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Huizenga Hands Investors a Lemon

Republic Industries keeps printing up and passing around stock to overpay for new car dealerships.

Conrad Hilton remarked late in his life that the secret of his success in the hotel business came down to making sure that shower curtains were installed to remain inside the tub when a guest was taking a shower. From which wisdom we may conclude, in the words of the Dutch architect Mies van der Rohe: God really is in the details.

This brings to mind the current sorry state of affairs at

Republic Industries

(RII)

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, the only company in America that can truly be said to be operating as its own private mint for the printing of legal currency ... by which we mean Wayne Wampum. I refer to the avalanche of common stock that has been rolling down from the financing heights of Wayne Huizenga's Florida-based, multibillion-dollar business empire, most of which involves, one way or another, the selling of cars.

When last we visited Huizenga in May 1997, the road ahead for Wayne's World looked pretty bumpy -- though, as you might imagine, Huizenga's paid public congratulators (a.k.a. his flacks) saw things differently. They chastised us roundly for not endorsing their point of view (which is to say, Mr. Huizenga's point of view) regarding what they apparently took as our "mean-spirited" suggestion that too much of anything -- even sex and, most certainly, stock -- can cheapen its value.

But this is how things have worked out, both for

Bill

and

Monica

and, as it happens, for Wayne and his Wall Street wampum machine. That's because, as the record will show, when last we dropped in on Republic Industries, Wayne's wampum machine had already cranked out a total of 350 million shares of the stuff, putting a market value of $9.6 billion on the company at the then-going rate of $27.50 per ... what, "wampus"?

In any case, if we now vault forward to today, we find that with the wampum machine cranking overtime, there are now 467.1 million Republic Industries wampum swirling through Wall Street. With their per-wampus value having fallen by nearly 45% to roughly $15.44, Wayne's Wigwam is now worth only $7.2 billion. Just as has been the case with news of the sexploits of the president and Ms. L., so too has it been with Republic Industries stock: The more of it there is, the less anyone cares.

Republic Industries, as you may know, is (or was) in the garbage business and is now in the process of exiting from same. (One might say that in some ways, Wayne's still in the garbage business.) Until last year, the company was in the burglar alarm business or some fancied-up version of it, too. Which means that, for all practical purposes, Republic has now more or less been pared down to a single line of work: the car business.

But don't get the idea that we're talking pared-down as in "small." In car sales, Wayne is it -- the Big Chief: a single company with more than 1% of the entire American new-and-used-car retail sales market, one of the most fragmented markets there is. Think about it: Wherever you go, wherever you drive, for every 100 cars you see on the road, one of them got there via one of Chief Sell-Some-More's car lots. And in addition to car lots and dealerships, the company also owns

National Car Rental System

and

Alamo Rent-a-Car

. It's cars, cars everywhere ... and they all come from Big Chief!

Republic got that way by the frenzied printing up and passing around of Wayne's wampum to purchase car dealerships all over America. The company now owns more than 260 new car dealerships selling more than 36 different kinds of cars and light trucks. It also owns a network of 26

Auto Nation

used car mega-lots that are sprouting up everywhere. If you drive from New York to Miami down I-95, you'll see them all over the place, these sprawling lots with 100-foot-tall Auto Nation signs reaching skyward.

I think Wayne got into this business because he went out to buy a car one day and got jerked around by a salesman. I think he came away from the experience scarred for life and went back to his house in Palm City, Fla. -- rumored to be as big as Andorra and around which he drives a golf cart as if he were a 60-something Richie Rich -- and said, "I'll fix that so-and-so." I think he then whistled for his aides and commanded them to buy all the car lots in the world so that the salesman who had insulted him (and who was probably named Max or Lou and was probably born with the stub end of a soggy White Owl permanently affixed to the corner of his mouth) could be given a lesson in civil comportment when the majestic presence of the great H. Wayne Huizenga appeared godlike before him.

Frankly, I think something like that is a pretty good possibility because here's the party line inside Wayne's World, memorialized in the company's latest annual report to shareholders, regarding why the world beyond needs Auto Nation:

The Company believes consumers are generally dissatisfied with the service and retail experience offered by existing automotive retailers, particularly with respect to used vehicles ... consumers generally are unable to find used vehicles that have been extensively reconditioned, to obtain comprehensive warranties on used vehicles, to see and test drive a broad selection of used vehicles in one location, or to be offered a convenient and pleasant, no pressure, "no haggle" shopping environment.

Sounds pretty reasonable, no? Wouldn't we all like to shop for a car without having the salesman come up and do the car lot version of spraying perfume in our face?

Unfortunately, here's one of many shower-curtain-in-the-bathtub details that Wayne overlooked when he set out single-handedly to remake the face of automobile retailing: Car salesmen

like

to be pushy. It's in their genes. They can't help themselves. Tell a car salesman he can't needle and weasel you for a sale, and he'll quit in an instant and get into aluminum siding or sign up to take his registered rep Series 7 exam.

Actually, when you think about it, used car lots serve a genuine -- if underappreciated -- social purpose: They keep the type of people who gravitate toward that line of work isolated from the work force at large. Can you imagine what life at the office would be like if you came to work one morning and found the place festooned with pennants and every window in the building smeared with Glasswax messages reading, "She's a Honey" and "Blowout Bonanza!!!"?

I have a friend named Russell who has a car lot in Orlando. Might even be the last lot in central Florida that Wayne doesn't own. Anyway, here's what Russell says about Wayne's woes:

His employees don't get commissions; they work on straight salaries. So they have no incentives to sell a single car. He's turned them from salesmen into order-takers. They can't negotiate prices or anything. Over at my place, we're constantly getting job applications from salesmen who want to quit Auto Nation and come work for us.

But the real problem here is the slow-growth, cyclical nature of the used-car business. This is the kind of high-cost, low-margin, economically sensitive activity that smart businesses are trying to get out of -- and here's Wayne trying to get into it.

Depending upon whether you look at the most recent three-month or nine-month figures, Republic's automotive-retail-segment revenue has been growing year over year at anywhere from a 103% to 112% pace. But 97% to 100% of these gains are coming by way of acquisitions. In other words, Wayne's spending his wampum to buy businesses that are basically dead in the water. So what if he can pick up a few marginal customers by keeping muzzles on his salesmen? His operating performance -- which is now running to a lousy 14% on a gross margin basis -- is as good as it's ever going to get, and it's terrible. That's because 86% of every dollar of revenue is eaten up in simply acquiring the cars that he turns around and resells. What's left has to pay the freight for the rest of the business.

How that money gets spent is hard to figure out because the company doesn't break down its segment-reporting data enough to be helpful. And the situation is further complicated by the fact that the company hasn't yet fully shed its garbage business and won't do so until later this year.

Thus, strictly on a back-of-the-envelope basis (which means, maybe not exactly right, but probably not far off), we can say that Republic's net profit margin from its auto-retailing business is probably running at somewhere around 2.1%, which is frankly rather pathetic. Here we are at the top of the business cycle, at the end of the longest economic expansion on record, with the lowest unemployment rate in more than 30 years, and Wayne's knocking down 2.1% in a business that's not going anywhere? What happens if car sales weaken?

On paper, the company's balance sheet gets by, with roughly $3.2 billion of working capital, $325 million in cash, $3.5 billion of long-term debt and $5.4 billion of shareholder equity (but we'll get to this later). But $1.5 billion of this is tied up in cars that are either sitting on lots and waiting to be sold or that are held by the company's two rental outfits -- Alamo and National.

Then comes another $1.6 billion that is tied up in receivables. Having jumped by 62% in the past year, receivables are by far the fastest-growing major asset item on the balance sheet. That alone isn't alarming since the receivables are probably good assets. It just costs money to carry them, meaning that they eat up cash. This helps explain why, as Wayne has moved deeper and deeper into the car business, Republic has been transformed from a generator of cash to a consumer of cash, chomping through nearly $79 million of the stuff between January and September 1998 (the latest data available.)

Finally, we come to the telltale item on the balance sheet that explains why the stock stinks: nearly $3 billion of intangibles, which when coupled with $2.8 billion of property and equipment (which is probably not worth much of anything anyway), equals all the equity the company has. How much of the intangibles have come from overpaying for garbage dumps and how much for car companies is hard to say, but you can get some idea of how bad the overpaying has been by simply looking at car lot acquisitions between January and September 1998.

During that period, Wayne peeled off 21.9 million shares of his wampum at an average price of $23.16 per share, or $507 million, then threw in $683.5 million more in cash (approximately $1.2 billion in all) and acquired dealerships at what appears to be 20 times their earnings -- this when Republic itself now looks to be selling for somewhere around 12 times earnings. In other words, either Wall Street is grossly undervaluing Republic, or Wayne is grossly overpaying for his acquisitions.

I think he's overpaying, and so does Wall Street. And the more he overpays (which he has no choice but to do because who wants wampum, anyway?), the further down his stock will sink. With earnings per share coming in at around $1.10 for all of 1998, it's hard to understand why this stock should be worth any more than $10 a share.

In other words, Wayne, your whole business strategy is a loser that violates the First Rule of Holes: When you're in one, stop digging!

Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. At the time of publication, Byron held no positions in any of the stocks discussed in his column, though positions may change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column.