Westward Ho!

This merger has almost doubled O'Reilly's footprint, opening the West Coast for market penetration and significantly narrowing the store count gap relative to the two largest auto parts retailers in business today — that is, AutoZone and Advance Auto Parts.

When asked what had influenced the company's decision to purchase CSK, Greg Henslee, O'Reilly's chief executive officer, replied that combining CSK's strong western presence with O'Reilly's midwestern and southeastern presence was simply "very compelling."

"Our belief is that once the two companies are combined, we will be positioned to further leverage O'Reilly's strong dual market strategy in CSK markets," Henslee adds.

According to Tony Cristello, senior vice president at BB&T Capital Markets Equity Research, the merging of the two companies will offer O'Reilly a tremendous opportunity to leverage its buying power with vendors and expand its gross margins, while at the same time reducing operating expenses. Cristello also says that the acquisition will give CSK's vendors and suppliers a new partner to work with — one that is in much better financial condition and can provide more stability for its distributors. (See Cristello's column.)

In addition, the merger will provide distributors and jobbers on the East Coast with a little bit of breathing room, says Cristello.

"O'Reilly's will have to temper its expansion eastward while it integrates CSK into its operations," he adds. "There won't be as much encroachment into those markets up and down the East Coast as there would have been if O'Reilly's hadn't successfully completed this transaction."

"This acquisition provides O'Reilly team members with the unique opportunity to participate in the upside potential of the combined entity," says Henslee. "This transaction provides growth and advancement opportunities for O'Reilly team members as they will be a part of a growing industry leader with a national platform."

Changes are ahead for the new company

Although the transaction is still in the early stages and isn't scheduled to close until the end of the second quarter, the Federal Trade Commission recently granted O'Reilly's early termination of the waiting period under the Hart Scott Rodino Antitrust Improvements Act of 1976 for the impending acquisition of CSK. Termination of the waiting period satisfies a condition to the closing of the proposed acquisition.

Still, the future of the combined company is the subject of much speculation. Will O'Reilly's change the CSK storefronts to the O'Reilly name, or shut down CSK stores that overlap with O'Reilly stores? And, more importantly, will the inventory of the West Coast stores change to better reflect O'Reilly's 50/50 mix of wholesale/retail sales?

"There is still a detailed analysis that needs to be done before we make our final determination," he says. "We have always had a great amount of respect for CSK and the brands they have established over the years. Part of our plan with this merger is to evaluate the effectiveness of CSK's current brands and the markets in which they operate. We will then determine whether or not it makes sense to consolidate the CSK brands into O'Reilly," Henslee adds.

Henslee acknowledges that the company has not decided if it will consolidate any CSK stores into the O'Reilly storefronts. While he admits that there is some overlap in a couple of markets where consolidation would make sense, it does not appear to be a problem for the vast majority of the stores.

From a financial standpoint, Cristello says this attitude of "watchful waiting" makes sense.

"I think the first thing that will happen once the dust settles is that O'Reilly will go to the vendors that supply the CSK stores and decide whether to keep those vendors or replace them with the vendors who supply the O'Reilly stores," he says. "I would guess they'd then have to decide what the inventory mix is going to be in the new stores — will it switch over to a 50/50 mix, or will it be based on what the customers who already patronize the CSK stores are demanding?"

Still, Cristello warns that these changes won't take place overnight. The company should give these considerations their due diligence and really do its homework to see what will work best in the new market if it wants to be successful. Cristello foresees the process taking two to three years and doesn't expect to see any O'Reilly signs replacing the CSK signs until the company puts new systems in place to guarantee a smooth conversion.

Although unable to make any firm statements about the company's future plans, Henslee did hint that a dual-market strategy is a possibility.

"Our approach with past acquisitions has been to dual brand for some time and then transition the stores in phases to the O'Reilly brand," he says. "As you may know, we've been reasonably successful executing our dual market strategy in our current stores. Our expectation is that the CSK stores would eventually have a similar operating mix to our existing stores."

Merger benefits CSK, opens doors for O'Reilly's

Under the terms of the agreement, CSK shareholders will receive $11 of O'Reilly common stock, subject to a collar, plus $1 in cash for each share of CSK common stock. This is a 20 percent increase in share price, compared to the price of CSK stock before the merger, Payne says. In addition, O'Reilly's will absorb approximately $500 million of CSK's debt.

"The benefits of this transaction are very compelling," CSK Auto's President and Chief Executive Officer Larry Mondry says in a statement released to the media. Mondry could not be reached for further comment at press time.

"After careful consideration of a number of viable alternatives, our board has determined that partnering with O'Reilly is clearly the best course of action for our shareholders," Mondry says. "As part of a stronger, more financially flexible company, shareholders, creditors and suppliers will have a meaningful opportunity to participate in the development of a company that will be well positioned to be a nationwide leader in the automotive aftermarket industry. This transaction provides growth and advancement opportunities for CSK's team members."

"As a combined company, we will be even stronger, with the ability to better meet the continuing evolution of the automotive aftermarket industry," Henslee adds.

While mergers can oftentimes spell disaster for the employees of the company being bought out, Henslee is quick to point out that this is not necessarily the case for CSK.

"This transaction is about growth and improving our competitive position," he says. "There will always be places for good people in the combined company. We believe much of the value of this combination will come from improvements in our business, rather than cost-cutting."

While the transaction clearly stands to benefit CSK shareholders, O'Reilly is poised to come out on top once the merger is complete.

"More than anything else, this transaction means that there's another player in the DIFM market, particularly on the West Coast," Payne says. "And while that's not great news for AutoZone or Advance Auto Parts, it's going to be great for O'Reilly's. This just proves that if you have to choose one category to pursue right now, DIFM makes more sense in terms of economics and the market segment's growth potential."

Cristello agrees: "CSK currently operates with an 80 percent retail to 20 percent commercial mix, so there is definitely opportunities for the new company to focus on the DIFM market."

But at the end of the day, O'Reilly's is determined to be the best retailer and professional supplier it can be, Henslee says, and the acquisition of CSK will take the company one step closer to meeting its goal.

"A major part of our success is due to our dual-market strategy," he concludes. "We strongly believe that, in the CSK stores, we will be able to generate a business mix similar to that of our existing stores over time as we integrate these two great companies."