Pep Boys: A No Brainer Takeover Target

 |  Includes: AAP, AZO, ORLY, PBY
by: Mark Krieger

Pep Boys (NYSE:PBY) has had its share of problems, and the market has certainly not shown any sympathy in the process, beating the shares down to all time historic lows. The stock is so low, that PBY’s annual cash dividend of 27 cents represents a mindboggling 10% yield. The company, which operates 562 locations, has significant real estate holdings (it just completed selling 22 properties for $77 million in a sale leaseback transaction while retaining 240 properties) and is the only company capable out of the big four (AZO, ORLY, AAP and PBY) of also installing what it sells through 6000 service bays. These service bays' bread and butter are the installation of new tires and brakes, which are nondiscretionary items.

More consolidation in the sector? ORLY scooped up CSK Auto for next to nothing last year when it hit bad times. The deal was pure genius, as it acquired the company through a stock swap requiring it to dish out only $1 per share in cash, while assuming CSK’s debt. Will there be more acquisitions in the auto parts retailing sector? It would not be surprising at all, especially considering the decimated market caps some of the players have experienced.

Enterprise value: EP is a good gauge of what a company would be required to lay out to acquire a competitor, because it takes into consideration how much debt must be assumed, less the company’s cash on hand. PBY’s current market cap is $157 million. If you subtract its cash of $38 million and add its debt of $331 million, an enterprise value of $450 million is computed.

AAP’s buyout scenario: AAP could acquire PBY for about $450 million representing only 15% of its market cap of $2.98 billion, while juicing up its top line by 36% from $5.21 billion to $7.14 billion (by picking up PBY’s annual sales of $1.94 billion). AAP’s debt would increase by about 50% from $653 million to $984 million (it would assume PBY’s debt) and it would incur some dilution, but the deal would certainly be accretive to earnings right out of the gate. AAP’s shares outstanding would swell by about 5% from 95 million shares to 100 million shares.

AZO’s high debt: If AZO acquired PBY, its debt would increase about 15% from $2.27 billion to $2.6 billion. The deal would represent about 6% of AZO’s current market cap of $7.64 billion. AZO’s top line would grow about 29% from $6.57 billion to $8.5 billion in a successful integration scenario. AZO would have to print up an additional 1.1 million shares required to swap to PBY holders, representing a 2% gain from 57 million shares to 58 million shares.

ORLY buying one more time? If ORLY decided to pursue PBY, its debt would rise about 50% from $665 million to $996 million, with the acquisition representing about 12% of its current market cap. ORLY’s sales would increase 41% from $4.69 billion to $6.62 billion. Its outstanding shares would likely increase from 135 million shares to 140 million shares, if a deal with PBY was ultimately consummated.

Why PBY is vulnerable: The stock has reached such low levels, it could be worth more dead than alive at this juncture. This scenario often produces opportunists wishing to exploit the situation. The vultures could be starting to circle. Management has done a poor job communicating its turnaround vision with Wall Street. The company has stressed it seeks to get back to basics by providing better customer service and more relevant inventories, but its quest to acquire 20-30 repair shops is perplexing and contradictory to say the least. Why would management want to take on another project, when they are still unsuccessful getting their own house in order?

Bottom line: PBY has gotten so cheap that many of its competitors could easily pick it up without batting an eye. Furthermore, the company is susceptible to being dismantled by a private equity firm looking to make a fast buck. The company’s financial condition could not be as bad as it seems, as PBY just reported, the closing of a new $300 million credit facility at a reasonable interest rate (LIBOR plus 3%) with a consortium of banks. The syndicate of lenders included B of A, Wells Fargo and Regions Bank. It was a notable accomplishment in light of“very tight credit markets, and the deal surely emphasizes the lenders' continued confidence in Pep Boys.