I’m on my way to Las Vegas for SEMA AAPEX 2016 right now. Super excited as always for these industry events. Are you in town? If so, please join me and scores of other industry insiders Thursday afternoon at the Westgate for Happy Hour. It’s all very casual, but a great opportunity to gather around, grab a bite to eat or an afternoon drink, and meet someone new.
This week I want to recap an area that I’ve spoken about in the past – synergy in the automotive aftermarket. When helping clients with mergers and acquisitions, we spend a lot of time identifying and quantifying synergies. Synergies are advantages that come about through the combination of two companies that are otherwise unachievable by the standalone company. If you are evaluating a sale, or considering growth by acquisition, understanding the role synergies play is important when evaluating if a transaction “makes sense”. There are three common types of synergies we see add a lot of value to a deal: revenue, cost, and financial.
Revenue Synergy in the Automotive Aftermarket
A revenue synergy is when, as a result of an acquisition, the combined company is able to generate more sales than the two companies would be able to generate separately. For example, consider LKQ and Keystone in the collision parts distribution business. Prior to LKQ’s acquisition of Keystone, LKQ sold primarily used parts. Keystone sold primarily aftermarket parts. However, in the combined company, LKQ could leverage its existing distribution network and sales force to sell more aftermarket parts into the industry than Keystone could sell as a stand-alone organization.
Often, when a larger consolidator acquires a smaller competitor, the larger consolidator leverages existing client relations to drive more sales into the new business than the stand-alone operator is able to on its own.
Revenue synergies can create very attractive economics for both buyer and seller. A savvy seller can command a substantial premium if the revenue synergy that the selling company provides is unique to the buyer. Conversely, a savvy buyer can often justify paying a greater premium than is typical, confident that increased revenues post close will offset the additional consideration provided to the seller.
Cost Synergy in the Automotive Aftermarket
Cost synergies refer to the opportunity for the combined company to reduce costs more than the two companies would be able to do individually. Cost synergies are a driving force of continued consolidation throughout the automotive aftermarket. Carl Icahn’s acquisition of Auto Parts (formerly of Uni-Select) was designed to take advantage of scale and cost synergies in auto parts distribution. Icahn’s recent acquisition of Pep Boys further plays into that strategy, providing additional revenue and cost synergies.
Another example in automotive parts distribution is when LKQ acquired Keystone. When LKQ acquired Keystone, LKQ could distribute aftermarket parts through its existing distribution network. LKQ was able to eliminate significant costs by combining companies in a way that Keystone was unable to on a stand alone basis (e.g. associated delivery trucks, fuel, insurance, delivery drivers, warehouses, storage, etc.). As a result of the LKQ – Keystone acquisition, LKQ’s overall cost of doing business dropped while its sales nearly doubled. LKQ’s recent billion dollar acquisition Rhiag-Inter Auto Parts Italia, a multi-national distributor of aftermarket mechanical parts, is another example of both revenue and cost synergies. Through the Rhiag acquisition, LKQ can leverage the existing infrastructure between the two businesses to reduce marginal costs while expanding its sales base.
Financial Synergy in the Automotive Aftermarket
In some cases, combining companies can result in financial advantages the stand-alone companies would be otherwise unable to achieve individually. For example, smaller companies generally have to pay a premium when borrowing money relative to larger companies. However, two mid-sized companies can merge and lower their combined cost of capital more than they could individually. There may also be unique tax benefits and possibly an increased debt capacity as a result of merging that would otherwise be unavailable.
Be cautious when evaluating financial synergies, however, as studies have demonstrated that these synergies tend to be illusive. However, in certain situations they are worth considering.
Identifying Synergy in the Automotive Aftermarket
Synergies in the automotive aftermarket can be tricky to identify, and even more difficult to articulate. But without clearly identified and quantified synergies, most acquisitions simply do not make financial sense. Accurately articulating the financial value of specific synergies is critical for both buyers and sellers.
For sellers, it is important to understand the synergistic opportunities your company provides to the acquiring company. A detailed description of these synergies likely will increase the price an acquirer is willing to pay for your company. Even experienced buyers may not readily see all the potential synergies in acquiring your business. A skilled M&A advisor will assist in identifying and quantifying these synergies.
For buyers, it is even more important to clearly understand the potential synergistic benefits of an acquisition prior to a close. Clear insight into both revenue and cost synergies drives a conversation around valuation. Understanding how and when these synergies will be realized is important in developing a deal structure that helps ensure that the synergies are captured appropriately.
Consolidation and Synergy in the Automotive Aftermarket
Synergies play a substantial role in driving valuation (i.e. increasing price). The ability of a management team to identify and extract the expected synergies plays a major role in the success or failure of an acquisition. Consolidation in the industry will continue, even in the face of political uncertainty, increasing interest rates, and other challenges often a richly-valued acquisition can appear moderately priced after taking into account the impact of revenue and cost synergies post close.
If you want to know more about how we identify and quantify synergies in a transaction, you can use my contact page to reach me (subscribers simply hit REPLY). And if you think all this talk about synergies is overrated – share that with me too and tell me why. I read all the emails and respond to most so don’t be shy. I enjoy chatting with others in an industry I’m passionate about.
Until next week!