Who’s footing the bill?
As expected the deal was finalised last week for the acquisition of UK based dealer group Jardine Motors by Lithia of the US. It is anticipated that the coming months will see more activity by Lithia as they seek to expand their UK footprint from the upper premium focus that Jardine currently has. Although not published, it appears that the value of the Jardine transaction itself was around US$500 million so with a few more bolt-on deals, the total investment could easily be approaching a billion dollars. That’s a lot of money by any standards, but based on Lithia’s comments, it was financed from “existing balance sheet capacity”, i.e. cash and existing loan facilities.
That balanced approach to funding deals appears to be common amongst established dealer groups who are pursuing growth strategies. When Robert Forrester, the CEO of acquisitive UK dealer group Vertu (ranked by us as #11 in the European Top 50 last year), announced their last half year results a few months ago he referred to the group as having “significant firepower to expand its footprint of franchised dealerships across the UK.” This was demonstrated a few months later when they announced the acquisition of regional group Helston Garages with 28 outlets for a total consideration of £117 million, financed through a combination of renegotiated and new debt facilities. Investors appear to approve as the share price has grown steadily since last October, up over 10% since the deal was announced.
It is then interesting to compare this with the approach adopted by the so-called disruptors, who seem to depend mainly on other peoples’ money to fund their ambitions. I've commented before on the fall and fall of Cazoo which has continued since I last wrote about them two months ago. Since then their share price has more than halved reducing the value of the business by a further $91 million to the current share capitalisation of only $73 million. I wonder whether the elevation two weeks ago of Jonathan Dunkley (formerly CEO of CarShop, and then a member of the board of Sytner, the UK arm of Penske, following their acquisition of CarShop) from Strategic Adviser to Chief Operating Officer might be the first step of a management buy-in? Setting that question aside, it is obvious that the vast majority of the funds that have been spent on the marketing blitz and acquisitions subsequently sold at pennies in the pound has not come from the founders, bank lenders or trading profits but from external investors.
Looking then at Constellation Automotive Group, unusually in automotive retail it is owned by a private equity firm, TDR Capital. Constellation has created the cinch business as a startup in the used car sector competing directly with Cazoo as well as traditional players, but also acquired the CarNext business from LeasePlan (another portfolio company of TDR), Marshall Motor Group (European #15 at the time) in a deal finally concluded last spring and a 20% stake in Lookers (European #5). Results for the financial year 2021/22 were announced back in January which showed that cinch lost £149 million pre-tax over that period, whilst the Constellation Group as a whole made a pre-tax profit of just £34 million. It is standard operating procedure in my experience for any private equity firm to require their portfolio businesses to fund any deals on their balance sheet as well as the related deal costs. So if the funding for this shopping spree and the launch of cinch did not come from the shareholders or retained profits, where did it come from?
It was reported that Constellation raised £1 billion in private capital in May 2021 from investors including the Abu Dhabi Investment Authority (ADIA) and GIC (the Singaporean sovereign wealth fund), though TDR remains the controlling shareholder. These new funds appear to have been in the form of bonds, rather than shares. I am not a financial analyst, so I make these observations somewhat tentatively, but looking at available reports from the leading rating agencies, Fitch and Moodys, a large part of the funds went back to TDR, with the balance remaining in the business. Fitch described the company’s financial policy as “aggressive” due to high balance sheet leverage, and both currently show a negative outlook, i.e. they expect things to get worse rather than better.
What does this all mean back in the real world off automotive retail? I would suggest that it means we should look at consolidators and new entrants in three categories, each representing a different level of risk in terms of their ability to stay the distance. The trade buyers such as Lithia and Vertu clearly understand the industry and take a relatively cautious approach to funding acquisitions incrementally. I see their focus as building long term value. Constellation Automotive Group falls into a second category in my view, where it has a successful operational record in the sector but the ownership is reflected in more use of financial engineering to support rapid growth and the potential for a profitable exit by current shareholders. This is inherently riskier, particularly with the multiple uncertainties that face the sector at present. And then we have the ‘houses built on sand’ like Cazoo where I think my views are clearly understood by anyone who reads my blogs.
Consolidation in the retail sector has been underway for years and is accelerating as the deals become bigger. Nothing will change that, but we also need to understand the extent to which the buyers have ‘skin in the game’ and therefore the likelihood but they will stay the distance to generate the benefits that can come from the consolidation process. There is room for all types of players – including the pure start-ups, but we should not view them as equals.