We’ve talked a bit about the state of the industry and the Big 4, or the Big Boys as I sometimes call them (Boyd/Gerber, Caliber, Service King, ABRA). While they may be in the same business of fixing cars, the way they do things is systematically different.
(Editor’s Note: Keep an eye out for our upcoming article on the role of franchise based MSO’s and their impact on the industry.)
Perhaps the least understood difference is at the core of their business – how they actually make money for their shareholders.
Some people believe they give heavy discounts and make it up in volume. Others believe they don’t actually make money, and are barely holding on.
The reality is that these businesses are making millions upon millions of dollars. But not the way you may realize.
The Big 4 are owned by large Private Equity Groups (PEG’s). The PEG’s often invest money on behalf of public institutions (i.e. pension plans, insurance funds, etc.). They also have a slew of individuals with master degrees in Finance, Business, and Applied Mathematics.
Why is this important?
You probably focus on running a great business that focuses on delivering a great product, done right and delivered on time, in a way that delights your customers while also generating healthy cash flow and strong profit margins.
For large institutional investors those things are important. But even more important (and exciting) is growing a business.
Growth is exciting because the whole of the business is worth more than the sum of the parts. Or in other words, 2 + 2 = 5.
In the collision industry, often the easiest way to get to 2 +2 = 5 is to expand the number of locations under management.
That is because a business with five locations is more valuable than a business with only one. Similarly, 50 is more valuable than 10.
From a management standpoint a company owned by a private equity group will likely have a mandate to focus on growth and expansion while maintaining margins.
A smaller privately held business will instead most often have a mandate to maximize profit margins first, and then focus on growth and expansion second.
The difference in approach to firm management has significant implications for the industry.
For example, a financial analyst reviewing a potential acquisition by a private equity group may assume that the business to be acquired will generate NO free cash flow to equity holders.
The analyst may even assume that at some point the business will require an additional cash infusion to stay afloat.
In other words, it will cost the PEG money in excess of what the purchase price to run the business.
And yet this may still be an attractive target for a private equity group.
The PEG may feel they can increase the overall value of the firm even if the firm produces no profit and no free cash.
How is that possible you ask? This is the difference between maximizing enterprise value rather than maximizing profit margins.
We’ll talk more about the difference in future letters and the impact this is having on the industry.
reminds me of the follow logic.
Mick and Pat started a business buying and selling potatoes. They would drive to the potato farm 75 mile away early in the morning, load the truck, pay the farmer $20 per kg and drive to the market, set up the stall by 10 am and sell the potato’s for $20 per kg. After a few weeks they had drained all their cash reserves and were scratching their heads trying to work out why?.
After a lot of deliberation Mick had a blinding flash of a brain wave. Pat he said,
“We’ve got to get a bigger truck”.
Don’t kid yourself, they do make money. They don’t focus on the problems and whine all day. They do what they do best and that is make money. While you guys are busy complaining about not getting paid 2 10th they are signing up a new contract. Hint: start co-op buying negotiations.
I believe they see the future labor rate changing. And once it does it will not stop. Then they will sell.LOL
I was a market manager for one of those big boys. James Moy is DEAD ON !! they will continue to grow, they will continue to profit and they will continue to take market share. All while the rest of the industry whines and complains.
Thanks all for the input. The Big 4 are changing they way business is done in the collision industry. These companies are professionally managed, often in a manner far superior to the stand alone collision repair facility. As the industry evolves, depending on your point of view, this can be a huge opportunity or an intimidating threat.