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Morningstar | A.P. Eagers Lobs a Takeover Bid for Automotive Holdings Albeit at a Slim Premium

A.P. Eagers, Australia’s second-largest Australian automotive dealership announced a conditional takeover offer for narrow-moat-rated market leader Automotive Holdings. The deal is structured as an all-scrip offer of one A.P. Eagers share for every 3.8 Automotive Holdings shares owned. This implies a value of AUD 1.92 per Automotive Holdings share (based on A.P Eager closing stock price on April 4, 2019) an 8% premium on the AUD 1.78 per share closing price on the day prior to the announcement of the merger. We believe a deal can be done between the two firms, although the current premium is unlikely to suffice in our view. At this point, we maintain our AUD 2.60 per share fair value estimate on Automotive Holdings.

The timing of the takeover is opportunistic, given shares in Automotive Holdings are currently depressed, having fallen by 50% over the past year and, prior to the announcement, were trading at 30% below our standalone intrinsic assessment. The modest premium materially undervalues the firm and is an underwhelming outcome for holders of the approximate 70% of shares not already controlled by A.P. Eagers. At this early stage, we recommend shareholders take no action, although as more information becomes available and we delve further into A.P. Eagers' financials, we will be in a better position to undertake a valuation of the combined entity.

From a strategic standpoint, the merger makes a lot of sense, especially given the cyclical and structural headwinds currently faced by the entire automotive dealership industry. New vehicle sales have endured a challenging 12 months, falling by approximately 7% over the past 12 months. This reflects the declining residential property market and consequential negative wealth effect, which has weighed on consumer confidence and AHG’s sales revenue. Meanwhile, unfavourable regulatory reform has restricted the commission earnable on the sale on finance and insurance products. These products were previously a meaningful contributor of group earnings, and the reform has weighed on margins. The tie up will see both firms better placed to weather what is likely to remain a challenging environment for the near-term future, against a still fragmented industry backdrop.

Operationally, the proposed merger should benefit both firms for the following reasons: (1) increased portfolio diversification, both geographically, but also from a vehicle brand perspective. This will help smooth out the impact of changes in consumer preference and increase the firm’s ability to adjust its product offering; (2) cost synergies, which A.P. Eagers has flagged at AUD 13.5 million per year (if full ownership is achieved), mainly through consolidating corporate and IT costs; and (3) strengthening the balance sheet which will provide the combined entity with the firepower to continue consolidating the fragmented industry.

The merger is subject to several conditions, one of which being the approval of the Australian Competition and Consumer Commission, although we believe this is unlikely to be a major hurdle. Despite the merger being between the two largest players, the combined entity would still only account for less than 15% of the highly fragmented Australian automotive dealership industry. Additionally, the two firms are concentrated in different regions with Automotive Holdings strong in Western Australia while A.P. Eagers' operations are skewed to Queensland and New South Wales.

Shares in Automotive Holdings jumped by over 20% on the day of the announcement signalling the potential for a higher bid from A.P. Eagers, a bid from an external party, or assumption of synergy benefits. A.P. Eagers indicated the likelihood of a competing proposal is low, given the firm already owns 28.8% of Automotive Holdings, although we wouldn’t rule this out. The board of Automotive Holdings has advised shareholders to take no action in respect to A.P. Eagers’ offer. They will review the bidder’s statement and produce a recommendation in the near future.