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Pep Boys – Manny, Moe & Jack (NYSE:PBY) could get carved up in a potential sale process, three industry bankers told this news service.
In late June, the Philadelphia, Pennsylvania-based automotive aftermarket retail and service business announced it had hired Rothschild to conduct a strategic review that might include a sale or merger. The announcement followed a report last month by The Wall Street Journal, noting that Pep Boys had attracted the interest of several suitors, including Golden Gate Capital.
To date, Pep Boys’ business model of selling auto parts in a retail setting as well as offering auto repair services has not delivered compared to standalone retail or service businesses, the second banker said. Its real estate also poses a conundrum for potential suitors who may not be interested in the collective entity, the bankers said.
Private equity firms are most likely to examine the company together with a sale-leaseback opportunity for its owned real estate portfolio, the first banker said. As Pep Boys is highly levered, the company could unlock the most value by selling all of its real estate as a portfolio and paying down its debt, while also offloading liabilities associated with the property, the third banker reasoned.
But buyers in a sale-leaseback transaction would need assurance that the properties in the portfolio were not subject to extensive remediation, the second banker added. The company values its property and equipment at USD 600m.
Potential suitors for the company’s real estate include National Retail Properties (NYSE:NNN) and Realty Income (NYSE:O), the latter of which has already purchased properties occupied by quick-change service centers and tire retailers, the third banker said.
Strategic suitors such as Advance Auto Parts (NYSE:AAP), AutoZone (NYSE:AZO) and O’Reilly Automotive (NYSE:ORLY) could also express interest in Pep Boys, but might first focus on its retail business, the first banker said. In such a scenario, the banker noted that companies such as Jiffy Lube, Midas and Sears Auto could be potential acquirers of the service business.
Carving out the company’s retail business could be problematic for a strategic, however, as its supercenter locations combine both the service and retail operations under one roof, the second banker said. He cautioned that the retail segment has also been hit hard by big box retailers such as Target (NYSE:TGT) and Wal-Mart (NYSE:WMT), who also offer auto care accessories.
As the service side of the business has seen more upside than the retail side, mostly due to a continuing customer shift from “do-it-yourself” to “do-it-for-me,” Pep Boys as a whole could attract retail strategics that lack a service component, the second banker said.
Pep Boys’ net profits over the past three years have sagged from USD 13m in FY12 to a net loss of USD 27m in FY14. The company’s EBITDA margins are around 5%, compared with its larger peers who sport EBITDA margins ranging from the mid-teens to low twenties, the third banker noted.
Because of this, the business has traditionally traded between 8x and 9x EBITDA, at a discount to peers such as Advance Auto, AutoZone and O’Reilly which trade at 10x, 11x and 14x EBITDA, respectively, the second and third bankers said.
A core issue for Pep Boys is the size of its physical footprint, two of the bankers said, with the third noting the company’s stores are around three times as large as its competitors yet sell roughly the same volume of products.
Pep Boys previously explored a leveraged buyout when it agreed to be acquired by The Gores Group in January 2012. Under terms of the merger agreement, Gores was to acquire Pep Boys for USD 15 per share in cash. But the deal fell through that May, costing Gores a termination fee of USD 50m. Shares currently trade around USD 12.
Gores sought to acquire Pep Boys at a multiple of around 6x EV/EBITDA in 2012, the second banker said. Today the company is trading higher on an EBITDA basis, so some PE suitors might see limited upside beyond its real estate, this banker said.
Pep Boys general counsel Brian Zuckerman said the company will “focus on value-enhancing opportunities” upon the appointment of its new CEO, Scott Sider, on 15 June, and that these opportunities will be “evaluated against strategic alternatives,” declining to elaborate.
Pep Boys has a market cap of USD 649m.
by Anthony Valentino, Marlene Givant Star, Sam Weisberg and Carl O’Donnell
As seen in the mergermarket newsletter on 02/07/2015