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On February 1, Bill Simpson wrote an analysis of U.S. Auto Parts Network (NASDAQ:PRTS). The IPO began trading on Feb. 9. The company raised $100 million, with 10 million shares that sold for $10 each, the bottom of a $10 to $12 forecast range.

The text of Mr. Simpson's original writeup follows:

• • •

U.S. Auto Parts Network plans on offering 11.5 million shares (assuming over-allotment is exercised) at a range of $10-$12. Insiders are selling 3.5 million shares in the offering. RBC Capital and Weisel are lead managing the deal, Piper Jaffrey and JMP are co-managing.

Post-offering PRTS will have 29.8 million shares outstanding for a market cap of $328 million on an $11 pricing. Approximately 40% of ipo proceeds will be utilized to repay all outstanding debt, the rest for working capital and general corporate purposes.

Oak Investment Partners, not selling any shares on ipo, will own 22% of PRTS post-ipo.Oak has had a piece of a number of ipos over the past few years including LoopNet, Inc. (NASDAQ:LOOP)/ Shop.com/ GMARKET (GMKT)/ Caribou Coffee Company, Inc. (NASDAQ:CBOU)/ Dick's Sporting Goods Inc. (NYSE:DKS).

From the prospectus:

We are a leading online provider of aftermarket auto parts, including body parts, engine parts, performance parts and accessories. Our network of websites provides individual consumers with a comprehensive selection of approximately 550,000 products, identified as stock keeping units or SKUs. We have developed a proprietary product database that maps our 550,000 SKUs to over 4.3 million product applications based on vehicle makes, models and years.

Websites are located at www.partstrain.com and www.autopartswarehouse.com.. Each was launched in 2000. In September 2006, PRTS' two sites combined had approximately 6.9 million unique visitors with autopartswarehouse.com being the more popular of the two. Average order value of purchases on the sites is approximately $120.

PRTS discusses how they are able to directly acquire from the manufacturer, thus eliminating intermediaries. In essence, PRTS websites become the intermediary or 'middle-man' in the auto parts supply chain. As with many online retailers, PRTS feels the lack of brick/mortar expenses and their flexible fulfillment methods allow them to discount prices at attractive levels for buyers.

Industry

The U.S. aftermarket auto parts market is $200 billion business. PRTS believes their addressable total market domestically is a little over $90 billion. Overall the U.S. auto parts market is characterized by slow growth, specifically in recent years as auto manufacturers' new car quality ratings have increased. Better built new cars, means slowing demand for aftermarket auto parts. PRTS believes the exception to this slowing growth is the online auto parts aftermarket niche. Currently just 3% of the U.S. aftermarket auto parts market activity is done online. That number is expected to grow to 13% by 2010.
auto parts
PRTS made a substantial acquisition in the first half of 2006. The acquisition was Partsbin, another online retailer of auto parts. Price was approximately $60-$70 million in cash, stock, and other considerations. The acquisition significantly increased PRTS product offerings and number of SKUs, particularly in the area of engine parts and performance parts and accessories. One of PRTS biggest challenges at the start of 2007 will be continuing to profitably integrate this acquisition into their business.

Note - The PRTS acquisition did add to cash flow in the back half of 2006. However, Partsbin's products have historically sold at a lower gross margin than PRTS products and the acquisition resulted in amortization charges on PRTS' earnings sheet. So while the acquisition is adding cash flow and appears to be a potential growth driver for PRTS, it is dragging down gross margins and GAAP earnings in the short term. The result of this is that PRTS is actually doing much better financially than their recent earnings reports would indicate.

Competition
While there isn't a public pure play comparable for PRTS, there is intense competition in the aftermarket auto parts business. Historically, this sector has been dominated by brick and mortar retailers such as Napa, Pep Boys (NYSE:PBY), AutoZone (NYSE:AZO), Advance Auto Parts (NYSE:AAP), etc... While all of those still derive the majority of their revenues from their retail outlets, each does offer an extensive parts catalog online as well.

Also auto parts wholesaler LKQ Corp. (LKQX) has done very well since its ipo in 2003. This is a very competitive niche, which was indicated by PRTS' gross margins sliding a bit annually the past few years, as the 'brick and mortars' focus more attention on their online businesses.

It's a very low barrier to entry here for the established payers to compete effectively with a company such as PRTS. In fact, the established companies may indeed have two very nice advantages, name recognition and deeper advertising pockets.


Financials

$1 1/2 per share in cash, no debt. PRTS is paying off on IPO all debt incurred in the Partsbin acquisition.

For full year 2005, Partsbin's revenues were approximately 63% of PRTS. PRTS booked $60 million in 2005 revenues, Partsbin $38 million. Backing Partsbin into 2005 numbers results in total revenues for 2005 of $98 million. Gross margins for PRTS business in 2005 were 42%, for Partsbin 24%. Gross margins for the combined companies was 35%.

Note the acquisition of Partsbin will mean approximately $0.25 in amortization charges for PRTS in 2006/2007/2008. This will not effect cash flow, but will impact the GAAP bottom line by that $0.25 annually.

2006
- Through first nine months combined PRTS/Partsbin revenues appear on track for $140-$145 million, a strong 45% increase over the combined PRTS/Partsbin 2005 revenues. Gross margins have slipped a bit for the combined entity to 33%. Really though not much of a drop for the % revenue increase. It would appear then that much of the revenue increase has been organic and not a result of PRTS slashing prices heftily to boost revenues.

Folding out the amortization charges, operating expenses look to be 25% of revenues. This is an improvement on 2005's 27%, which covers for the gross margin erosion.

GAAP and non-GAAP: For a small online ipo, that $0.25 in annual amortization charges due to the Partsbin acquisition is really going to impact GAAP earnings. We'll take a look at the net margins and earnings with and without that amortization charge. Normally I like to only look at the official bottom line number, however the Partsbin acquisition appears as if it will 1) grow PRTS business/reach nicely, 2) add products PRTS has previously not offered, 3) not add any debt to PRTS balance sheet thanks to the ipo, 4) add to cash flows as the business is integrated. To me the potential positives here outweigh the anchor of the $0.25 annual amortization charge through 2008.
auto parts logo
2006 net margins and earnings without amortization charge: Through first 9 months, net margins appear as if they will be 6%-6 1/2%. Net for full year of approximately $0.30. On an $11 pricing, PRTS would be trading 37 X's 2006 earnings. 2006 with amortization charges: net margins of 2 1/2% and earnings per share of $0.12. In my opinion, the $0.30 number is more reflective of PRTS current operations than the $0.12 number.

2007 - The 2006 revenue growth for the combined entity was outstanding. I would not expect similar 45% growth in 2007. However, based on the strong 9/06 quarter of nearly $40 million in revenues, PRTS would appear to be gaining strong traction in the online aftermarket auto parts niche. Their growth in the past three years has easily outpaced the sector and it appears the Partsbin acquisition has opened up new customer bases for the company. I would be surprised if PRTS is not able to hit $180 million in 2007 revenues.

As always I prefer to be a bit conservative with projections, especially since we've yet to see the 12/06 quarter. I would expect a bit more gross margin contraction, which should be made up on operating expense decline. Without amortization charges then, PRTS could quite conservatively earn $0.40-$0.45 in 2007. On an $11 pricing, PRTS would be trading approximately 25 X's current year earnings. Official earnings will be much less of course with the amortization charges, $0.20 or so.

Note - 2007 estimates are a ballpark projection. We'll have a much better idea after the 12/06 quarter, which should be released in the next month or so. Also, once again, keep in mind PRTS through 2008 will actually be doing much better operationally than the official GAAP earnings number.

Conclusion
There's a lot of competition in this sector and PRTS does not appear to have anything proprietary to push revenue growth. However, PRTS continues to rapidly grow revenues. The 2006 revenue growth was simply outstanding. This is even with backing in the Partsbin acquisition, as if it occurred 1/1/05. The revenue growth here is what interests me. They've managed to grow in a competitive niche without killing their gross margins. That revenue growth would seem to indicate the company is doing something very 'right' to attract business.

Yes I'm concerned with the brand name brick & mortar operations competing online with PRTS; as of now, though, PRTS is more than weathering that competition, they're organically growing revenues in the face of it. This is an ipo whose quarterly reports must be watched very closely for signs of gross margin deterioration. However, I'm recommending this deal in range, based entirely on their 2006 revenue ramp in a very competitive sector.

Note - for first 2 years public due to the amortization charges, PRTS will appear much more expensive on a PE ratio than the underlying business actually represents. I would imagine this perceived 'pricey-ness' would tend to grow the short interest here on any move up.

Source: IPO Analysis: U.S. Auto Parts Network Gains Traction