Automotive Finco Corp V.AFCC.H

Canaccord Initiating Coverage - AFCC $4.00 Target

[Cowtownskier]

Accelerating auto dealership consolidation
Automotive Finco Corp. (AFCC) provides long-term/perpetual, unsecured debt financing
to consolidate auto dealerships. We are initiating coverage of AFCC with a SPECULATIVE
BUY rating, for the following reasons:
Fragmented market ripe for consolidation: According to a PWC study, ~65% of all
Canadian auto dealerships are owned by small groups with fewer than four dealerships.
Furthermore, ~70% of existing dealership owners would like to exit the market in five
years. This has allowed large dealership groups to accelerate consolidation activity.
There is a similar theme in the U.S. where dealership groups have attracted investments
from Warren Buffet, George Soros and Bill Gates.
Enabling smaller dealership groups to consolidate the market: We believe accelerating
consolidation activity has expanded dealership EV/EBITDA multiples to 5.0x-8.0x.
However, typically, banks have maintained goodwill acquisition financing of 2.0x-3.0x
turns of EBITDA and term to maturity of five years for at least smaller dealership groups.
The increasing equity requirement along with limited FCF availability during the first five
years after servicing principal payments is preventing smaller dealership groups from
meaningful consolidation activity. AFCC offers better terms than banks as it lends based
on dealership's resilient Parts and Services cash flow stream rather than asset coverage.
Attractive acquisition finance products: We conclude 31% higher NPV and 5% increase
in IRR using AFCC debt over bank debt if we make the following assumptions: (1) an
investor has $3.5M in equity to acquire dealerships for 6.0x EV/EBITDA; (2) banks offer
2.5x Debt to EBITDA, a 5-year term and 3.5% interest rate while (3) AFCC offers 4.0x
Debt to EBITDA, a 25-year term and 10.5% interest rate. Also, we estimate FCF available
in the first five years to pursue additional acquisitions is $2.9M utilizing AFCC debt
compared to $0.5M using bank debt. We believe dealership cash flows can decline
40-50% before they default on AFCC loan.
Strong visibility on financing opportunities: The CEO of AFCC is also the GP of Alpha
Auto Group (AAG). According to management, AAG has acquired 12 dealerships over
the last 2.5 years, grown annual revenues to $500M with EBITDA margins of ~5%
and expects to double its size in the intermediate term. AFCC provided $33M in debt
financing to AAG in Q1/17 and expects to provide another $67M in debt financing in the
intermediate term. We estimate a total revenue opportunity of $10M for AFCC based on
AAG's existing dealerships and an incremental $10M based on its acquisition pipeline.
Overall, we estimate a 5% penetration with small Canadian dealership groups implies
EBITDA for AFCC of $26M. We assume AFCC grows its EBITDA to $14M by 2018.
Target price: We derive our $4.00/sh target price using 13.8x EV/2018 EBITDA. The
valuation multiple is calculated by applying a 60% weight to the average EV/NTM
multiple of restaurant royalty companies and 40% to automotive dealerships. AFCC aims
to pay out 85% to 95% of its free cash flows in dividends. It has a dividend yield of 5.7%
and we see potential for ~10% increase in dividends based on our 2018 estimates.
SPEC. BUY: Key risks include significant growth expectations embedded in current share
price, requiring $100M in capital to achieve our 2018 estimates, customer concentration
and potential conflicts of interests with AAG, limited disclosure on dealership economics,
unsecured loans, uncertain adoption rate of third parties, re-investment risk.