Description

Boyd Group is a multi-shop operator (MSO) of auto collision repair stores.  They are the largest MSO in Canada and among the largest in North America. 

The basic thesis:

1. Boyd has carved out a niche as a consolidator of garages in a highly-fragmented industry.
2. In this niche Boyd enjoys a competitive advantage through increased access to insurance-company referrals that allows its garages to be operated more profitably than the majority of its competitors.

Industry Dynamics:

Boyd estimates the collision repair market in North America to be $40b annually, and car dealerships have about 1/3 share.  Non-dealership MSOs (such as Boyd) have 10% of the market, and the remaining 57% belongs to local independent family-owned businesses.   The relationship between insurance companies and the garages is increasingly moving toward Direct Repair Programs (DRPs).  In a DRP, the insurance claim process takes place entirely between the collision repair garage and the insurance company.  This eliminates the need for the customer to fill out paperwork on-site or to serve as a middleman between garage and insurer.  Often the business terms for repairs are pre-arranged, which allows for a speedy, standardized procedure for claims to be submitted, evaluated, approved, paid, and completed without the customer haggling over details. 

Garages benefit from participating in DRPs because they get a steady stream of referrals from the insurance carrier; insurance companies benefit by having many parts of the claims submission, evaluation, and payment process automated, reducing average processing expense per-claim. 

In many locales, insurance companies require a garage conform to a certain level of integrity, convenience, physical appearance, quality of work, turnaround time, etc. before a DRP is established.  If this customer-facing repair shop were to provide a poor level of customer service, the insurance company would risk being associated with a traumatic repair experience (especially if they had made the referral) and, post-claim-handling, it might lose the insured driver to a competitor.  Therefore it is not uncommon for insurance companies to compete with each other for 'shelf space', whereby each assembles a network of clean and professionally managed garages in conformity with high standards. 

For that reason, Boyd has a competitive advantage versus the 57% of the market belonging to independently owned and operated Mom & Pop shops.  Boyd has built brand recognition through acquiring and professionalizing such shops and applying the same consistent high service standards throughout their chain.  This makes it easier for an insurance company to choose to establish a DRP with a Boyd garage versus the family-owned one around the corner whose quality is more uncertain.  This also leads to a collaborative arrangement in which an insurance company often notifies Boyd of its intention to add a location to its DRP network inside a particular geography.  Armed with this soft sponsorship, Boyd can make its acquisitions very intelligently, and can ramp-up the DRP program and the garage's profitability very quickly post-acquisition. 

Thoughts on Valuation:

Boyd is on track to earn 14.2mm of EBITDA in 2009.  After subtracting maintenance capex of 0.8% of sales (1.8mm) and amortization of unearned rebates (of 1.4mm), their pre-tax unlevered free cash flow will be in the neighborhood of 11.1mm.  My TEV number of 77mm comes from reducing MV + Net Debt by i) 2mm as a PV of cash that they have yet-to-receive from vendors in the form of prepaid discounts, ii) 3mm representing a tax holiday from the changes in the tax rate applicable to Canadian Income Trusts starting January 2011.  I also add 2.5mm of net debt which reflects my estimate of the cost of the 5 new locations they acquired in early December.   

To expand on these two items:

(i) Boyd often receives cash payments from its vendors (e.g. paint supplier) when it acquires a new location, in exchange for promising to exclusively use the vendor's products in the shop.  This discount is amortized over time into expense reduction on the income statement, so current margins are slightly overstated owing to this non-cash expense reduction that does not last into perpetuity.  As of Q3 '09, 2mm of such payments have not yet been received as cash but are owed to the company, so this 'receivable' reduces net debt. (see footnote 3 on page 7 of the 2009 Q3 interim report to unitholders, available from the IR section of their website)

(ii) Starting in January 2011 all Canada Income Trusts such as Boyd will have to pay taxes on any distributions made to trust unitholders, whereas currently such distributions can be deducted against taxable income.  This had the effect of creating tax shields, and often allowed trusts to avoid paying anything more than a de minimus tax rate to the Canadian government.  Assuming a 100% payout of levered free cash flow and assuming a tax rate in the low 30s, their 1-year tax holiday is worth roughly 3mm, which I also subtract from net debt.  

It is reasonable to value Boyd on an unlevered free cash flow basis because management has a somewhat risk-averse posture with regards to debt.  This stems from at least two experiences: 1) having levered up the company back in 2004 to fund the purchase of Gerber Collision & Glass, only to subsequently suspend distribution payments to equity holders in order to pay down debt.  With Boyd's equity units largely held by retail buyers who expect distribution income, the stock plummeted. 2) observing the credit crisis of 2008/2009 made management uncomfortable with the idea of becoming dependent on debt refinancing, period.  

Therefore even though new locations are often entirely financed with capital leases, seller financing, and prepaid discounts from vendors (and therefore require zero equity capital upfront), Boyd has chosen to consume equity capital in order to pay down capital leases and seller financing on a mortgage-type amortization schedule, without replacing these liabilities with term debt.  This in spite of average new locations generating 300k of EBITDA for an average purchase price of 500k, which means new locations could theoretically be financed exclusively with debt and the company's leverage ratios would only creep toward something like 1.6x Debt/EBITDA.  But even being entirely equity financed, new locations on average generate 225k of pre-tax cash operating profit (300k EBITDA - 25k capex - 50k allocation of incremental overhead [conservative estimate]) on 500k of equity capital for a 45% pre-tax return on incremental growth capital spent (or 30% after-tax).  See presentation on the IR section of their website for more details.  Also noteworthy is that Boyd's shops are run at negative net working capital.  

Assuming 2009 is a trough year and assuming a conservative 0% same store sales growth from 2009 to 2010, Boyd should see EBITDA grow around 12% (coming from high single digit revenue growth through having opened 8 new locations in 2009, plus a bit of margin expansion as management has stated that overhead need not grow proportionally with acquired revenue).  So figure 16mm 2010 EBITDA, less 1.5mm non-cash amortization of unearned rebates, less 2mm of maintenance capex, gives about 8.5mm unlevered free cash flow, assuming a 32% tax rate (the 2010 tax holiday was accounted for in the TEV calculation above).  On a TEV of 77mm, this gives a buyer of the entire enterprise an 11% unlevered free cash flow yield.  

Sources of Upside:

• 2009 proves to be a trough year for collision repair, and same store sales revert to historical mean of 1-2%, with the potential for accompanying margin expansion if corporate overhead expansion is kept to a minimum.  
• Boyd could increase the value of the enterprise by paying out its cash in a one-time distribution to equity holders before 2011, when distributions from Income Trust structures can no longer be made tax-free.
• Boyd takes share as the effects of dealership closures and Boyd leveraging its DRP network allow for further upside to same-store-sales beyond 1-2%.
• The pace of acquisitions continues at 8-10 per year or even accelerates, with each new location providing unlevered returns to equity of 30%.
• Management's allergy to debt becomes less severe and equity holders can earn higher returns on a levered basis.

Risks

There has a been a trend in which more vehicles have been declared "total losses" because as cars become more sophisticated, the same magnitude crash becomes more expensive to repair (airbags are deployed and need to be reset, delicate electronics and sensors may need to be replaced and re-wired, etc.).  Therefore if an increasing share of collision incidents are so severe as to render repair uneconomical (since in many cases it will be cheaper for an insurance company to replace a heavily-damaged car with a check for its blue book value rather than repair it), Boyd's garages would take a revenue hit.  This trend is difficult to monitor and predict, but our research shows that this trend has hit a plateau and the rate of vehicles being declared a total loss has actually decreased in the recent quarters, owing to used car prices increasing in value and therefore making it more difficult for a damage repair estimate to exceed the bluebook value level.  

Furthermore, management has expressed some concern over a competitor executing a transformative acquisition, whereby they become the scale player in the industry and, if they had a large enough share of the DRP network, take the value proposition away from Boyd.  In this case, concerns arise regarding whether Boyd's management team would feel compelled to overpay for an equally transformative acquisition in order to retain its scale advantage.  Management owns about 17% of the shares outstanding (almost $10mm CAD market value), and they claim to have learned their lesson in 2004-2006 regarding overpaying for large acquisitions and destroying shareholder value.  While I do not sense an inspiring amount of confidence regarding management's superior capital allocation discipline, neither do I expect they are on the cusp of frittering away a large amount of cash anytime soon.

Catalyst

• Management announces a continually increasing level of distribution payments
• Some non-zero probability of a large one-time distribution payout before Jan 1, 2011
• Highly-accretive acquisitions done at a faster pace than 8-10 per year
• Boyd gets acquired at a premium
• Same store sales show a marked improvement as they comp against the steep declines of 2009.