We’ve talked a bit about the state of the industry and the Big 4, or the Big Boys as I sometimes call them (Boyd/Gerber, Caliber, Service King, ABRA). While they may be in the same business of fixing cars, the way they do things is systematically different.
(Editor’s Note: Keep an eye out for our upcoming article on the role of franchise based MSO’s and their impact on the industry.)
Perhaps the least understood difference is at the core of their business – how they actually make money for their shareholders.
Some people believe they give heavy discounts and make it up in volume. Others believe they don’t actually make money, and are barely holding on.
The reality is that these businesses are making millions upon millions of dollars. But not the way you may realize.
The Big 4 are owned by large Private Equity Groups (PEG’s). The PEG’s often invest money on behalf of public institutions (i.e. pension plans, insurance funds, etc.). They also have a slew of individuals with master degrees in Finance, Business, and Applied Mathematics.
Why is this important?
You probably focus on running a great business that focuses on delivering a great product, done right and delivered on time, in a way that delights your customers while also generating healthy cash flow and strong profit margins.
For large institutional investors those things are important. But even more important (and exciting) is growing a business.
Growth is exciting because the whole of the business is worth more than the sum of the parts. Or in other words, 2 + 2 = 5.
In the collision industry, often the easiest way to get to 2 +2 = 5 is to expand the number of locations under management.
That is because a business with five locations is more valuable than a business with only one. Similarly, 50 is more valuable than 10.
From a management standpoint a company owned by a private equity group will likely have a mandate to focus on growth and expansion while maintaining margins.
A smaller privately held business will instead most often have a mandate to maximize profit margins first, and then focus on growth and expansion second.
The difference in approach to firm management has significant implications for the industry.
For example, a financial analyst reviewing a potential acquisition by a private equity group may assume that the business to be acquired will generate NO free cash flow to equity holders.
The analyst may even assume that at some point the business will require an additional cash infusion to stay afloat.
In other words, it will cost the PEG money in excess of what the purchase price to run the business.
And yet this may still be an attractive target for a private equity group.
The PEG may feel they can increase the overall value of the firm even if the firm produces no profit and no free cash.
How is that possible you ask? This is the difference between maximizing enterprise value rather than maximizing profit margins.
We’ll talk more about the difference in future letters and the impact this is having on the industry.