Pep Boys' Real Estate Could Be Key in Pep Boys Attracting a Buyer

NEW YORK (The Deal) -- Pep Boys - Manny, Moe & Jack's (PBY) real estate is likely key to a potential sale

The automotive repair and parts retailer's stock closed up over 16% Wednesday after the Wall Street Journal reported that private equity firms, namely San Francisco-based Golden Gate Capital, had "expressed interest" in acquiring the Philadelphia company.

The article, however, cautioned that Pep Boys had not yet hired an investment banker and there were no negotiations currently taking place.

The automotive aftermarket service company's real estate is worth about $700 million, or $11.50 per share, according to Brian Sponheimer, an analyst at Gabelli & Co., which is separate from the Gamco Asset Management unit that has an investment in Pep Boys.

Sponheimer said the company would make an attractive acquisition for either a financial or strategic buyer. He argued that the company's real estate can be valued at $11.50 a share after subtracting taxes and acknowledged that a sale-lease back arrangement for the real estate would result in rent payments subtracting from Pep Boys earnings.

Nevertheless, Sponheimer said that Pep Boys locations are in markets that could be attractive to strategic buyers including Advance Auto Parts (AAP) and O'Reilly Automotive (ORLY).

Pep Boys says its real estate and property is worth about $600 million, according to a 10-K for the fiscal year ended Jan. 31 filed with theSecurities and Exchange Commission on April 16. Even so, Sponheimer indicated that a strategic buyer, eyeing Pep Boys' locations, could make more sense.

And the target's enterprise value would be a bit rich for a leveraged buyout. With nearly $40 million in cash and cash equivalents and about $210 million in debt as of Jan. 31 according to regulatory filings, Pep Boys would have an enterprise value of $745 million based on a market cap of $575 million.

That valuation is a multiple of approximately 9.3 times the roughly $80 million in Ebitda Pep Boys generated in its most recent fiscal year ended Jan. 31, according to data provided by Bloomberg.

Private equity bidders would have to weigh the auto parts chain's poor historical performance, particularly when compared to competitors, against the amount of debt that could be arranged to finance such a transaction and the equity that would have to be sunk into a deal.

It should be noted that potential private equity-backed leveraged buyouts for Pep Boys fell apart twice in its history, the most recent being a deal in 2012. PE firm Gores Group agreed to a deal to buy Pep Boys for $15 a share and assume about $210 million in debt in January 2012, valuing the company at $1 billion.

In the Gamco note, Gabelli suggests that Schenker has followed the automotive parts industry and "published significant research on the industry." Gabelli had previously nominated Schenker as a dissident in a proxy contest at Superior Industries International Inc.

Upon receiving Gabelli's change of control contest note, Pep Boys on April 30 announced it was postponing its 2015 annual meeting to July 10, roughly 13 months after its June 11, 2014 meeting. The postponement was likely to give Pep Boys more time to consider how to respond to Gabelli's change-of-control proxy fight and also to consider strategic alternatives such as a sale.

A person familiar with Gabelli's campaign noted that the activist fund hasn't officially submitted its candidates for election because the company's move to postpone its annual meeting means the deadline to nominate director candidates hasn't passed yet. "We're leaving all our options open," he said.

The Gabelli campaign comes after Barington and Pirate Capital, another insurgent fund that is now defunct, waged separate campaigns against the retailer in 2006.

At the time Pep Boys had put itself on the auction block. After withdrawing the auction in August of that year because of little interest, Pep Boys made peace with both firms by accepting four directors from Barington, including the activist fund's founder, Jim Mitarotonda.

The person familiar with Gabelli noted that the activist fund manager is "well aware" of Mitarotonda and his pro-shareholder activism. He declined to comment on whether Gamco wants to see Mitarotonda taken off the board.

Meanwhile, Pep Boys faces strong competition from the likes of Advance and O'Reilly, both of which dwarf the potential target.

Advance has an $11 billion market cap and around $1.6 billion in debt based on revenue of approximately $9.8 billion and Ebitda of $1.2 billion as of Jan. 3, according to data provided by Bloomberg.

O'Reilly has a market cap of nearly $22.5 billion, and cash of roughly $470 million and debt of around $1.4 billion as March 31, based on revenue of about $7.2 billion and Ebitda of nearly $1.5 billion as of Dec. 31, according to data provided by Bloomberg.

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