Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids: Real M&A

A buyout of Pep Boys at the lowest auto-parts valuation in a decade is leaving the door open for a bidding contest that may cost the winner 27 percent more.

Pep Boys - Manny, Moe & Jack agreed to sell itself to private-equity firm Gores Group LLC for $15 a share yesterday. Including net debt, the $1 billion takeover values Pep Boys at 5.9 times its earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg. That’s less than any deal for an auto-parts retailer worth at least $100 million since 1999, the data show.

With analysts projecting Pep Boys will generate the most free cash flow in almost a decade in the coming fiscal year, Avondale Partners LLC now says the Philadelphia-based company could be worth as much as $19 a share in an acquisition. While its operating margin has recovered after Pep Boys lost more than a penny for every dollar of sales in 2008, private equity firms still have room to increase its profitability that still lags all its closest rivals, according to Gabelli & Co.

“The bid price leaves some room for another financial buyer to pay up,” Brian Sponheimer, an analyst for Gabelli in Rye, New York, said in a telephone interview. “The company is well positioned to generate strong free cash flow over the next several years.”

Gabelli is a unit of Gamco Investors Inc., which owned shares of Pep Boys as of Sept. 30.

Stan Neve, a spokesman for Pep Boys, said in a telephone interview that the “merger agreement with the Gores Group was reached after careful evaluation.”

Relative Value

“The merger agreement includes a go-shop provision to determine whether other prospective buyers would offer even more value for the company,” he said.

“We think this is a full and fair price,” said Ryan Wald, managing director at Los Angeles-based Gores Group. “The management team and the board have done a great job of maximizing value for all of the shareholders.”

Pep Boys traces its roots to 1921 when four Navy friends pooled $800 to open an auto parts supply store in Philadelphia, according to the company’s website. Since becoming a publicly traded company 65 years ago, it has grown to more than 700 locations that repair vehicles and sell parts such as tires, brake pads and windshield wiper blades.

Average Price

Gores Group’s offer of $15 a share in cash was 34 percent higher than Pep Boys’ average price in the previous 20 trading days and valued the company at $1 billion including $215 million in net debt, according to data compiled by Bloomberg.

While the agreement contains a 45-day “go-shop” period that lets Pep Boys consider other offers, the deal is expected to be completed by the end of the fiscal second quarter of 2012, the companies said in a statement yesterday.

The acquisition sent Pep Boys’ shares as high as $15 yesterday before closing up 24 percent at $14.93. That was the biggest gain since May 2001, according to data compiled by Bloomberg. Pep Boys rose as high as $15.01 today and was up 0.5 percent to $15 at 10:30 a.m. in New York.

Gores Group’s offer valued Pep Boys at 5.9 times its Ebitda of $171.4 million in the past 12 months. That was the lowest for a takeover of an auto-parts retailer worth more than $100 million since Unipart’s 1999 purchase of Partco Group Plc in the U.K., data compiled by Bloomberg show.

Sales Discount

The current Ebitda multiple for Pep Boys is at least 22 percent less than 11 other U.S. automotive retail companies worth more than $500 million, data compiled by Bloomberg show. Pep Boys also trades at a 61 percent discount to sales of $2 billion in the past 12 months.

“The price is going to prove to be particularly attractive for the buyers,” Stephen F. Roseman, chief executive officer at New York-based Thesis Fund Management LLC, said in a telephone interview. “It’s a classic private equity turnaround.”

The Thesis Flexible Fund has about 4.8 percent of its assets invested in Pep Boys, the highest proportion for any fund, according to data compiled by Bloomberg.

Other buyout firms may emerge because Pep Boys is boosting its free cash flow and has margins that can be improved, according to Bret Jordan, a Boston-based analyst at Avondale.

Operating Margins

After deducting capital expenses, Pep Boys will produce about $66 million in cash from operations next year, according to analysts’ estimates compiled by Bloomberg. That would be more than it has generated since 2004, the data show.

The company had an operating margin of 4.1 percent in the past 12 months, data compiled by Bloomberg show. Its largest rivals, including Monro Muffler Brake Inc., O’Reilly Automotive Inc. and AutoZone Inc., all had margins of at least 7.1 percent.

Pep Boys may be able to get a price in the “higher teens,” Avondale’s Jordan said. An offer for $19 a share would be 70 percent higher than the stock’s average in the 20 days prior to Gores Group’s bid and 27 percent more than its current agreement, according to data compiled by Bloomberg.

Still, Pep Boys ended 0.5 percent below Gores Group’s offer at $14.93 a share yesterday, signaling some traders aren’t yet betting on a competing bid, the data show.

Pep Boys had halted efforts to sell itself last year after failing to attract a high enough price, two people with knowledge of the negotiations said in February.

‘A Formality’

It had received initial indications of interest at $10 a share to $11 a share, the people, who declined to be identified because talks weren’t public, said at the time.

“$15 per share is pretty much as good as it’s going to get for Pep Boys,” Anthony Cristello, a Richmond, Virginia-based analyst at BB&T Capital Markets, said in a telephone interview. “The go-shop provision is more of a formality. The likelihood of another private equity or financial buyer coming in is probably fairly low at this point.”

With analysts projecting a fourth straight year of earnings growth as the company rebounds from the biggest profit slump in at least two decades, according to estimates compiled by Bloomberg, Avondale’s Jordan says Pep Boys can attract more takeover interest.

“It’s been trending upwards from a profitability standpoint as they refocus the business,” he said. “I wouldn’t be stunned by a higher-teen offer.”

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