposal requesting that the company include a vote to redeem its preferred stock purchase rights (issued pursuant to the company’s Rights Agreement) with the company’s proxy statement for its 2012 Annual Meeting. In essence, GAMCO believes that the company’s poison pill is not in the best interest of shareholders, whom would be better served by retaining the right to decide for themselves what would be a reasonable offer for their holdings from a potential bidder.
While it is possible that private equity would take a look at Midas, we believe that there is far more value to be realized in a takeout of Midas by a strategic buyer. In particular, we believe that for Pep Boys and Monro Muffler Brake, an acquisition of Midas would make a great deal of strategic sense, for the right price of course. In 2011, we estimate that Midas will generate earnings before interest, taxes, depreciation and amortization (EBITDA) of $29 million. For a strategic buyer, we believe that total synergies could range between $30 and $60 million, depending on the amount of distribution cost savings that could be attained. Midas currently trades at an enterprise value (EV)/EBITDA multiple of approximately 7.9 times on estimated 2011 earnings. Adjusting for an estimated $20 million in change in control payouts, Midas is currently trading at approximately 8.6 times estimated 2011 EBITDA. On a post-synergy realization basis, and including our estimate of $20 million (approximately $1.50 per share) in change in control payouts, we estimate that Midas currently trades in the range of 2.8 times to 4.2 times EV/EBITDA. In addition, with Midas shedding roughly 50-80 franchise locations annually (as owners turn in their keys and challenging credit market conditions make re-franchising locations more difficult), we believe that perhaps the greatest benefit to a strategic buyer is the multi-year pipeline of new store growth at minimal per unit cost.
With a nationwide presence but limited local market density (just 729 stores in total, including 562 supercenters, 159 service & tire centers, and 8 legacy The Pep Boys [PBY] express/retail locations), and a Supercenter store base that is characterized by much larger unit footprints than necessary (approximately 20,000 square feet per unit, compared to approximately 7,000 for its retail peers), we believe PBY would benefit greatly from an acquisition of Midas, and in particular the opportunity to distribute parts from its Supercenter locations (significantly enhancing returns on its existing capital base) and developing its “hub and spoke” service strategy at an accelerated rate. Given the lingering drag from Big 10 and other recent acquisitions, PBY would have to make sure of 2 things: 1) that it did not overpay and 2) that it has an experienced enough team in place to balance existing integration issues with the material challenges that a Midas acquisition would entail.
Monro has a proven track record with acquisitions and as with PBY, we believe the acquisition would make strategic sense. With its best in class, low-cost operating model, we believe that Monro has the highest chance of successfully integrating an acquisition of Midas, although the key here is that Monro won’t/can’t overpay. Whether the board actually decides to sell the company should be decided in the next several weeks as Midas management had noted a likely conclusion to the review by yearend. With Gabelli getting more active, there could be one extra gift under the tree this year for one of these companies.
About BB&T Capital Markets:
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket. BB&T Capital Markets is a division of Scott & Stringfellow, LLC, member NYSE/FINRA/SIPC. Scott & Stringfellow is a wholly-owned nonbank subsidiary of BB&T Corporation, one of the nation’s largest financial holding companies with $155 billion in assets. Securities and insurance products or annuities sold, offered or recommended by Scott & Stringfellow are not a deposit, not FDIC insured, not guaranteed by a bank, not insured by any federal agency and may lose value.
Disclosures:
BB&T Capital Markets makes a market in the securities of Midas, Inc.; Monro Muffler Brake, Inc.; and The Pep Boys—Manny, Moe & Jack.
BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Midas, Inc.; Monro Muffler Brake, Inc.; and The Pep Boys—Manny, Moe & Jack in the next three months.
An affiliate of BB&T Capital Markets received compensation from Midas, Inc.; and Monro Muffler Brake, Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.
