Friday, March 10, 2006

AutoNation: In Need of Higher-Octane Growth.

On March 7, 2006, AutoNation, Inc. (AN-$21.82), America's largest automobile retailer, announced its intent in an 8-K filing with the SEC to sell $900 million of senior secured notes, along with about $450 million of bank financing and cash, to carry out a stock repurchase and bond redemption plan.

As part of the Company's recapitalization, AutoNation has commenced a cash tender offer to purchase up to 50 million shares of its common stock at a price per share of $23. The number of shares proposed to be purchased in the offer represents approximately 19% of the Company's currently outstanding shares. Since it is expected that more than 50 million shares will be tendered, AutoNation will purchase the shares proffered on a pro rata basis.
The Company is also seeking to repurchase all of its existing 9% senior notes due 2008 in the aggregate principal amount of $323.5 million through a concurrent cash tender offer and consent.

"The tender offer for our common stock demonstrates our confidence in the future of AutoNation," said management, "The transaction will allow us to deliver stockholder value while retaining financial flexibility to take advantage of future opportunities."

Mr. Edward S. Lampert, a member of AutoZone's Board of Directors, added that the transaction will "create a more efficient capital structure."

Management returned 5.76% on company assets in the trailing twelve-months, in line with peer comparables. Will adding an additional billion (+) in leverage to the balance sheet truly benefit shareholders?

Management expects that the buyback(s) will add 8 cents to 10 cents a share to the Company's annual earnings.

The capital structure will change. When AutoNation replaces this equity with debt, the balance-sheet will have an approximate net debt-to-capital ratio of 30%, compared to about 9% before the deal. Contrary to management's comments, shareholders get the buyback's benefits at the expense of owning a more leveraged business.

But while investors seem to be delighted with the recapitalization news, Fitch Ratings downgraded AutoNation's debt to junk status, from BBB- to BB+, citing the increased debt-serving and the dismal state of domestic automakers and the impact further weakness could have on the company.

The 10Q Detective took the time to peruse AutoNation's most recent 10-K, filed with the SEC on March 3rd. The Company's recent performance metrics suggest that Fitch, a leading rating agency providing independent and timely credit market opinions, was correct in its analysis to downgrade AutoNation's debt status.

As of December 31, 2005, AutoNation owned and operated 346 new vehicle franchises from 269 stores located in major metropolitan markets in 17 states, predominantly in the Sunbelt region of the United States. The Company sells a broad range of well-known vehicle makes within each of its key markets, including autos manufactured by Ford, General Motors, DaimlerChrysler, Toyota, Nissan, Honda and BMW.
Historically, new vehicle sales have accounted for approximately 60% of total revenue, but less than 30% of total gross margin. Parts and service & finance and insurance operations, while comprising less than 20% of total revenue, contribute approximately 60% of gross margin.

For 2005, AutoNation earned $496.5 million, or $1.85 a share, on revenue of $19.25 billion. The year before, the company said it earned $433.6 million, or $1.59 a share, on revenue of $19.04 billion. In 2005, year-over-year overall same store gross profit growth--not surprisingly--was driven by increases in used vehicles sales prices and predictable growth in parts and services.

Of interest, same store new vehicle revenue for 2005 decreased compared to 2004, primarily as a result of a 2.1% decrease in same store unit volume.

Same store used vehicle revenue for 2005 increased 4.6% year-over-year to $4.4 billion, attributable to an increase of average revenue per vehicle retailed (ARVR) of $510. This increase of ARVR masked a glaring data bit buried in the SEC filing, for same store used vehicle unit volume grew by a miniscule of 0.3 percent.

In 2005, new vehicle and used vehicle average selling time on the floor increased year-over-year 3 days and 6 days, respectively, to 56 days and 43 days, respectively.

Here is another crumb found under the table: "the growth of our automotive retail business since our inception has been primarily attributable to acquisitions of franchised automotive dealership groups." Given no-growth in recent same-store unit sales--this statement morphs into more than a two-dimensional statement. Given deteriorating fundamentals, aside from propping up earnings--might there be another reason the Board of Directors ratified corporate's tactical need to do a leveraged buyback--as opposed to seeking acquisitions that could be accretive to earnings?

The 10Q Detective believes that it is important for prudent investors to sort through management's rhetoric to determine alternative--but plausible--reasons behind the buyback. Only then can investors figure out whether a repurchase plan is a signal to buy -- or to avoid the stock.

Investors need to look at the "options factor." For one thing, companies are more active in buying back shares to offset growing numbers of options they are issuing to their employees. "The focus has been on the buybacks, but in many cases we as investors have simply been overlooking the other side of the equation," says Tim Morris, executive vice president of Bessemer Trust Co., a New York based money-management firm. "Yes, it's interesting if a company has been buying back its shares, but if with the other hand it's issuing shares through options, what's been gained here?"

For the year ended December 31, 2006, AutoNation had 22.0 million options exercisable, with a weighted-average exercise price of $15.91 per share.

Investors ought to do some due diligence on disguised insider-selling, too. Insider selling can be considered bearish for the overall market as well as for individual stocks. Oh--but AutoNation is just doing an aggressive buyback--befitting and benefiting ALL investors. [ed. note. "chuckle!chortle!chuckle!"]

ESL Investments, Inc. and certain affiliates, which own 77,061,800 shares, or 29%, of the Company's common stock, have agreed to tender all of their shares in the offer. Two of the Company's directors, Edward S. Lampert and William C. Crowley, are Chief Executive Officer and President and Chief Operating Officer, respectively, of ESL Investments, Inc.
Readers should remember the aforementioned Ed Lampert, who thinks that "the transaction will lead to a more efficient capital structure." Talk about a double standard. While touting the benefits of investors owning AutoNation stock, these two executive seem to be running to the bank teller's window. In our opinion, an unctuously transparent method to cash-out 14.63 million shares--and pocket $336.5 million. And since AutoNation will be pro-rating its repurchases, ESL's percentage stake in the Company will remain unchanged!

Michael E. Maroone, a Director of AutoNation and the Company's President and Chief Operating Officer, has also advised the Company that he intends to proffer approximately three million shares of common stock that he owns in the tender offer. Mr. Maroone beneficially can hope to tender approximately 570,000 shares, walking away with a payday of approximately $13.11 million.

Should readers interpret the buyback as a bullish signal?

AutoNation is currently trading at 13.9 times expected 2006 earnings, which compares favorably with three competitors: United Auto Group (UAG) at 15.6 times 2006 EPS, Sonic Automotive, Inc. (SAH) at 10.8 times 2006 estimates, and Carmax (KMX) at 23.2 times, according to analyst's average estimates.

The 10Q Detective does not believe that the current trading price of AutoNation makes for a compelling entry point. We expect the stock to trade in a narrow channel, between $20.94 (200-day moving average) and the tender price of $23.00 per share. It will take more than stock buybacks to move this stock upward--like higher octane growth prospects.

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