Pacific Automotive

PACIFIC AUTOMOTIVE
CASE STUDY
This case note was prepared by Paul Evans, Director of Gresham Private Equity
Limited under the supervision of Geoff Waring, AGSM as a basis for class discussion
rather than to illustrate the effective or ineffective handling of an administrative
situation. No warranty is made as to any facts in the case study nor should any of
them be relied upon as being correct.
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Pacific Automotive
1. Introduction
It is J anuary 2001. The Australian icon Pacific Dunlop Limited is under intense pressure. The
Shamrock investment group has become an increasingly vocal and active shareholder, dissatisfied at
the poor performance of this diversified group. The Pacific Dunlop management teams plans to spin
off the Ansell rubber products business in a US-based IPO have been rejected. Shareholder pressure
has now been brought to bear to run three separate sale processes for Pacific Automotive, Pacific
Brands and South Pacific Tyres and leave Ansell in the Pacific Dunlop shell.
The first of these sale processes is Pacific Automotive. Deutsche Bank as a major lender to the group
has been appointed as the selling adviser.
The initial attempts to sell the business to offshore trade buyers seeking in excess of $300m falter, as
the global economy slows. Peter Mummery and his management team at Pacific Automotive now
realise that this is their opportunity to have a crack at an MBO. They have approached you for your
views on the attractiveness of this proposal, what due diligence you need to undertake, what price
you can offer and what deal you can do for the management team.
2. Overview
Pacific Automotive has five core operating divisions, namely Repco Australia, Repco NZ, Ashdown,
Motospecs and CarParts. These businesses operate in different parts of the supply chain. Motospecs
is an assembler of replacement kits and services either wholesalers or resellers. CarParts is a
wholesaler servicing independent resellers. Ashdown and Repco in Australia and New Zealand are
resellers and service either trade repairers, Original Equipment Manufacture (eg Ford, Holden,
Toyota etc.) (OEM) dealers or the end consumers. Pacific Automotive stocks approximately
80,000 SKUs in 10 distribution centres. Management believe that there is significant opportunity to
rationalise the number of SKUs and hence reduce stock, costs and complexity in the business.
An illustrative summary of divisional sales by channel is as follows:-
J une 2001 Fcst Repco Ashdown CarParts Motospecs Repco NZ Total
Trade General $345 m $70m $415 m
Trade Auto Elec $61 m $61 m
Retail $120 m $51 m $171 m
Wholesale $123 m $6 m $129 m
Specialty $50 m $50 m
Total Sales* $465 m $61 m $123 m $50 m $127 m $816 m
* Motospecs revenue is the annualised revenue as some acquisitions were completed mid year.
Overall, whilst Pacific Automotive has strong competitors in individual markets, it remains 4 times
larger than its nearest Australian competitor and 3 times larger than its nearest New Zealand
competitor. It is also the only national competitor in both Australia and New Zealand.
Pacific Automotive has 3,900 employees, operates 11 distribution centres and 406 stores. It is the
largest player by far in the market. Significant opportunities appear to exist to lead industry
consolidation and rationalisation, of which there is strong and successful evidence in the US and
Europe.
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Pacific Automotive
Repco was founded in 1922 as the Re-Engineered Parts Company, a manufacturer of automotive
parts, before later developing a distribution focus. It now operates 301 stores throughout Australia
selling automotive parts, consumables and accessories. The Repco brand is synonymous with the
automotive industry and in 1966 Sir J ack Brabham drove a Repco Brabham to win the World
Formula 1 Championship. Pacific Dunlop acquired Repco in 1988, and subsequently sold off all
Repcos manufacturing activities. The business has grown to have a national presence and has begun
to service the retail market in addition to its traditional trade customer base.
The business that is Repco NZ was initiated by Repco but subsequently sold and owned separately
from Repco from 1983. In 1992 it was purchased by Pacific Dunlop. Post-acquisition, Repco NZ
was still run separately from Repco, and it was not until 1999 that it became a part of Pacific
Automotive. Under Pacific Dunlop ownership. Repco NZ gained a national presence and has
significantly grown both its retail and trade business. It now operates 87 stores throughout NZ
selling automotive parts, consumables and accessories.
Ashdown, founded in 1965, began to focus on the automotive electrical sector in 1975. Today
Ashdown is the dominant reseller in the automotive electrical market in Australia with 18 stores. It
was acquired by Pacific Dunlop in 1992.
Motospecs was formed in 2000 from the identification of the opportunity to grow into specialist
product categories as a value-added wholesaler. Four businesses were acquired between March and
November 2000.
CarParts is an automotive parts wholesaler, which was formed in late 1999 from the merger of
Traders Autospares, owned by Pacific Automotive, and CarParts, owned by Atkins Carlyle. It
currently continues to operate as a J V, but on the sale of Pacific Automotive, Atkins Carlyle will be
bought out.
3. Industry Analysis
The automotive parts aftermarket industry comprises the distribution and sale of automotive
replacement parts and accessories, as well as automotive related tools and equipment, to automotive
repairers and retail consumers for passenger and light commercial vehicles. The expression
aftermarket distinguishes this segment as different from the sale of items sold as part of the
original sale of a vehicle.
The Australasian market is estimated to be worth at least $5bn and should continue to grow steadily.
All segments are growing apart from DIY hard parts which remains flat. The overall market appears
to be growing strongly on the back of fleet growth (now over 11m vehicles) and increasing average
vehicle age (up by 2 years since 1985 to 10.6 years), despite longer component life and reduced
service intervals.
The core target market for Pacific Automotive - namely vehicles which are over five years old and
hence outside manufacturer warranties etc. - is growing, and it is believed will grow faster than the
overall fleet for the next four years.
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Pacific Automotive
The industry is relatively fragmented, with a large number of participants in each channel. However,
Pacific Automotive is the only company that operates in every non-OEM segment of the market and
supply chain. The end users for automotive parts are vehicle owners. There are three main sales
channels through which automotive parts are supplied to car owners in Australia and New Zealand,
namely:
1. Trade repairers who service and repair vehicles. Trade repairers account for a large
proportion of the total automotive parts aftermarket. Trade repairers are typically
independent operators, either operating from service station or specialist repairers. There
are approximately 19,000 independent operators. Pacific Automotive is a leading supplier
to trade repairers through Repco in Australia and NZ.
2. Third-party resellers who sell parts and accessories to vehicle owners who repair or maintain
their own vehicles. Repco in Australia and NZ and Ashdown are resellers. CarParts and
Motospecs sell to resellers.
3. Dealer service arms of original equipment manufacturers who repair and service vehicles.
In recent years OEMs have introduced a number of initiatives aimed at achieving a greater
share of the automotive aftermarket. The initiatives have included extended warranties and
greater emphasis on retail customers. However, evidence suggests that customers maintain
a preference for non-OEM service channels.
However, there is some overlap between these channels, with some OEM products sold through
third-party resellers. This is set out in a diagram below, with the position of the Pacific Automotive
business units clearly marked.
OEM Manufacturers Other Manufacturers Assembl y
Wholesalers
Resellers
OEM Dealers Trade Repairers
End Consumers
OEM Manufacturers
(eg Ford, Holden)
Parts Manufacturers Assemblers (Motospecs)
Wholesalers (CarParts)
Resellers (Repco, Repco NZ, Ashdown)
OEM Dealers Trade Repairers
Vehicle Owners
One feature of Pacific Automotives market position is that its wholesale businesses (CarParts and
Motospecs) have as their core customers the key competitors of Repco and Repco NZ, such as
Bursons, Supercheap, Marlows, Autobarn, the mass merchants etc.
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Pacific Automotive
4. Distribution Problems
The financial performance of Pacific Automotive and more specifically Repco Australia and
CarParts has deteriorated over the past two years. Peter Mummery and his management team are
frank about the fact that the key issue which impacted financial performance in 2000 and 2001 was
caused by senior Pacific Dunlop decision making rather than by any initiatives from his management
team.
In December 1999, Pacific Automotive merged its wholesaling business, Traders Auto Spares, with
Atkins Carlyles CarParts business. As part of this joint venture arrangement, Pacific Automotive
acquired the distribution centre (DC) operations and the inventory and entered into a service
arrangement to provide CarParts with distribution and merchandising services.
This resulted in the number of DCs within Pacific Automotive increasing from 12 to 23 as well as the
number of stock keeping units (SKUs) 50,000 to over 80,000. It was planned to consolidate these
DCs and rationalise down to 9.
In J anuary 2000, Pacific Dunlop made a strategic decision to form a specialist distribution business,
The Distribution Group, which took control of the management and operations of the DCs and
warehouses for Pacific Automotive and Pacific Dunlops other businesses Pacific Brands and The
Electrical Group. This business was to operate independently of Pacific Automotive.
In March 2001, the decision was made to unwind The Distribution Group, as the performance of the
DCs had deteriorated significantly during its existence, including dropping from a DIFOT
performance of over 95% to below 80% and even lower in some states.
Additionally, this distribution turmoil led to inventory blowing out from $160 million in FY99 to a
peak of approximately $230 million in early 2001.
During the past 6 months, these DC operations have returned to Pacific Automotive and the DIFOT
performance has improved measurably to above 95%. This has corresponded with improving
performance in Repco Australia. Unfortunately, the lag in CarParts is much greater and there has
been no short term appreciable increase in its revenue base.
5. Key Strategies
5.1 Operational Improvements
Reducing the cost of sourcing product and delivering to the store is viewed by Pacific Automotive as
a significant opportunity to improve profitability. A range of initiatives have been introduced during
2001 and have already started to have a positive impact on performance. These initiatives and
further DC cost initiatives are expected to result in additional cost savings in future years.
5.2 Expansion of the Retail Business
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Pacific Automotive
Repco NZ began targeting the retail market during the 1980s and currently its sales are split 50:50
between trade and retail customers. Repco is targeting a similar sales split and plans to pursue
overall sales and margin growth by expanding the retail business through the continued conversion,
where appropriate, of traditional trade stores to dual format trade and retail stores. $10m of
additional capex over and above maintenance levels has been allowed in each of 2002 and 2003 for
this.
5.3 Market Consolidation
The Australian and NZ automotive parts aftermarket is currently fragmented and rationalization is
expected to occur. Pacific Automotives goal is to increase market share through participating in
market consolidation.
6. Management and Staff
Pacific Automotive employs over 3,900 full-time, part-time and casual employees. An outline of the
Group's staff is set out below:
Function Number
Repco Australia 1,960
Repco NZ 690
Ashdown 250
Motospecs 110
CarParts 125
Distribution 650
Merchandise 74
Property 25
Other centralized functions 21
TOTAL STAFF 3,905
The executive team is set out below:
Peter Mummery is the CEO of Pacific Automotive. He joined PacAuto in 1999 after a 20 year
career with Shell in retail network management and mergers and acquisitions. Peter is in his
early 40s. Peter is keen to lead an MBO and has indicated that he and his management team
would be prepared to invest $2m upfront. Peter himself wishes to invest more than $500,000.
This is a very substantial investment and Peter and his team are known to be extremely
enthusiastic about and focused on deal on the capital upside available for them.
Peters senior team comprises: -
Bob Wyeth GM, Merchandise
Bob joined Repco NZ in 1986 and prior to this role ran that
business for 10 years. He is in his mid 50s and is currently based in
Australia running Group merchandising and purchasing.
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Pacific Automotive
Brendan Redmond GM, Repco
Brendan Redmond is a former GE consultant who joined Repco in
1998 as manager of store operations, before taking full
responsibility in 2000. Brendan is in his late 30s.
Jeff Taylor GM, Repco NZ
J eff joined Repco NZ in 1987 as a branch manager and progressed
through a variety of roles to become GM in 2001. J eff was
previously in his own business.
Trevor Garrard GM, Ashdown and Motospecs
Trevor has been the GM of Ashdown since 1981, is in his late 50s
is suffering from poor health and is due to retire in December. He
will not participate in the MBO although he will remain available
in a consultancy capacity.
Mike Bergin GM, Distribution and Logistics
Mike joined Repco NZ in 1991 and had the distribution and
logistics role there for 8 years. He came to Australia late last year
to manage the full Groups DCs and logistics. He is in his mid 40s.
Neil McBain GM, CarParts
Neil joined CarParts in 1999, having previously run CarParts
major competitor National Parts. He is in his late 50s.
Gary West GM, Strategy and Business Development
Gary is a former PwC corporate finance executive who manages a
variety of projects. He joined Pacific Automotive in 2000. He is
34.
Peter Cooper GM, Financial Controller
Peter joined Pacific Automotive in 1999 after a varied career in
finance roles in industrial companies including AXA and BOC.
He is in his late 30s.
7. Financial Performance
Historical Financials are attached at Appendix A. Comments are as follows:-
The decline in performance at Repco Australia between 1999 and 2001 has been driven by
poor stock availability and delivery performance (and hence reduced sales), a modest fall in
margins and substantially increased costs. Repco has recovered sharply since Pacific
Automotive regained control of its DCs from Pacific Distribution in March 2001.
Motospecs represents the combination of four separate acquisitions. The 2001 number
includes some part years and hence does not represent a full annualisation of these
acquisitions.
CarParts represents the trading performance of the Traders Autospares business only until
1999. In 2000 it was merged with the Atkins Carlyle owned CarParts. Distribution problems
in the first year of operation led to a 25% reduction in sales.
Forecast Financials are attached at Appendix B.
Repco Australia is forecasting incremental growth driven by the store revamp programme.
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Pacific Automotive
Repco NZ is forecast to continue its strong historical performance
Motospecs represents the combination of four separate acquisitions. The 2002 number
represents a full annualisation of these acquisitions and the ask appears aggressive.
CarParts forecasts assume a turnaround, and as a result look aggressive. However, we have
assumed no improvement after 2002. A number of initiatives in hand should significantly
assist CarParts performance;
Head Office costs are shared between the business units.
Standalone costs and an increasing contingency have been applied by Management
8. Risks
RISK COMMENT
The robustness of the retail strategy in
Repco Australia
Repco is currently performing well in both
trade and retail.
The performance of CarParts and its
importance strategically
CarParts needs to demonstrate rapid
improvement in return on capital
Integration of the Business Support
Services proves more disruptive than
anticipated and is higher cost than expected
Costs will be audited and underwritten
initially by PacDun. Adequate transition
time and resource will be allocated if we
elect to bring the service back in house
Finding additional management team
members especially General Managers for
Motospecs and Ashdown
Recruitment is underway.
The cost savings identified by management
are illusionary or any savings are translated
into pricing decreases.
Performance improvement in F2001
appears to countermands this.
Growth in Repco NZ and Ashdown slows
or enters a period of decline due to
increased industry pressure or new entrants.
These businesses continue to perform well.
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Pacific Automotive
9. Summary
You now have to start forming your assessment of the Pacific Automotive business. Peter Mummery
and his management team are meeting with you this afternoon.
They have approached you for your views on the attractiveness of this proposal, what due diligence
you need to undertake, what price and terms you can offer.
Whilst you realize that the financial fundamentals, earnings growth, cash generation and net assets
will be your starting point, some assistance might be provided by listed comparatives Alesco and
Coventry which are direct competitors of Pacific Automotive in automotive and automotive electrical
components. Both however have significant other activities unrelated to the automotive sector -
Alesco in building products and tyres, and Coventry in fasteners and manufacturing.
Their financial valuation parameters are as follows:-
$m EV/EBIT EBIT EV Mkt Cap Net Debt Year
Alesco 8.0 23 183 107 76 6/01
Coventry 10.8 15 163 137 26 6/01
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Pacific Automotive
APPENDIX A
Summary Historic Performance from Information Memorandum
Year to 30 June actual $m
1999 2000 2001
Sales
Repco Australia 464.8 472.6 466.7
Repco NZ 118.8 118.2 128.9
Ashdown 53.4 56.8 61.3
Motospecs 0.0 4.2 36.1
CarParts 80.4 123.0 120.9
Group Consolidation / Other* 0.0 (28.6) (52.0)
Total Sales 717.4 746.2 761.9
Cost of sales (430.9) (458.6) (466.4)
Gross Margin 286.5 287.6 295.5
Employee costs (119.9) (121.5) (127.7)
Warehouse costs (37.9) (34.4) (35.2)
Occupancy (29.5) (27.5) (27.9)
IT (19.5) (13.5) (11.1)
Advertising (3.5) (8.4) (11.1)
Other (21.3) (35.0) (33.7)
EBITDA 54.9 47.3 46.6
Amortisation of Capitalised Expenses 0.0 (0.2) (1.5)
Depreciation (11.1) (11.0) (10.3)
EBIT** 43.8 36.1 32.8
* Th 00 and 01 historical information includes the results of the CarParts J V on an equity
accounted basis. In the forecast information CarParts has been consolidated in full as it will
be 100% owned.
** excludes unusual items
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Pacific Automotive
APPENDIX B
Summary Financial Projections
2002
Sales
Repco Australia 466.8
Repco NZ 140.0
Ashdown 65.3
Motospecs 55.0
CarParts 111.2
Group Consolidation (13.2)
Total Sales 825.1
Cost of sales (499.8)
Gross Margin 325.3
Employee costs (139.8)
Warehouse costs (33.0)
Occupancy (30.1)
IT (13.8)
Advertising (13.3)
Other (45.3)
EBITDA 50.0
Amortisation of Capitalised Expenses (1.5)
Depreciation (10.6)
EBIT 37.9
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Pacific Automotive
APPENDIX C
Unaudited Balance Sheet at 30 June 2001
June 30 2001 $m Unaudited
Stock 191.9
Debtors 108.5
Cash 6.6
Other Current Assets 3.3
Total 310.3
PPE 44.2
Deferred Costs 7.7
FITB 14.7
Total 66.6
Total Tangible Assets 376.9
Creditors (114.2)
Provisions (30.0)
Total (144.2)
Net Tangible Assets 232.7
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Pacific Automotive
APPENDIX D
Capital Expenditure
A$M Actual Actual Actual Forecast
FY99 FY00 FY01 FY02
Non-Discretionary
Fleet Maintenance 3.0 3.5
Store Maintenance 3.6 4.4
Warehouse Maintenance 1.0 1.0
Warehouse Relocations 0.9 -
8.5 8.9
Discretionary
Store Development 2.6 11.8
Other 1.0 -
Total 9.0 12.1 12.1 20.7
The projected increase in capital expenditure over the FY01 to FY02 period is driven by the
company strategy involving the implementation of growth initiatives including customer partnering,
new store openings and relocations. Most of the more than 70% increase is as a result of store
openings or redevelopment/relocation at a capital cost of $11.8m
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