Shares of Pep Boys closed higher in a wild day of trading as news of a potential sale of the company surfaced. Management declined to comment, and perhaps in doing so affirmed that it was in fact shopping the company.
Who would be a buyer? We do not foresee any strategic buyers that would be interested in PBY, but rather if the company was to be sold we believe that private equity would likely be involved. Although it's possible that an international buyer could have some interest similar to when Sumitomo acquired TBC in 2005 for purposes of distribution or when Japan's Autobacs Seven acquired Strauss Auto (similar model to PBY) out of chapter 11 in 2007. What's different today? In our minds Pep Boys has always been considered for sale, particularly given the very activist board/shareholder involvement associated with the company. The last "official" time we can recall PBY exploring strategic options it was a much different company - poorly run with limited strategic vision, bad inventory mix, and a model that in our opinion was simply structurally flawed. If there was any point in time where PE or a strategic buyer should have been interested, it was then and to our knowledge, there were no takers. Fast forward to today and this is a much different situation. While the business model still has its inefficiencies, we believe the strategy to build a "hub and spoke" service model is the right one albeit one that will take time. Mike O'Dell and team have done a solid job at attacking costs and returning the company to profitability. So in our minds the "low hanging fruit" that typically makes an acquisition target compelling is absent. Instead, the buyer will likely need to heavily invest and accelerate the pace of service store purchases.
But is the return really there? We believe that for Pep Boys, the current strategy to lead with service and build out a "hub and spoke" model would allow it to build density within its fragmented store base as well as provide the company with substantially greater buying power and leverage a national advertising message. For that to work we think the company would need to at least triple its existing store base, bringing the total number of company stores to 1,500-2,000. Perhaps a buyer would want to segment the company into separate East Coast and West Coast businesses, but we wonder if buying Pep Boys is really the best way to consolidate the still fragmented DIFM service industry. To put it in perspective, it took Monro Muffler about 10 years to double its store base from the 350 locations it had in 1999; in order to fully leverage PBY's Supercenters, we think the company would need ~10,000 total spoke service centers. Ultimately, we think that there are more efficient ways to gain distribution capabilities for a service model roll-up than through a purchase of Pep Boys. In our opinion a PE transaction, while not unfeasible at current levels given current interest rates and the amount of equity capital available, is unlikely.
