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Letter to the Editor
This article originally appeared in the September, 1999 Issue of INSIGHT
September 1999 Investment Update
Each of the paint companies, with no exception that we know about, has developed its own market strategy to assist consolidators financially to make new acquisitions.
One way this may be accomplished is with loan guarantees, a process where the guarantor or paint company guarantees to the bank that the consolidator’s loan will be repaid.
It may work like this: Company X budgets $10 million as a potential reserve for “gone bad” loan guarantees. If they are careful as to whom they "sign for," this balance sheet reserve, as the loans are drawn down, could cover up to $100 million in potential loans, if one were to assume a ten percent reserve - not a bad number if care is exercised choosing who they cosign for.
Now, every $10 million in bank loans to the consolidator should result in $20-30 million in collision repair volume, depending on how the deals are structured. On that basis, assuming a four percent materials sales to the shops at jobber cost, over a million dollars of new paint volume to the manufacturer has been generated for every $10 million guaranteed and million shown on the balance sheet.
Using the 60 percent GPM figures for paint manufacturers that we used in the BASF example last month, this means that the $1 million reserve which may never be called has produced new gross profit of $600,000 on an annual basis. It’s a little bit like the "loaves and fishes," a reserve for debt allowance of $1 million has generated $600,000 in annual gross profit.
Is this a better deal for the consolidator than the outright investment a la BASF? Well, it just might be. Consider first that more money is probably available this way. Even BASF has a limit on how many millions they can invest directly. Using loan guarantees puts an up to ten multiplier on the funds, given a reserve allocation of ten percent.
By having the paint company guarantee the loan, the consolidator number two gets the money from a major bank at a competitive interest rate in a relatively short period of time with reduced loan preparation, application, and processing costs.
Over a period of time, both the loan proceeds are drawn down and repayments are made. You can bet that controls are in place through the loan documents that both require the continuous use of the guarantor’s paint line and also outlines continuous performance criteria for drawing down the loan for future acquisitions.
After the loan has run a few years, the acquisitions have been made, and loan payments met out of cash flow, and at that point it wouldn’t surprise me if the paint company stepped in to help pay the loan off, both to protect their position and to open up the availability of funds for even more acquisitions, assuming that cash flow is positive and other loan criteria are being met.
With the exception of ABRA, with GE Capital behind it, and Collision Team of America, with Ford, and perhaps Caliber, with Zurich and Bass, most consolidators are having to scramble for money to make more acquisitions to show more growth so they can attract even more money, and to hopefully do an Initial Public Offering.
Unfortunately, for most consolidators it is not all "milk and honey" days. Same store sales in many cases are down or stagnant, production and overhead costs, instead of going down, have gone up as insurers have demanded faster cycle times and higher quality, and pushed some of their administrative costs down to the shop level, while at the same time demanding discounts based on volume.
Couple a four to seven percent corporate administrative overhead charged to the shop that they did not have before as an independent and you can see that there is a real profit squeeze going on with consolidators.
While we have discussed loan guarantees in depth, outright cash up front is also an increasingly popular method of buying a "supply contract," on the part of paint manufacturers. It is simple and fast, but provides no leverage. I believe that, along with deep discounts, we’ll see less and less of "up front" payments.
On another subject, and that is First Priority Group, I received an interesting press release that extols the fact that EDS is-was-or-will be developing a website for First Priority that will allow them to undertake for insurers much of today’s claims handling process.
The release said to call Arlene Orliss at 516-694-1010 ext. 264 for access, which we did. However, Barry Seigel got on the line and basically said we weren’t welcome, and thus we will have to wait for others to fill us in on this new venture.
It could be that First Priority actually has something here in contrast to their foray into catalog sales, attempted acquisition of Scott Bigg’s Bodyshop Development Group, and the Car Club merger, all of which failed or resulted in no profits. Time will tell. And, at $1.45 I have taken a flyer and purchased some stock, as I believe that, at a recent $0.95, it truly hit bottom and has nowhere to go but up.
I am unable to comment at length this month on Unistar, as I had promised in last month’s INSIGHT. Trading continues to be suspended for the company while both AMEX and the Texas insurance commission continue their investigation.
Also CCC has incurred the wrath of at least one investment writer this month, through a private purchase of their stock outside the market at a $2.50 premium. The 500,000 shares had been given to a private trust by Dave Phillips, and CCC repurchased them directly from the trust at a premium - great for the trust but not so good for the rest of the company’s stockholders. Subsequently, the stock dropped to below $10 per share, but has since " “bottom feeder," I purchased some CCC stock along with FPG. (Note: Let it be said that the success or lack of success of these personal investments will not change the thrust or content of INSIGHT’s editorial coverage.)
All in all, it could have been a better month for collision industry related stocks, including insurers. Insurers have the same problems as paint companies: no growth, over capacity, and vicious price competition. However, they also have hanging over them the specter of higher interest rates, which means their existing bonds and interest bearing securities will drop in value as rates go up, making higher earnings even more elusive.
-Charles Baker-
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