Editor’s note: Focus Advisors managing director David Roberts recently penned an analysis of the state of the collision industry as the COVID-19 pandemic hopefully winds to a close. At this time when repairers might be catching their breath and taking stock, his perspective offers both MSOs and single-location repairers alike a sense of where the market might go, what modifications to a business model might be needed — and what the competition might be feeling.
By David Roberts
In dozens of discussions with shop owners over the past four months, there is a marked divergence among MSOs about their plans for the future. Many who are experiencing a strong rebound in revenues, have strong balance sheets and managed their expenses throughout the pandemic have embarked on more aggressive expansion. Others are reconsidering their alternatives post-COVID-19, as their recovery proceeds more unevenly and more slowly than anticipated.
The former are carefully identifying expansion opportunities. One client is in the process of buying a dealer body shop. Another client has committed to building a large greenfield location in a rapidly expanding portion of his market.
Among those who are reconsidering their future are some who have been planning their exit opportunities for a long time but have been reluctant to pull the trigger. Others are exhausted: “I just don’t have it in me to roll this rock up the mountain one more time. COVID really took it out of me.” Slow recovery seems to be a common thread: “I’m finally ramping up, but at this rate it will take me over a year to get back to where I was.”
COVID may be the straw that broke the camel’s back for some. Between pressures from insurance companies (including being dropped by State Farm or USAA), additional investments for certifications and new equipment, and the retirement of senior technicians, several operators have decided that it’s time to let somebody else take over the business.
For some of our clients, the hard decision to sell has already been made. Now they’re spending their time preparing their companies for a positive exit with a more defined future for their technicians and managers.
One operator who is still sitting on the fence is concerned that an acquirer may not treat his employees as well as he does. Another is worried that because his children have no interest in the business, the family name on the door will be lost forever. Another is uncertain about whether he will ever regain his pre-COVID profitability even though his revenues are coming back strongly.
For operators who are reengaging positively with their businesses, many have taken the opportunity during the pandemic to revamp their operations, restructure their teams, improve their training and upgrade their facilities. One of our clients improved his margins by two points during COVID. His comment was, “I finally got around to doing things I’d wanted to do for 15 years.”
Undoubtedly, savvy operators are recognizing that staying in the industry will require more capital, more scale and better leadership. Some have very frankly recognized their own limitations and decided to add senior management with capabilities greater than their own. One of the questions we get is, “How should I compensate a senior leader with better management skills than me?”
Our response is to never be afraid to pay somebody really well if they are contributing more value to the business than you can do by yourself. A smart operator who intends to create equity value in the business to be harvested in the future can’t do it alone. So be prepared to pay a generous salary and benefits as well as some equity or stock appreciation rights to that new leader.
Another area where operators are finding increasing need is in finance. For those growing beyond the $20 million mark in revenue with six or more shops, really competent and experienced financial assistance is a necessity. One option is to outsource contractors. Part-time CFOs are an alternative. A really well qualified controller or CFO can relieve the owners of many administrative and financial burdens in a rapidly growing organization.
Questions if you’re selling — or expanding
Both expanding operators and those who are considering exiting the business are asking many of the same questions.
What about valuations? How much will my COVID numbers hurt me? Will I be judged valued on my 2019 numbers or my 2020 numbers?
In general, all acquirers look primarily at the trailing 12 months revenues and EBITDA. However, our firm has been successful in helping acquirers understand that full year 2019 and first quarter 2021 are fairly indicative of the capability and health of the business.
In looking ahead to 2021, business performance in 2019 is a fairly reliable indication of where the business will likely return or exceed.
However, as 2019 falls farther back in the rear-view mirror, we think valuations will be more based on 2021 results and their progression.
How do acquirers look at EBITDA during the PPP loan period?
PPP loans can be challenging for acquirers to analyze. Their impact on the business is admittedly hard to tease out. Highlighting excess labor that was retained during COVID in accordance with the PPP loans has been a successful way for our clients to engage with acquirers. However, we have also been successful treating PPP (and EIDL) loans as grants, and thus income, which tend to more than offset the extra costs imposed by their forgiveness criteria.
Is it a good idea to grow right now?
Yes. We think there are opportunities in just about every market to find and acquire other operators who are struggling or who just want to exit.
By acquiring another operator, you get immediate cash flow and (hopefully) EBITDA, a trained staff, and an operating business. Fixing an underperforming business isn’t simple but if the core staff and relationships are there, it’s a more immediate return than starting from scratch.
A brown- or greenfield startup is lots of fun and challenging with infrastructure costs, hiring staff, obtaining licenses, and establishing new DRP relationships, but EBITDA is slow in developing.
For those operators who are acquiring, we’ve also seen creative methods for financing the purchase, including seller financing and SBA loans that wrap both the business and the real estate into one loan.
Almost every large acquirer paused briefly to reassess their own acquisition criteria and to stabilize their operations. Caliber, which has slowed its pace of acquisitions over the last year and a half, temporarily suspended rent payments to a number of its landlords. It also paused or eliminated some internal and external initiatives. However, Caliber restored both back rent and current payments to landlords in the midst of the pandemic and has not wavered since.
Several of the more seasoned super-regional acquirers such as Crash Champions and Classic Collision hardly slowed at all. And new entrants Quality Collision and CollisionRight launched in the midst of the pandemic. CARSTAR and Fix Auto USA continued to add new franchisees although at a slower pace than pre-COVID. Smaller operators such as Mitchco, now up to 4 locations in Florida, G&C with 19 locations in Northern California, and several others took advantage of local opportunities to continue growing their footprint.
In short, the additional competition for quality MSOs has kept buying interest and valuations high despite the pandemic.
What to watch
People ask us what we are paying most attention to in the industry.
Number 1: OE requirements and certifications. We think OEMs are increasingly recognizing that access to technologically complex parts and certifications gives them more ways to improve their OE parts sales and margins. A $4,500 headlight with a patented sensor included is a not-so-subtle way to insure parts profitability.
Number 2: Consolidation. We expect the acceleration of consolidation to continue.
Number 3: Diversification. Caliber has emphasized its diversification into glass, service and ADAS work. LKQ has added ADAS services to its offerings and is buying up smaller ADAS firms. LKQ now claims that with the creation of the Elitek subsidiary, it’s the largest U.S. mobile provider. Regional operators are creating their own ADAS companies as well.
Number 4: Changes in DRP networks. Referral growth accompanying Progressive market share growth, GEICO DRP changes and eliminations in the State Farm and USAA DRPs have impacted both large and small MSOs. Replacing State Farm volumes with smaller DRPs cannot make up the difference.
Number 5: Changes in insurance market share. When one considers the remarkable changes among auto insurers over the last 10 years, the most surprising and far-reaching impact is how the direct marketers – GEICO and Progressive – have grown their total market share. These two companies have grown from 16% to 27% of all premiums written in the U.S. in a decade. The top 10 insurers have grown to almost 75% of all vehicles insured. More and more clout is moving to fewer and fewer insurers.
What we expect
Miles driven: We think travel by car will come roaring back. People are so anxious to move around the country. They still can’t travel to Canada or Mexico very easily, so expect summer travel in the U.S. to be up above 2019 levels.
Many more transactions: With two active national consolidators, five super-regional MSOs and at least six private equity firms still looking for platforms, we expect to see many more transactions in 2021 and 2022.
Much of the volume will be driven by the expansion plans of these acquirers. Some will be driven by potential tax rate increases both at the national and the state level. Many will be driven by retirements of operators. And sadly, many will be driven by the exits of struggling businesses.
David Roberts is managing director of Focus Advisors.
David Roberts, Focus Advisors, May 13, 2021
Some repairers might have emerged from the COVID-19 pandemic energized, while others might be ready to throw in the towel. (alexsl/iStock)
Focus Advisors anticipated that purchasers of body shops would evaluate them based upon the first quarter of 2020 and 2019 — not the pandemic quarters of 2020. (matejmo/iStock)