LKQ Corporation (LKQ) Acquisition of Uni-Select, Inc. Conference Call Transcript

LKQ Corporation (NASDAQ:LKQ) Acquisition of Uni-Select, Inc. Conference Call February 27, 2023 8:00 AM ET

Company Participants

Joe Boutross – Vice President-Investor Relations

Nick Zarcone – President and Chief Executive Officer

Justin Jude – President-Wholesale North America Operations

Rick Galloway – Senior Vice President and Chief Financial Officer

Conference Call Participants

Scott Stember – ROTH MKM

Daniel Imbro – Stephens Inc.

Craig Kennison – Baird

Bret Jordan – Jefferies

Michael Hoffman – Stifel

Operator

Thank you for joining this morning's analyst call to discuss LKQ Corporation's Definitive Agreement to Acquire Uni-Select Inc.

I would now like to turn the call over to Joe Boutross, LKQ's Vice President of Investor Relations. Please go ahead.

Joe Boutross

Thank you, operator. Good morning, everyone, and thank you for joining us to discuss the definitive agreement LKQ has entered into to acquire Uni-Select Incorporated. With us today are Nick Zarcone, LKQ's President and Chief Executive Officer; Rick Galloway, our Senior Vice President and Chief Financial Officer; and Justin Jude, President of our Wholesale North America Operations. Please refer to the LKQ website at lkqcorp.com for our release issued this morning as well as the accompanying slide presentation for this call.

Now let me quickly cover the safe harbor. Some of the statements that we make today may be considered forward-looking. These include statements regarding our expectations, beliefs, hopes, intentions or strategies. Actual events or results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors. For more information, please refer to the risk factors discussed in our Form 10-K and subsequent reports filed with the SEC.

Before I turn the call over to Nick. When we open the call for questions, we request that you please limit your questions to the prepared remarks, the press release, slide deck that we provided ahead of this call. Given we have not disclosed on this pending opportunity, close, and we are limited on what we can say beyond the materials that we provided.

And with that, I'm happy to turn the call over to Nick Zarcone.

Nick Zarcone

Thank you, Joe and good morning to everybody on the call. We greatly appreciate your time and attention today as we have some very exciting news to share with you. Early this morning, we signed a definitive agreement to acquire Uni-Select, a publicly traded company that is headquartered just outside of Montreal and traded on the Toronto Stock Exchange. This call is to provide you with an overview of the transaction. As Joe mentioned, there's a slide deck available on our website that we will refer to during this call.

Page 4 of that presentation sets forth the LKQ mission statement. I start every presentation with the slide because everything we do at LKQ comes back to the words on this page. The same is true with the transaction announced this morning. It is wholly consistent with our goal of being a leading global value-added and sustainable distributor of vehicle parts and accessories and bringing Uni-Select into the LKQ family will allow us to better serve our customers.

Now on to Page 5, where we provide some highlights on the transaction. As you will note, the offer is to acquire Uni-Select for C$48 per share in cash. The price reflects a premium of about 19% over Uni-Select's closing price on Friday afternoon. From a valuation perspective, it represents a multiple of approximately 9.7x 2023 EBITDA on a U.S. GAAP basis after taking into account the full run rate of synergies that we anticipate we will get from the transaction. And lastly, we will be selling Uni-Select's UK-based business to be responsive to the antitrust process in the UK.

There are some very significant financial benefits that will accompany this acquisition that Rick will highlight including US$55 million of cost savings that we are confident will be fully obtained within three years of closing. There are other growth and margin opportunities based on the combined product lines and the transaction will be EPS accretive in the first-year post closing, and then we'll build from there.

We have a solid financing plan and we are highly confident this transaction will not impact our investment-grade ratings. The transaction funding will initially take our leverage ratio to about 2.4x, but we will be able to get back below 2x within about 18 months. As is typical, the transaction needs to be approved by Uni-Select shareholders. Importantly, two of Uni-Select's largest shareholders have provided voting and support agreements as part of the overall acquisition agreement, which in Canada is called a plan of arrangement. In addition to the shareholder vote, we will need to receive the consent of the Canadian court and regulatory approvals in three separate countries. With all that, we anticipate the transaction will close sometime in the back half of this year.

So who is Uni-Select. Well, as highlighted on Page 6 it is a wholesale distributor of automotive aftermarket products with approximately $1.7 billion of revenue over 400 branch operations and 5,200 employees engaged in three primary lines of business. The first FinishMaster, which is a leading distributor of automotive paint and allied products that are primarily sold into the collision repair industry in the United States and Canada. This business had $722 million of revenue in 2022 and is literally a hand in glove fit with our North American wholesale segment.

Second, Canadian Automotive Group, which is a leading wholesale distributor of automotive aftermarket mechanical parts operating across Canada with both a two-stop and set delivery model. This business had revenue of approximately $600 million in 2022. As you all know, LKQ is the largest distributor of these part types in Europe, and we are confident we can create benefits from the transaction by working collaboratively.

And lastly, GSF, which was formally referred to as Part Alliance is a hotel distributor of automotive aftermarket accounts in the UK. Given the market presence of our LKQ's Euro car parts operations in the UK that business will need to be sold to be responsive to the regulatory framework in the UK.

So why are we so excited about the transaction? As noted on Page 7 of the slide deck, the strategic fit is compelling, as FinishMaster and the Canadian Automotive Group will enhance the existing LKQ businesses and allow us to continue to achieve profitable growth. FinishMaster brings new brands and customers that will complement LKQ's current paints distribution operations.

This will allow us to serve a broader array of customers with a broader array of products and with a better level of service. The integration risk here is minimal. The Canadian Automotive Group gives us a scaled entry into the attractive Canadian automotive mechanical parts market with the number two wholesale distributor. And again, we are confident we can leverage our experience in Europe to add value.

While Uni-Select is a large company in many ways, this is more like a big tuck-in acquisition, given the extremely close fit with our existing businesses. As mentioned, there are readily identifiable cost synergies of $55 million that will drive favorable returns on investment over time. Rest assured, we will continue to focus on our operational excellence programs, and we will be able to pull Uni-Select business into those programs as well. Both FinishMaster and the Canadian Automotive Group will become part of our North American wholesale segment.

As you know, Justin Jude, our President of North America, has done a terrific job over the past four to five years, driving operational improvements and a significant margin expansion in our North American segment and he will lead the charge on the integration of these businesses into LKQ. And speaking of Justin, he is not going to take a few minutes to review the FinishMaster and CAG businesses.

Justin Jude

Thank you, Nick. And turning to Slide 8, please. As we had great FinishMaster, taking their strength as a leading automotive paint distributor and really combined with our unmatched distribution network. We will provide an even greater experience for our customers. LKQ as a strong team that has many integrations under their belt. And we will ensure the integration are smooth, non-disruptive all while delivering value creation to our shareholders.

And we feel Canadian Auto Group's position as number two in the market, along with the access of the part supply network from our European operations that Nick mentioned, we'll be able to drive strong procurement synergies as well as revenue growth. I could not be more excited about walking these two companies to the LKQ family.

Turning over to Slide 9. FinishMaster they have a strong reputation as a paint supplier to both MSOs and the traditional body shops. In combination with FinishMaster and LKQ will provide an even broader product offering, better fill rates in a customer service that will be hard to replicate in North America. The unity of our two companies will continue to transform the unloaded paint distribution business for North America for years to come.

Our two companies jumping to Slide 10, it shows that we will to pass $1 billion in paint sales and related products that are used by body shops across North America. Now today, LKQ delivers parts of the vast majority body shops with limited access to paint. And taking expert knowledge that FinishMaster brings on paint, their strong supplier partnerships and their expand product offering will allow us to increase our sales into this existing customer base. And our MSO partners will see an improved and improved service level, and we will be able to do this at a lower cost to serve as well as adding – as we will be adding another part of the truck or in this case, I guess, I can.

Moving on to Slide 11. We are excited about the Canadian Auto group will also part of the portfolio well. LKQ was always looking to expand into adjacent markets. Markets that will give us the opportunity to further diversify or give us the avenue for revenue growth. And with the aging car park growing in Canada, we see the hard parts marketing in Canada will still have a steady growth for years to come.

Being able to leverage our procurement size in Europe with the scale of Canadian Auto Group footprint as a number two distributor in Canada, and in fact that the market is still highly fragment, will give LKQ a great runway for growth.

I'll now turn it over to Rick Galloway.

Rick Galloway

Thanks, Justin. All right. If we turn to Slide number 12. Europe, our largest business segment, purchased over $3 billion of these products annually. Strong vendor relationships and significant volumes will allow us to leverage our procurement expertise to optimize the combined spending between LKQ and CAG segment. We will look to expand product offerings and rationalize products within categories as we drive additional solutions to CAG customers.

Turning to Slide 13. We view Uni-Select's FinishMaster segment as one of the strongest paint distributors in North America, as Justin mentioned, we're excited to welcome them into the LKQ team. We believe LKQ provides our customers and the industry with significant cost advantages with our existing breadth and depth of inventory. With this combination of businesses, we believe we can further improve the cost to serve both LKQ and Uni-Select customers as many of those customers overlap.

While LKQ has minimal sales of paint to the existing MSOs, we are already delivering various products to a majority of their locations daily. This combination will allow our joint companies to better serve the customer while minimally impacting the cost of delivery. The majority of the procurement synergies I already discussed on Slide 12. In addition, LKQ has a long history of successfully integrating businesses, including public companies to reduce duplicative costs between the combined businesses.

Transitioning to Slide 14. Combining our two businesses is likely to uncover several additional revenue and margin expansion opportunities. We will likely uncover more as we work together more closely. We’ve identified six areas we will focus on as we close on the transaction. LKQ provides tens of thousands of remanufactured engines, transmissions and many other products, and CAG will provide a more efficient method to get these products to the end consumer.

With LKQ’s breadth of product offerings, we believe there’s additional opportunity to enhance the CAG private-label offerings as well as increased vehicle and branded European product offerings to the Canadian market. CAG will provide an additional avenue to deliver LKQ collision parts as well as continue to build on the existing CAG BUMPER to BUMPER brand through additional acquisitions.

And now finishing on Slide 15. LKQ is very proud, and we remain committed to maintaining our investment-grade credit rating. While this is a sizable transaction, we don’t believe this transaction puts our IG rating at risk as we do not believe our debt-to-EBITDA will ever get to the 3x EBITDA that the agencies have disclosed as a key metric. In addition, we remain committed to staying below 2x leverage, and we’ll emphasize our M&A discipline. Well, this is a larger deal. We felt the fit was right. And thus, we were willing to go above the 2x for a period. We will still look at tuck-in acquisitions but will likely pass on large deals until leverage comes back down. We will reprioritize our excess cash to debt repayment until we achieve our 2x target, and we expect to be below 2x within 18 months after closure of this acquisition.

And with that, I will turn the call back over to Nick for any final comments before we open up the call for questions.

Nick Zarcone

Thanks, Rick. And before we get to the formal Q&A, I will answer a question that may be on your minds. And that is after five years of intense focus on operational excellence, does this transaction reflect a new strategic focus and a swing back to emphasize large M&A transactions? And the answer is a definitive no. While this is a larger transaction, it is also a bespoke opportunity. What I mean by that is, given the businesses that comprise Uni-Select, this is a tailor-made transaction for LKQ. As I mentioned in my formal comments, we think about this as a large tuck-in acquisition that will seamlessly meld into our existing operations.

We will continue to drive the key objectives across LKQ, including profitable revenue growth, enhanced margins, strong free cash flow, investing in our business, having a balanced capital allocation strategy and attracting and developing great talent. And operator, you can now open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Scott Stember, ROTH MKM. Please proceed.

Scott Stember

Good morning, guys and thanks for taking my questions. When looking at the total, some of the key figures here on Slide 6 the $1.7 billion sales and the EBITDA margins. How does the – some of these metrics change, particularly on the EBITDA margin side once you subtract the UK business?

Nick Zarcone

The UK margins are pretty commensurate with the overall corporate margin. So there won’t be a big shift there, Scott. What there will be, obviously, that does not include the benefit of the $55 million of synergies and so we believe that once we’re all together as one family, we’ll be able to drive the Uni-Select margins north.

Scott Stember

Got it. And then just lastly, on the FinishMaster and CAG. Can you talk about the growth rates historically that this business has seen in particularly the last couple of years?

Rick Galloway

Yes. So thanks, Scott. What we’ve seen with COVID, in particular, there was a little bit of a backwards movement from 2019 to 2020, since then there’s been pretty significant growth in both CAG and the FinishMaster business. And we think the trajectory is pretty solid as we look at both businesses, where we’re looking at relatively, call it, 2% to 4% growth rates over the next roughly 10 years is what we’re kind of looking at.

Nick Zarcone

And those are really market growth rates. We believe, as we said in our formal comments that we’ll be able to accelerate the overall growth on both the FinishMaster and CAG side due to the ability to work together with the existing LKQ businesses and better serving our customers.

Scott Stember

Got it. Thanks guys and congratulations.

Nick Zarcone

Thank you.

Operator

Our next question comes from the line of Daniel Imbro from Stephens Inc. Please proceed.

Daniel Imbro

Good morning, guys. Congrats on the deal.

Nick Zarcone

Good morning, Dan.

Daniel Imbro

I want to start on just a financial question with. I guess on the synergies, you guys said $55 million of run rate by year three. I don’t hear any discussion around the kind of pace of capturing those? Should we expect this to be kind of linear years one, two and three? is there more a hockey stick kind of in year three as you plan to capture the procurement, I think the procurement SG&A and one of their bucket of main synergies. Can you kind of walk through the expected time line of those three different bucket of synergies?

Nick Zarcone

Yes, I think it’s important to note, we’re unclear when it actually close. So assuming a 12-month after closure, the way to probably think about this is more like the $15 million to $20 million in year one and then bulk of the remainder happens in year two with a little bit of lag into year three. I think by the end of year two, our objective would be to be pretty significantly close on that, call it, upwards of $45 million or so of synergies by the end of year two and then remainder get you last $10 million in year three.

Daniel Imbro

Thank you for that color. And then, Justin, maybe thinking about the CAG business you guys are acquiring, I think in the slides, you said the market is going to grow, call it, 3-ish percent in the next decade. I guess can you provide some background color and forgive the ignorance, is there a reason this business never expanded into the U.S. like strategically, could it expand into the U.S. and can we accelerate that growth and kind of become a player in the U.S. mechanical aftermarket parts distribution.

Justin Jude

Yes, historically on the CAG’s revenue, they’ve outperformed the market, looking over the last three to four years. We still see large opportunities to expand into Canada. And at some point, could that give us a footprint to get into the U.S. possibly, but we’re really focused on going after the Canadian market where we see great trends. I mean as I mentioned earlier, aging car park, quite a bit of fragmentation that still exists. So we want to concentrate on that market with that team up there and continue to grow that business in Canada.

Daniel Imbro

I’ll leave it there. Thanks so much guys.

Nick Zarcone

Thank you.

Operator

Our next question comes from the line of Craig Kennison from Baird. Please proceed.

Craig Kennison

Hi. Good morning. Thanks for taking my question as well. I wanted to ask about the supplier base for CAG. What’s the overlap between those suppliers and the suppliers to your European operations. I’m curious about your ability to extract a synergy there.

Nick Zarcone

Great question, Craig and good morning. Obviously, we’ve looked and studied this very hard. A good portion of the synergies are procurement. We’ve been able to actually match up on a SKU to SKU basis, supplier to supplier basis. And we do believe there is a good overlap in the supplier base. We think we will have the ability to expand their private label offerings based on who supplies does in our European theater. And there will be close kind of communications and working together between our procurement team over in Europe and the procurement team at CAG. So we’re very optimistic about our ability to create value for our shareholders.

Craig Kennison

And as a follow-up, how do CAG’s payable terms compared to what you’re able to do in the UK or Europe?

Rick Galloway

Yes. So one of the things that we’re into with CAG is they do have a supplier vendor financing program that we believe will be able to enhance that and go larger than what CAG has been able to achieve thus far, just due to the size of LKQ and the ability for us to enhance that. So I think there is, Craig, upside on the payable side of the business for CAG to improve to get to the levels that we have over in Europe.

Craig Kennison

Okay. Thank you.

Rick Galloway

Yes. Thank you.

Operator

Our next question comes from the line of Bret Jordan from Jefferies. Please proceed.

Bret Jordan

Hey, good morning guys.

Nick Zarcone

Good morning, Brett.

Rick Galloway

Good morning, Brett.

Bret Jordan

On the sale of the UK asset, I guess, have you gone down that path and have a buyer and I guess we do expect that you probably sell it for less than the multiple paid for Uni-Select, given the fact that you’re probably viewed as a forced seller. I guess, how do we look at that UK asset divestiture?

Nick Zarcone

Yes, so nothing has happened yet, Brett, because we just signed the definitive agreement to buy Uni-Select. We’re anticipating that as we work through the antitrust review with the CMA, which is the regulatory body over in the UK that we will need to sell the business, given the market share that ECP already has. So no, there are no buyers lined up. We are going to run a very competitive process. And we think it’s a very attractive asset in terms of its size, its scale, profitability. It’s fully independent. There’s no real linkages back to the Canadian headquarters. And so it’s an asset that’s very easily separated from the mothership if you will. And we are going to hire a banker, actual Uni-Select, we’ll be hiring a banker and we will come to market just as quickly as we can. Evaluation will be based on what the market will bear and the competitive dynamics we can create through the sale process.

Bret Jordan

Okay. Last I checked, I think that parts UK had a what sort of high single digit market share over there?

Nick Zarcone

Yes.

Bret Jordan

Okay. And then I question on the CAG business. Could you talk about the distribution? I think years ago they were sort of transitioning between maybe more independent store base to more company owned store base. Could you give us a feeling for where they are now and sort of what the strategy around the actual to the customer distribution model looks like?

Nick Zarcone

Yes, you are correct, Bret. In the past they were a heavily three-step, a lot of job or a lot of members. They still support that business. LKQ would continue to support that business as opportunity for growth and trying to gain share a wallet with those customers, especially as Nick talked about with private label access. In addition, they have added some stores. They’ve shifted some more focus onto the two step to the actual store front delivering right to the shops. And LKQ is interested in expanding the two step as well as the three step when the opportunity arises. But they have done that shift and I think it’s about maybe a third, two step and two-thirds.

Rick Galloway

Yes. And I remind you, Bret, that when we went into the Netherlands, when we bought the what’s today the force business, that was entirely a three step distribution model. And we very successfully were able to transfer that. And today it’s 70%, 75%, two step, and the balance just three steps. So we’ve got experience in making the transformation. Our goal up in Canada is to support all of the customers, regardless of whether it’s an independent shop where CAG will deliver direct or to support the jobber community that will be distributing parts ultimately into the end market.

Bret Jordan

Okay. And most of FinishMaster’s revenues are U.S. based, right? I mean, they do more South of the border than North. I guess, what about that business was proprietary that you couldn’t home grow it versus acquire it?

Nick Zarcone

Yes, so LKQ sells the main brands that paint, but we’re very limited in the markets for which we can sell that. And as I mentioned on my call, we’re delivering almost every shop, maybe not every but 90% of body shops every day, but we don’t have the opportunity to offer those brands. FinishMaster will bring those brands to us. They’ve got the expertise. I mean, they are truly a top notch paint distribution business with strong Salesforce and strong relationships with suppliers. So we take that combination of their offerings and we combine it with LKQ’s network, we’ll be able to add more revenue growth in our existing customer base that we can’t offer that today.

Operator

Our final question comes from Michael Hoffman from Stifel. Please proceed.

Michael Hoffman

I got to love these conference call services. I can’t always get there. Anyway…

Nick Zarcone

Good morning, Michael.

Michael Hoffman

…to talk to you. How are you guys? Rick, on the leverage, your comment in your script, I assume what you mean is you’re not going to do buyback and you’re not going to do other M&A. So that means cash piles up this year, cash piles up on a net debt basis. You get faster to that two time –- back to two times is my gut because I’m not spending on buyback. Is that the right way to think about this?

Rick Galloway

Yes, and as we talked last week, the way we modeled it within our guidance is using net excess cash for debt pay down. So the model should work the exact same as what we had projected before on our guidance.

Michael Hoffman

Right. So you’re, you’re going to end this year even less levered and then you add this transaction and it’s just, I get to where you’re going faster.

Rick Galloway

Yes. You’re spot on. That’s exactly the way we’re thinking of it.

Michael Hoffman

Okay. Okay. And then on margins, can we talk about the comparison to LKQ’s existing round numbers, 300 million of FinishMaster, like versus the FinishMaster, which is in the sort of seven, 7.5 range. And then, what can that combined go to given that all of North America’s supposed to be sort of run rate 17.5 and the same thing for the Canadian Auto Group versus LKQ’s mechanical, how do they compare and then can I get to LKQ like margins?

Rick Galloway

Michael, as you know, we don’t provide product level margin detail in any of our disclosures. What I can assure you is our existing paint business is not running at a 18% margin, the total North American segment is. The FinishMaster margins, as I indicated, their whole company is in the high single digits. The paint margins are in that vicinity, but we will be able to drive that north with the synergies and the cost savings that we’re going to be able to get.

There’s public disclosure out there on FinishMaster hard parts margins up in Canada because that’s a separate segment. That’s kind of low double digits. And again, that low double digit margin is pretty consistent with what’s available in the wholesale aftermarket parts distribution industry. Not, a couple of the players out there have higher margins that’s due to their retail operations. But in wholesale kind of that low double digits is a good market rate. Again, we’re going to try and drive the margins as north as we can. But nobody should expect that we’re going to be able to take their revenue and drive it to an 18% margin. That’s pretty unique given our standing in the North American marketplace.

Michael Hoffman

Okay. The other interpretation though is because of a mix shift, the 17.5 comes down.

Rick Galloway

Absolutely. The 17.5 will come down. What we’re focused on is creating value through EBITDA dollars. And the margins will come down a little bit exact as you said, because of mix. But the EBITDA dollars will go up pretty dramatically and that will provide the cash flow we need to continue to grow our business.

Michael Hoffman

And that will keep you in that 55% to 60% free cash conversion still too.

Rick Galloway

Absolutely. Yes.

Michael Hoffman

Okay. All right, cool. Thanks.

Rick Galloway

Thanks, Michael. Okay. Any other questions before we bring the call to our close?

Operator

There are no more questions. I would now turn the call over to Nick Zarcone for closing marks.

Nick Zarcone

Okay. Well again, I want to thank everybody on the call for joining us today. I know you had short notice to dial in, but we are really excited about this opportunity. We think it’s going to be a – it’s terrific for LKQ customers. We think it’s going to be very beneficial to the combination of LKQ and Uni-Select employees. And ultimately it will drive value for all of our shareholders which is first and foremost on our minds. We – it’s going take some time to get the closure. You can never get these done, these transactions done quick enough, but we need to follow the normal processes and we’ll come back prior to closing to adjust our guidance. At that point in time, we’ll know how much of 2023 will be left and what we can expect as far as the financial impact for this year. Until then we again, thank you for your time and attention and look forward to continuing our dialogue with the investment community about LKQ.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s call. Thank you for your participation. You may now disconnect.