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Letter to the Editor
This article originally appeared in the August, 1999 Issue of INSIGHT
August 1999 Investment Update
From the BASF corporate standpoint, the deal is so small that it has no impact. However, it is interesting to speculate on just how the deal works, who really pays for it, and where the return is for BASF.
As I see it (and this is my own opinion only, as both BASF and Boyd are bound by confidentiality agreement not to reveal nor discuss any issues relating to the contract), here is how it may well work:
First, by securing this deal, BASF keeps competition out of the 41 current Boyd locations. Given the size of their operations, I believe that Boyd probably got $200,000 to $300,000 in cash up front. Now, moving on to acquisitions, let’s say Boyd buys a $3 million shop, for example, and agrees to pay $1.5 million for it, half in cash and half in notes and stock. Let’s further assume that, of the $750,000 in cash, BASF steps up with about $300,000 as a part of their $17 million investment commitment. The remaining $450,000 would come from Boyd’s current line of credit.
Well, that $300,000, if it were loaned out or put into the bank by BASF, would return about $21,000 per year, and, at the end of ten years, if it were a bond for example, they would get the $300,000 back when the bond reached maturity. To make this example simpler, let’s then say that the overall cash back to BASF would average something like $51,000 per year ($21,000 + $30,000 - forget discounted cash flow, inflation, etc.).
Allright. For this first acquisition deal to look at all attractive then, BASF should somehow get $50,000+ out of it per year. Based on a $3 million acquisition, paint purchases alone at jobber cost should be about $120,000 per year. That would be the sales revenue paid to corporate by their captive distributor ART. Based on our research, BASF GPM on the $120,000 should be about 60 percent. Thus, Gross Profit of $72,000 flows back into BASF, plus the Gross Profit on the $2+ million of sales to the existing Boyd stores, which they probably would have lost to another, almost equally aggressive paint supplier, had they not made this deal. That’s another $120,000.
When you bring it all down to a pre-tax net basis, the cost of the acquisition money, in this case seven percent of $300,000 invested ($21,000) in the acquisition probably is not equaled by the estimated EBIT on the sale to their captive jobber of $120,000, which are probably at 15 percent, or $18,000 per year. This shortfall of $3,000 is more than offset, however, by the net on the continuing 41 stores’ sales.
If the example store grows at 10 to 15 percent per year in volume, the deal then becomes profitable on a stand-alone basis. In total, however, since BASF also has to amortize the $300,000 capitalized contract, probably over 10 years, that extra $30,000 per year will be tough to recover.
Now, accounting can be very creative, so if you considered the $300,000 expenditure as buying a ten-year supply contract you could put the $300,000 on your balance sheet as an asset, and depreciate/amortize it over 10 years. Voila! You have turned lemons into lemonade.
It is our best guess that future acquisition investments on BASF’s part will probably level off at a single digit percentage of store sales.
While BASF carries the Boyd contract on its balance sheet, we would only assume that, if the whole deal should go south, or if another supplier really wanted that Boyd volume, that BASF’s involvement would be bought out. Thus, the risk to BASF is tied to the success or failure of Boyd, given that the investment is basically unsecured.
On the Boyd side, it can carry the contract investment as a prepaid discount on materials, and draw this down over the life of the contract, reducing its materials cost on the company’s income statement and thus passing through a profit improvement.
Is this, overall, a profitable move for BASF? Time will tell whether their approach to buying market share as contrasted to loan guarantees or, as in other recent developments, acquisition of competitors, is the most profitable.
Will smaller independents really be paying the price for these market share development expenses? Yes and no. Paint sold to these accounts will be at a competitive price, but probably not at as deep a discount as they could drive with this buying power, and no strings attached. In some respects, this, and especially loan guarantees, may be a lower cost program than DuPont’s and PPG’s acquisition route, albeit those acquisitions had major ramifications beyond the U.S. refinish market.
Next month, we will look at loan guarantees, their real cost, and where and how they end up on suppliers’ balance sheets and income statements.
In general, all of these programs carry a tremendous risk for suppliers, and there is no question that each would prefer to compete on the basis of quality and service, rather than on some sort of pea-under-the-walnut shell type of financing, the benefits of which may elude both the supplier and the collision repairer.
BASF is not the first paint supplier to invest in a consolidator or car dealer chain. I am pretty certain that all suppliers have their fingers in the pie to some extent. It is just that BASF was the first to let a customer (Boyd, a public corporation) issue a press release, apparently required by the Winnipeg Stock Exchange, outlining the deal for all to see. Boyd investors loved it; competitors and independent body shop owners may have a different perspective.
From one perspective, as Russell points out in his editorial this month, all of these deals unfortunately take the focus off the business of shops fixing vehicles and paint manufacturers and jobbers providing product and service, placing the emphasis on clever accounting with perhaps marginal benefit to the overall industry. Time will tell if this type of assistance is no more than recognition of new market dynamics as promulgated by an aggressive drive for market share.
A quick comment on First Priority Group, where stock prices have been touted to go over $6 based on their new web business, insurer contracts, etc., etc. Well, its stock still languishes at $1.25, and I see on Yahoo’s message page for First Priority that 30 of the last 30 insider trades have been Sale or Intends Sale as shown on the SEC Form 144 filed by those insiders - not much apparent confidence, I would have to say.
We will no longer track The Colonels International on this page, since they have moved out of collision repair industry parts and are concentrating on truck accessories.
Next month, we will also cover Unistar, the Dallas-based insurer/reinsurer wholesale agency that owns two body shops in the Dallas area. Their stock has been selling at an over 800 PE ratio - most unusual for an insurer. Today, however, trading has been suspended, as the stock price dropped in two days from an over $60 high to $37.
-Charles Baker-
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