The Breakdown

Explaining Southern California's economy

Los Angeles' Gores Group spends heavily to acquire Pep Boys

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33164 full

Pep Boys, the auto parts and service chain, is leaving the public markets and leaping into the arms of private equity firm The Gores Group, based in Los Angeles. This is from the LA Times:

Manny, Moe & Jack are going private: Aftermarket auto parts chain Pep Boys is selling itself to Los Angeles investment firm Gores Group for $791 million in cash.

Expansion-minded Pep Boys executives say the total enterprise value of the deal is about $1 billion. The $15-per-share price reflects a 24% premium on Pep Boys’ Friday closing price of $12.08.

Philadelphia-based Pep Boys, which has benefitted from a trend of drivers holding on to their existing cars rather than buying new ones, watched its stock jump 23% to nearly $15 during midday trading Monday.

This is both interesting and worrying. First the interesting. The Gores Group has been around since 1987 and has made, as may private-equity firms have, many millions if not billions of dollars between now and then. The firm closed a third fund early last year, amounting to $2 billion. Now it's buying Pep Boys, all in cash (debt brings the value of the deal up to $1 billion). As the Wall Street Journal points out, the purchase price amounts to $15 per share, but it's been more than two years since Pep Boys closed at that level.

The WSJ also note that Gores is "putting $489 in equity into the deal." It's unclear how much of that is Gores money from its new fund and how much is borrowed. But it does put about a quarter of Gores' new fund at risk.

About the risk (this is the worrying part): Pep Boys has seen growth of late because people are keeping their cars longer, as the LAT notes. The chain made half its money in the first three quarters of 2011 on service. The average age of the U.S. auto fleet is at an all-time high: something like 11 years. The reasons for this are obvious. Unemployed people don't buy new cars. People who might lose their jobs don't buy new cars. People struggling to stay in the homes don't buy new cars. 

Or more accurately, they don't buy cars loans get into leases. New cars are all about the financing, when you get down to it. And people haven't been in good enough shape to even consider going into debt for new wheels.

This has reduced the number of cars and trucks sold in the U.S. from about 17 million in 2005 to just under 13 million last year. However, many analysts think that the auto market will recover to around 15 million, eventually. And this is where you have to question Gores' investment. 

If Gores' timeframe is typical, it will look to sell Pep Boys or return it to the public markets in five years. The question is: Will people be hanging on to their vehicles as long in 2017? And a deeper concern: Will Gores be able to extract increasing value from Pep Boys service? Or will it look to grow other aspects of the business, such as parts? 

You have consider this deal and ask yourself if Gores came too late to the keep-your-clunker-running party. But it still worth following to see how it all works out, if the deal ultimately goes through.

Follow Matthew DeBord and the DeBord Report on Twitter.

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