M&A Announcement

Dec 12, 2019

Good day, and welcome to the Asbury Automotive Group Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Matt Pattoni, Vice President of Finance and Treasurer. Please go ahead, sir. Thanks, operator, and good morning, everyone. Welcome to Asbury Automotive Group's Investor Update Call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's proposed acquisition of Park Place Dealerships was issued earlier this morning and is posted on our website at asburyauto.com. Participating with us today are David Holt, our President and Chief Executive Officer and Matt Pitoni, our Vice President of Finance and Treasurer. At the conclusion of our remarks, we will open the call up for questions and I will be available later for any follow-up questions you might have. Before we begin, I must remind you that the discussion during the call today is likely to contain forward looking statements. Forward looking statements are statements other than those which are historical in nature. All forward looking statements are subject to significant uncertainties and actual results may differ materially from those suggested by the statements. For information regarding certain of the risks that may cause actual results to differ, please see our filings with the SEC from time to time, including our Form 10 ks for the year ended December 2018, any subsequently filed quarterly reports on Form 10 Q and our earnings release issued earlier today. We expressly disclaim any responsibility to update forward looking statements. In addition, certain non GAAP financial measures, as defined under SEC rules, may be discussed on this call. As required by applicable SEC rules, we provide reconciliations of any such non GAAP financial measures to the most directly comparable GAAP measures on our website. It is my pleasure to hand the call over to our CEO, David Holt. David? Thanks, Matt. Good morning, everyone. Asbury's vision is to build the most guest centric company in the automotive industry. And today, we just took a major step towards achieving this objective. This morning, we announced a transformational acquisition for our company and entered into an agreement to acquire 10 of Park Place's dealerships. 9 are in the Dallas Fort Worth market and one is an open point in Austin. Park Place is one of America's largest and most predominant luxury dealer groups and they are regarded as one of the best and most efficient operators of luxury stores in the industry. Park Place has a strong base of loyal clients and 2,100 long term team members throughout the high growth Dallas Fort Worth market. Park Place has a unique portfolio of award winning luxury dealerships. Three stores are ranked among the top 10 stores in volume in the country amongst their franchise Mercedes Benz, Porsche and Bentley. In addition, the Jag Land Rover store and both Lexus stores are ranked in the top 15 and the Volvo store is ranked in the top 20. We have had great success acquiring large, well run stores and we fully expect Park Place to be equally successful. We are also excited to grow our presence in Austin with the Jag Land Rover Open Point, which is another high growth luxury market. We expect it to open in the Q1 of 2020. We truly believe Park Place will transform our company long term for the following reasons. First, this acquisition will meaningfully scale our business increasing our revenue by 30% and it will transform our mix of revenue from luxury stores from 33% to 50%. The luxury segment has historically delivered strong and stable margins that are significantly above those achieved by midline import and domestic brands. Luxury stores are more resilient in downturns, have higher and more stable margins, have fewer dealers nationwide and derive a higher portion of gross profit from parts and service. 2nd, this transaction will increase Asbury's geographic mix to 36% of its revenue derived from the high growth luxury dominant Dallas Fort Worth market. This market has a 30% higher This market has a 30% higher penetration of luxury new vehicle sales than the national average. Dallas is home to 23 Fortune 500 Companies and has had some of the highest population growth over the last decade. I have lived in Dallas and it is one of the best, if not the best luxury car markets in the country. 3rd, the combination of Asbury and Park Place is intended to build a company that derives approximately 50% of its gross profit from parts and service. Park Place generates 56% of its gross profit from parts and service versus Asbury's 48%. A huge amount of our focus over the last decade has been growing our parts and service business because it has higher margins, is more stable in downturns, has a higher gross profit flow through to income and has more organic opportunities to grow regardless of SAR fluctuations. This acquisition is expected to enhance these opportunities and improve our margins and the resiliency of our business. 4th, in addition to synergies and performance improvements identified, there are opportunities for organic growth. We will be acquiring the Jag Land Rover Open Point in Austin and Park Place also has recently begun subscription service. This will provide us an ability to explore this new selling method in more detail. Also, we have a strategic growth opportunity to build out Park Place's in house auto auction. 5th and most important, the people. Park Place built large award winning stores with an exceptional reputation. It takes long tenured, dedicated team members with strong processes to achieve these results. We believe that bringing together what Park Place does best and what Asbury does best will drive significant shareholder value and it will bring us closer to achieving our vision to become the most guest centric automotive retailer. Finally, I look forward to welcoming all the Park Place team members. We look forward to working with you. I also want to thank all the Asbury team members and our outside partners who have helped us with this transaction. We truly appreciate your support. I'll now hand the call over to Matt to discuss the financial impact. Matt? Thanks, David, and good morning, everyone. This is a transformational opportunity for our company, not only because it puts us many steps closer to building the most guest centric automotive retailer in the industry, but also because it magnifies our 2 part strategy of driving operational excellence and deploying capital to its highest return. In addition to increasing our revenue by 30 percent or $2,000,000,000 to approximately $9,000,000,000 in annualized revenues, we believe this transaction allows us to deploy over $1,000,000,000 at returns well above our cost of capital. The purchase price of approximately $1,000,000,000 includes $785,000,000 of goodwill, approximately $215,000,000 for real estate and leasehold improvements and approximately $30,000,000 for parts and fixed assets. This price excludes the cost of vehicle inventory. The purchase price reflects a 10x multiple on approximately $100,000,000 of EBITDA, which includes expected run rate synergies of at least $20,000,000 These synergies are expected to be realized over the next 3 years. The $100,000,000 is also reduced for floorplan interest. Not included in these synergies are potential operational improvements from combining the best of Park Place's processes with the best of Asbury's. In addition, we expect $11,000,000 in annual cash tax savings from goodwill amortization, which equates to approximately $90,000,000 in present value or equivalent to one turn on an EV to EBITDA multiple. This acquisition also includes the purchase of $215,000,000 of real estate, which trades at much higher multiples. This transaction will increase our own real estate and keep our own real estate percentage above 70 percent. We believe these factors combined with the incremental profit from the Open Point auction and other performance opportunities delivers a 3 year return return on invested capital well above our cost of capital. The acquisition of Park Place, assuming an end of March close, is expected to be accretive to 20.20 earnings per share by approximately $1 to 1.25 dollars excluding the impact of one time transaction costs. Asbury also expects to incur pre tax costs associated with the transaction of approximately $0.05 to $0.10 per share in Q4 2019. These costs are mainly financing related, but also includes legal, audit and other outside consulting related fee. This transaction is expected to be funded through a combination of Asbury's existing credit facilities, cash flow from operations and committed financing arrangements. Asbury has secured committed financing, which it expects to replace with permanent financing prior to closing. Although the transaction is expected to take our targeted leverage of 2x to 3x above that range, we believe that given the accretive nature of the deal, the strength of our business, the improved combined free cash flow generation, the increase in our real estate ownership, the increase in less cyclical luxury brands to 50%, the improved parts and service mix and the increase in organic growth opportunities, we can maintain a solid credit profile and delever to under 3 times by 2022. Our primary capital allocation focus will be on delevering through debt reduction and growth in earnings. We are We will now turn the call over to the operator and take your questions. Operator? Thank you very much. Ladies and gentlemen, at this time, we would like to open the floor for questions. Our first question will come from Rick Nelson. Thanks. Good morning and congratulations on the deal. Thank you. So David, can you provide some color around the synergies that you see here? And I know you indicate you see those synergies growing, if you could comment there as well? Sure, Rick. A lot of it has to do with 3rd party contracts, improved cost of capital and combining outsourced functions that we have internally. It's really taking advantage of our scale and lessening some of the hard costs that they have within the organization. It looks like this is a good operator. I'm calculating an EBITDA margin of 5.2% based on that $100,000,000 I think Asbury, you are at 4.6%. Greg, this is Matt. Yes, they are a great operator and the luxury store profile, they do have a strong operating margin, slightly higher than ours. So very attractive in that regard. So you're correct. And are there, in fact, opportunities to improve performance in used cars or F and I or SG and A? Sure. This is an amazing asset and the tremendous team members here who have a tremendous reputation. But the best run store in the country certainly has room for improvement. They have we look at their run rates over the last 3 years and where they're trending. Their parts and service growth trends with ours far as growth each year. So we're expecting that going forward. And there's certainly opportunities in F and I, the auto auction, Open Point and some other areas as well. And David, to you have the green light with all the manufacturers, Lexus is part of this deal and I know you had some Lexus stores, but I'm not sure how many you had prior to. Sure. We're through the due diligence period, but because of the size of the acquisition, the timing when this has to be announced, we now start that process with all the OEMs. We don't anticipate any issues at this point in time. So we feel good about where we're positioned with each of the brands. Got you. Can you remind me how many Lexus stores you had prior to this? Yes. We had 4 we have 4 Lexus stores in the United States right now. And this would be a 5th. What don't they have caps at 4 stores, Lexus? Nationally, the cap is 6 percent and I think they might have increased that to 8%, but it's a minimum of 6 percent nationally. Okay. Yes. Or maximize it. Got you. It. Thanks and good luck. Thank you, Rick. Thank you. Our next question will come from John Murphy. Good morning, guys. This is Erdan Amsellem on for John. I guess, can you maybe first talk about the rationale for buying an already strong and outperforming asset versus an underperforming group with more of a turnaround potential? Sure, this is David. I would say stability and resilience is important when you think about a portfolio. I think it's a high risk opportunity to take on a large underperforming platform. I think this really enhances our luxury presence. What excites us the most about this deal are, 1, the people. The brands are fantastic, but we're very focused on the throughput. All our time is in our current business is spent on how do we increase our throughput in the stores that we have. These are very large stores that have tremendous throughput and tremendous operating margin. So we think the stability of the group and their reputation will not only give us opportunities as an organization to learn from them, but really create resilience going into the future. And then in your press release, you've noted that the luxury dealers performed better in the last downturn in the financial crisis. So is this acquisition in any way reflected preparation for an expected downturn on your end? Sure. No, it wasn't intended for that at all. We actually were optimistic about 2020. It's tough to say beyond that at this point, but it was more a frame of reference to build the value in the luxury brand and how well it performs over time. Great. Thank you for that. And then, I know that parts and service is a little stronger for parts versus Asbury. So Is this largely a function of their brand mix or are there any lessons that can be learned and then be deployed back into the Asbury dealers? Well, I would certainly say that brand mix and throughput has a lot to do with that and their efficiency with it. But that is one of the things that we're excited about getting in there and really seeing what we can learn from them and bring to our other stores. Great. Thank you. And I guess just lastly, does this acquisition reflect maybe a more concentrated effort for you guys to get even more luxury into the mix? Or was this just a fact like was this a key factor in the process? We've looked at a lot of opportunities and a lot of acquisitions this year, and our thought process is not about being the largest, but how do we have the best portfolio of stores that is an attractive mix for our shareholders. This opportunity came up and it seemed like a perfect fit for us with our culture, who we are and the culture of this organization. We've learned over the years it's very easy to acquire some, much harder to run it, and we think that we could be very good stewards of this business. So it was a timing play and it was an opportunity for us to increase our luxury presence in a very strong and dominant market, which we also do believe it does build resiliency in our organization over time. Okay, great. Thank you so much. Thank you. Thank you. Our next question will come from Bret Jordan. Good morning. This is Mark Jordan on for Bret. Good morning. Just going back to the synergies, I know you mentioned there's certain third party services that can be brought in house, but the press release mentions potential additional synergies from operational improvements aside from the $20,000,000 that was identified. Where do you see those synergies coming from? Yes. F and I, natural growth in parts and service are 2 for sure and the auto auction as well as the open point. Okay, great. Thank you. And just one quick question on the parts and service business. Are you able to disclose the margin there? Is it higher than your current part and service business? It's when you look at Asbury's overall, it's higher. When you compare it and isolate it just to our luxury stores, it's similar. Okay, great. Thank you very much. Thank you. Thank you. Our next question will come from Amitis Sinkevicius. Great. Good morning. Thank you for taking the question. I guess my question comes around historically you've looked at assets that were a bit more on the value side. At least on our numbers, we have you trading at about 8x 2021 EBITDA. This comes at a higher multiple. So how did you get comfortable with the multiple of this sort of previously. So, sort of previously. So why now? What made you comfortable to do the transaction versus maybe you had passed on it previously? Sure. I'll address the first part and then I'm sure Matt will chime in as well. We look at this today on day 1, it is a higher multiple than what we trade. But when we look at the business and the opportunities and the potential for growth and the cash flow that this generates, we really believe that this multiple comes down in line, in the line of where we trade in 2 to 3 years from now. So we feel pretty good about that. The second piece of the question, and Matt will jump in, if I understood it correctly, why now? This was represented by a broker called Presidio. It went out to market and it went out competitively and the seller chose us, I believe, because he thought we'd be a good steward of the business and that we're agreeable on terms. This isn't something that we saw before and passed on. We saw this come to market. It was presented to us. We know living in this space what an exceptional opportunity this is to acquire a group like this. It's far above the brand, so the quality of the people and the way they run their business is a true differentiator and we recognize that in the space and start as a huge opportunity for us to really grow as an organization. Amit, this is Matt. To follow-up on the valuation, this is one of the things we're most excited about. When we look at this, it lets us put about $1,000,000,000 to work and add about $100,000,000 that's a 10x multiple. But the way we really think about it is in addition to that, there's about $11,000,000 in cash tax goodwill savings, which is about a turn. So that brings it down to 9 times. And that doesn't even include the Open Point, those other initiatives as we talked about, the auction and all those things we're really excited about. So that almost brings it down below the 9 times. And if you look at where we're currently trading at on an historical basis, I think we're actually over 9. So it's we're really excited about where we are and we believe we're putting this capital to work at a good value and that doesn't even include all those transformational things that this deal is going to do for us. So all in all, we're really excited about not only the value, but what it will do for the company. Okay. Appreciate it. And then so as we think about the deleveraging here over the next several years, presumably we sort of put a pause on buybacks and further acquisitions? Or do you still see some opportunity or the ability to be opportunistic if anything interesting comes up? This is David. If there's some small opportunities or tuck ins for us out in the Denver market, we would certainly consider that. But our main focus over the next 24 months or so is certainly going to be paying down debt. This is Matt. And to add to that, What's great about this is it will really improve our free cash flow. We'll probably be around $200,000,000 So we'll be able to bring that number down very fast over the next couple of years and that's going to be our number one focus is bringing it back down into our optimal range. Great. Appreciate it. Thank you very much. Our next question will come from Chris Bottiglieri. Hey, guys. Thanks for taking the question. I want to start with the used business. I was wondering if you could give us a sense for what their used to new ratio is? And then second related to that is, how has their used business trended recently relative to market level stats or however you want to frame it? So it seemingly has become a pretty competitive market. So I want to get a sense of what you're seeing there. They do a tremendous job with pre owned. They're almost one for 1 newly used with strong margins. And they've had what I would call stable growth trending up over the last 3 years. Okay. And then the auction business, how do you frame that opportunity? Is this something similar to what one of your peers is doing? You'll have 4 or 5 across the well, I guess, around your geographic footprint, it's a little bit smaller than theirs. But how do you frame the opportunity as a standalone business you think about growing? And then in context of kind of like the digital shift in that end market, how does that frame your view of the growth opportunity of the physical auction market that you're pursuing? Yes. The seller is a very he's a tremendous entrepreneur and saw an opportunity to open his own auction and branded with the name of the stores attracts a lot of buyers. It performs extremely well, is a traditional looking and running auction that they only sell their cars at this opportunity. This allows us to have additional days to open up and have other auctions with our cars from different markets as well, which really has a tremendous growth opportunity from an earnings standpoint. From the digital play standpoint, again because of our size and scale, we think it plays well into that as well. Got you. Okay. And then just one final one. So I want to get your perspective on the health of the import segment and to what extent that may have motivated you to pursue something this scale of diversification? I would say over 3 decades in retail, it's a cyclical business, not just the SAAR, but the brands and then the individual brands. I think we're always trying to be luxury stores. We're buying some very large luxury stores in a very strong market with tremendous throughput and margins that we know will actually enhance our business. And I can't stress this enough, the way they currently operate, this allows Asbury to learn a lot from them and how we can bring that to our current stores. So we see this as really transformational for our organization. Got you. Okay, helpful. Thank you. Thank you. Thank you. Our next question will come from Rajat Gupta. Hey, thanks for taking my question and congrats on the deal. I just wanted to clarify one of the earlier questions on the $100,000,000 EBITDA and just the margin. So the $100,000,000 I believe includes the $20,000,000 synergies, right? So it's more like $80,000,000 on $1,900,000,000 revenues. And then that's the upside opportunity basically to get it to like a luxury margin or to an as per your corporate margin. Am I looking at it the right way? Just want to clarify that. This is Matt. You're correct. So the $100,000,000 includes the $20,000,000 of synergies, which we expect to realize over the next 3 years. Got it. So the margin profile is more like low 4s right now for the business and you can get that to like 5% plus and maybe beyond with the additional opportunities? Correct. Their margins are similar to ours. They're very strong. So we do believe that combining the synergies once we achieve those, it will take the margin north of where we are. So that's one of the things we're really excited about. But since they are luxury, they do operate around where we are for operating margins. Got it, got it. And just the gross margin and the SG and A profile of the business, is it materially different or I'm assuming like the gross margins are probably higher, but is there opportunity to grow is more of the opportunity on the gross margin side there or is it more on the SG and A side going forward? Can you help dissect that a little bit? It comes back to the synergies are mainly focused on those, as David mentioned, those cost type SG and A items versus those operational things are more growth oriented. That's how we would break the 2 buckets down. But in terms of SG and A, once again, what we love about this is that they do have margins very similar to ours, especially because they're large luxury stores, and that's one of the benefits of large stores and the luxury brands. So it's very similar to our P and L structure. Got it. And just on the cash flow, I know you mentioned numbers earlier. How should we think about the CapEx requirements here? And just on a normalized basis, what's kind of like the free cash flow of this business? Yes, that's the other thing with this transaction. Most groups will have CapEx expense going forward. We have very minimal to no CapEx expense going forward. These are all premier facilities that are just impeccable high standards and all factory updated. So no immediate CapEx. Got it. And then just one last one on the EPS accretion. Assuming you're assuming 9 months of the deal here, could you give us a sense of how that would break down between like the cadence of the synergies you've seen in year 1 versus what you're assuming for cost of debt? Is there any more granularity you could provide there? Just in terms of expense and floor plan, yes. So for the 2020 EPS accretion, that is 3 quarters. We assume the transaction closed on March 31, so we have a full 3 quarters. It also takes into account the leverage, the issuance of a bond, the issuance of the mortgages, so factoring in all the financing. And then as we mentioned, a slow ramp up of synergies because we do expect to achieve those synergies over the next 3 years. So a very minimal portion of that would be included and it would only be the 3 months sorry, 3 quarters. Got it. Okay, great. Thanks for taking the questions and congrats again. Thank you.