Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Shareholders of Advance Auto Parts have been down this road before. 

The seller of auto parts and accessories climbed about 3 percent in afternoon trading on Wednesday, adding to an almost 6 percent gain a day earlier on news that it's exploring a sale after being approached. The stock had a similar surge three years ago when Advance Auto Parts was said to have hired Blackstone Group to explore options including a sale, and had reportedly attracted interest from private-equity firms (obviously, a transaction never transpired).

It's unclear who the suitor may be this time around, but there's a case to be made for O'Reilly Automotive -- the biggest player by market value among auto-parts retailers -- to step up if it hasn't already. It's an industry segment that's ripe for consolidation and has already seen movement after Japanese tire maker Bridgestone and Carl Icahn faced off for a smaller competitor, Pep Boys. 

Through an acquisition of Advance Auto Parts, O'Reilly -- which is set to meet its target of opening 205 stores this calendar year -- could quickly add 5,200 outlets to its existing tally of around 4,500. That move is already in its playbook: O'Reilly bought CSK Auto in 2008, bolstering its store count by more than 1,300.

A combined company would better penetrate Northeastern states where O'Reilly has a minimal presence, and Western states where Advance Auto Parts has a minor footprint. Plus, Sterne Agee analysts point out that significant store divestitures are unlikely to be needed to obtain antitrust approval. That's in part due to the sprawling reach of the other two big competitors in the market, AutoZone and Genuine Parts. 

Paying a premium of 30 percent to Advance Auto Parts’ closing price Monday would allow a deal to be immediately accretive to O'Reilly's earnings even before factoring in any cost savings, according to data compiled by Bloomberg. Such a price tag would represent a similar premium but a higher earnings before interest, taxes, depreciation and amortization, or Ebitda, multiple when compared to Bridgestone's sweetened offer this week for Pep Boys, a smaller auto-parts retailer and service chain that's become a target. 

Even though it has little debt, O'Reilly could choose to use a large portion of stock as currency to fund any transaction. While down from the all-time high it reached in October, the auto retailer is trading at at a forward price-to-earnings multiple of 24.3, well above the industry median. 

Shift Gears
O'Reilly Automotive's stock has outperformed that of its rivals.
Source: Bloomberg

One beneficiary of any deal is Advance Auto Parts shareholder Starboard Value, which said in a September letter that the stock could be worth "well over" $400 a share (more than double its current price) if the company can roughly double its operating margins to replicate O'Reilly. Though significant operational improvements would be required, O'Reilly may see the value in being the one to drive those changes and could easily impart its supply chain and distribution expertise. 

Stalled Out
Supply chain and other improvements could drive Advance Auto Parts's profitability closer to its peers.
Source: Bloomberg

Icahn Enterprises, which made a surprise bid for Pep Boys, is an outside chance to enter the fray for Advance Auto Parts. Although an acquisition of Advance Auto Parts would transform Icahn Enterprises' auto business, which posted $5.8 billion in revenue in the nine months ended Sept. 30, a deal looks like a stretch based on Advance Auto Parts' size (almost $12 billion) and valuation.

That said, a deal comes at an opportune time for any buyer. Advance Auto Parts is in a state of leadership flux: its CEO Darren Jackson is stepping down next month, leaving its president as interim CEO. And industry trends are favorable: in the U.S., the average light vehicle is more than 11 years old (a record high) and the number of miles driven in 2014 surpassed the pre-crisis peak of 2008, according to Bloomberg Intelligence. 

Journey's end, though, may make the most sense at O'Reilly's door. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net