How Third Point and Saddle Point Can Help Increase Margins at Advance Auto Parts

Business: Advanced Auto Parts is a supplier of automotive spare parts, serving professional installers and DIY enthusiasts. Its stores and branches offer a selection of brands, original equipment manufacturers and branded automotive aftermarket parts, accessories, batteries and maintenance items for a range of vehicles. It operates approximately 4,770 stores and 316 branches in the United States, Canada, Puerto Rico and the U.S. Virgin Islands.

Stock market value: $4.19 billion ($70.50 per share)

Ownership percentage: 8.04% economic exposure

Average cost: n / A

Comment from an activist: Third Point is a multi-strategy hedge fund founded by Dan Loeb, which will selectively take activist positions. Loeb is one of the true pioneers in the field of shareholder activism and one of the few activists who shaped what has become modern shareholder activism. He invented the poison pen letter at a time when a poison pen was often necessary. As times have changed, he has moved from the poisoned pen to the power of argument. Third Point has amicably gained board representation from companies like Baxter and Disney, but the company also won’t hesitate to launch a proxy fight if it’s passed over.

Third Point formed a group in this investment with Saddle Point. This group has a collective economic ownership of 4,781,557 shares (8.04%) of AAP stock, which is a combination of common stock and derivatives, a large majority of which is held by Third Point. Saddle Point is an investment firm led by Roy Katzovicz, former general counsel of Pershing Square Capital Management.

On March 11, Third Point and Saddle Point entered into an agreement with Advance Auto Parts, pursuant to which the following three directors were appointed to the board of directors: (i) Tom Seboldt, president of Seboldt Consulting Services and former executive of O’Reilly Automotive; (ii) Gregory Smith, SVP of Global Operations and Supply Chain at Medtronic and former SVP of Supply Chain at Walmart; and (iii) Brent Windom, former President and CEO of Uni-Select.

Third Point and Saddle Point are not the first activists of this title. Starboard Value ran an activist campaign at Advance Auto Parts from September 2015 to May 2020 and exited its investment in the first quarter of 2021, when the stock was trading at around $185 per share. In late 2021, the stock peaked at around $240 per share, but fell over time to around $120 per share by May 2023. After reporting a significant earnings shortfall of 72 cents per share in the first quarter of 2023, or 68% lower than the same quarter of 2022, compared to a consensus estimate of $2.57 per share, the stock price fell to $72.89 on May 31, 2023. This is at this At that point it became really interesting as an entry point for investors watching the stock.

Advance Auto Parts actually has two businesses: its core auto parts retail business and Worldpac, the company’s wholesale auto parts distribution business. Worldpac operates in a similar industry sector – it distributes automotive parts – but it is a completely different business with its own supply chain and distribution network. The first opportunity to create value here is to sell Worldpac. Advance Auto Parts does not separately report Worldpac’s financial results, but many consider it the crown jewel of the company and sellers estimate its value at about $1.5 billion. But with about $2 billion in revenue and earnings before interest, taxes, depreciation and amortization margins estimated at at least high single digits, Worldpac could fetch at least $2 billion at a conservative multiple of 10. A sale would management to sell its debts, immediately stabilize the company’s balance sheet and improve its S&P rating for junk debt.

Just as importantly, it would allow management to focus on the core retail business, which trades at a significantly lower value than its peers. After shrinking the $2 billion Worldpac business, Advance Auto Parts’ 4,770 stores are valued at about $1.25 million per store, while peers O’Reilly and AutoZone have valuations by store of $11 million and $8 million respectively. While some of this valuation gap is due to Worldpac’s estimated value and some is due to balance sheet issues, the real problem lies with sales and margins. O’Reilly generates sales of about $2.5 million per store, compared to AAP’s $1.8 million. This is not a marketing, pricing or sales staff issue. This is more of a supply chain and storage issue. There is little, if any, brand loyalty in the auto parts industry. Customers go to stores that have the part they need. AAP’s biggest problem has been keeping parts in stock for sale, forcing customers to go elsewhere. Solving this problem would not only increase their revenues closer to those of their peers, but it would significantly improve their EBITDA margins. With a 50% gross profit margin, almost half of every additional sales dollar goes to the bottom line just by having the parts in stock.

The good news is that Advance Auto Parts has a relatively new CEO who is extremely competent and ready to take on the role. Shane O’Kelly became CEO in September 2023. He has a strong background in retail and is a West Point graduate with the leadership skills to manage a team and the discipline to manage costs. All it needs is industry expertise and board support. This is what Third Point and Saddle Point offer with the recent settlement. On March 11, the two activists selected board seats for Thomas Seboldt, Gregory Smith and Brent Windom, all industry executives with experience in both the auto industry and the supply chain. supply. Seboldt spent most of his career at O’Reilly Automotive. Windom is an experienced automotive industry executive who most recently served as President and CEO of Uni-Select. Smith is a recognized supply chain expert with experience at Medtronic, Walmart and Goodyear. Finding the right directors to support a good CEO is one way many activists, including Third Point, create value for portfolio companies. In fact, when Third Point won three or more board seats during activist campaigns, it had an average return of 49.79% compared to 37.77% for the S&P 500 over the same periods.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.