Activist investor Carl Icahn has won the bidding war for Pep Boys, beating out Bridgestone Corp. to claim the Philadelphia-based automotive aftermarket chain. The deal is valued at roughly $1 billion—a staggering number when compared to the $800 the Pep Boys founders initially invested in 1921.
The automotive aftermarket sector represents a significant portion of the net lease market, and it’s unclear how Icahn’s acquisition of Pep Boys could impact that market. According to the most recent Net Lease Market Report from The Boulder Group, a real estate investment services firm, these types of properties remain in high demand among investors because there are limited investment grade options priced below $2 million, other than dollar stores. Investors seek to acquire auto parts stores for residual value as they are typically constructed as vanilla boxes, which are easier to re-tenant in the event the tenant vacates.
Currently, Pep Boys is the only aftermarket auto chain in the nation that is capable of serving all four segments of the automotive aftermarket: the do-it-yourself, do-it-for-me, buy-for-resale and replacement tires.
Today, Pep Boys has more than 7,500 service bays in more than 800 locations in 35 states and Puerto Rico. It offers name-brand tires, automotive maintenance and repair, parts and expert advice in addition to commercial auto parts delivery and fleet maintenance and repair.
Despite Pep Boys’ significant retail footprint, however, more net lease deals occur with its competitors: AutoZone, Advance Auto Parts and O’Reilly Auto Parts. Like Pep Boys, all three of these companies are publicly-traded, providing financial transparency for net lease investors.
“I personally think the auto part sector is one of the best investments out there for the net lease market,” says Tom Fritz, a director with brokerage firm Stan Johnson Co., adding that his firm has closed several net leases in this sector recently.
Fritz says auto parts stores are typically positioned in class-B locations with market or below market rent. “Auto part stores typically pay in the $10 to $18 per sq. ft. range, which is very replaceable from a multitude of users, depending on the particular market,” he notes, adding that store sizes vary from 7,000 sq.ft. to 10,000 sq.ft., which means they can be sub-divided and leased to smaller tenants.
“There are many backup plans, which helps mitigate investment risk,” Fritz says. “Plus, the sector as a whole continues to grow and show increasing profits. There are not a lot of retailers you can say [that about].”
Automotive chains outperform S&P
Earlier this year, investment banking firm Jefferies began covering the automotive aftermarket retailers and installers sector. It created the Jeffries AutoAM Index to track the sector’s performance. On a five-year and 10-year basis, the sector has outperformed the S&P 500.
The sector’s strong performance hasn’t gone unnoticed by Icahn, who is known not only as an activist investor, but also as a savvy investor with an interest in several industries. In June 2015, his firm, Icahn Enterprises, acquired Auto Plus, a Pep Boys competitor that has 259 stores and 22 distribution centers across the nation.
Initially, skeptics thought Icahn’s interest in Pep Boys was just for show. They claimed that the bidding war with Bridgestone was Icahn’s strategy to drive up Pep Boys’ stock value, thus increasing the value of the entire sector including Auto Plus. However, the firm’s acquisition of Pep Boys gives the automotive aftermarket sector even more credibility.
Analysts contend that Icahn’s interest in Pep Boys is focused on the chain’s retail presence. In filings with the SEC, Icahn’s firm noted that Pep Boys was an “excellent synergistic acquisition opportunity for Auto Plus.”
Bridgestone, meanwhile, had a different play in mind. It was focused on the service side of Pep Boys business. The acquisition would allow Bridgestone to expand the 2,200 tire and repair centers it already operates (most of them under the Firestone brand).
Americans driving older cars
The automotive aftermarket segment is benefitting from several trends, and Jeffries analysts Bret Jordan and David Kelley predict the segment will grow at a 2.4 percent compounded annual growth rate through the end of the decade.
The first and most important trend is that Americans are driving their cars longer. Today, the average car on the road is nearly 12 years old. And while it’s true that new vehicle sales have rebounded from the 2009 recessionary low and appear poised to surpass 17 million in 2015, Jordan and Kelley contend that households add to their “fleet” as opposed to retiring older vehicles.
To that end, experts predict that by 2020, 76 million vehicles will be at least 16 years old. And these older cars will need more maintenance, keeping service shops very busy.
Additionally, Americans are driving their cars more due to the improving job market and low gas prices. Now that people are employed again, they’re commuting and putting miles on their cars. And they’re adding wear and tear by taking more road trips for fun.
Finally, the licensed driver population is growing. Millennials might like public transportation, but as the total U.S. population will expand by 80 million through 2051, the number of drivers will expand as well.
“The entire industry has continued to grow,” Fritz points out. “There really isn’t one [chain] that stands out to be much stronger or different… Each company offers customers something a little different, and [they’ve] proven again and again that they can compete and survive in the same markets. The key for a lot of the stores is the location within the market and making them easier to access for customers.”
What will happen to the real estate?
With Icahn Enterprises focused on Pep Boys’ retail locations, experts wonder what will happen to the chain’s real estate. It’s quite common for new owners to sell off the real estate to generate higher returns. This strategy is one that private equity firms employ often when acquiring retail chains, and it could create additional opportunities for net lease investors.
Pep Boys leases the majority of its stores, according to the company’s financial filings. As of January 31, 2015, the chain leased 580 stores and owned 226. Analysts estimates the company’s real estate is worth about $600 million.
As for Pep Boys’ service and tire centers, Jordan and Kelley speculate that Icahn could create a joint venture with Bridgestone to take over those centers. Another possible partner is Munro Muffler Brake Inc., which previously tried to acquire Pep Boys, but was rejected by the chain’s board.
Icahn’s acquisition of Pep Boys takes the company private, which could ultimately shift the way net lease investors view the chain, says Randy Blankstein, president of The Boulder Group.
“Auto parts stores trade at a 25 basis point premium compared to other net lease assets,” he notes, “and typically, when companies are taken private, cap rates rise as financials for the company are not readily available.”
