AMA's transformation

AMA Group is up 25 per cent since we wrote about it last week due to a well-structured acquisition of its larger competitor in Gemini Accident Repair Centres. At 85 cents, the stock has now also nearly tripled since I first recommended it in October last year. Importantly, over the longer term this deal de-risks the business and the combined group will benefit from cost savings, synergies and further growth opportunities in the fragmented sector.

The deal includes $27-28 million cash up-front and the remaining consideration depends on 3.5 years of minimum performance targets. If the targets are hit it will value the deal at $100m but that includes two scrip tranches worth a combined $50m at 60 cents per share. At the current price the combined deal is worth approximately $120m if minimum targets are met.

Similar to prior deals, executive chairman Ray Malone has ensured it is mutually beneficial, with AMA benefiting from the broader geographical reach of Gemini. AMA has 28 of its 29 centres in Victoria, and Gemini is evenly spread in Victoria (7), NSW (8), WA (8) and then a larger 18 in Queensland. Gemini also has a centre in Auckland, New Zealand.

In total it will increase the group's panel repair shops from 29 to 70. Gemini achieved $150m revenue in FY15, allowing AMA to increase to $250m. Although this reinforces the group as a leading panel repair player, there are significant remaining opportunities in the $5 billion industry.

Prior to this purchase the two largest risks for AMA were that they over-pay for acquisitions or they became out of favour with the insurers and in particular IAG. After the transaction both of these risks will be greatly reduced.

Gemini and AMA have some key common qualities which should ensure a seamless integration. Firstly they both have excellent relationships with the auto manufacturers and insurers. Secondly they both have a faultless track record of integrating acquisitions. Finally they both have ambitions of benefiting from further consolidation in the fragmented market.

Gemini was founded in 2009 by Andrew Hopkins, who remains the majority owner. He is very well regarded within the industry and is a complementary addition to the AMA executive team. Hopkins will join the board and become CEO of AMA's panel repair business.

A key part of Ray Malone's strategy has been to make sure the deals work for both AMA and the seller. In an industry where everyone knows everyone, the key people from Ray's past acquisitions actually become a key marketing tool for him. There is no way that a larger competitor such as Gemini would come on board for such a low up-front payment unless Malone's reputation and integrity was first class.

Ray's focus on looking after everyone is starting to pay off. Alternatively, if he hadn't taken the team approach, Gemini would have competed hard against AMA with the potential for one of the groups to be a big loser.

Gemini has runs on the board as well, having successfully executed consolidation in the UK industry before coming to Australia.  

The larger group is likely to be good news for IAG, and if the insurer ever wanted to vertically integrate this would make its job easier.

As a reminder Suncorp has already vertically integrated through its purchase of Capital SMART. Then there is Smash Care and a number of smaller groups, including many single site panel repair operations.

With Suncorp and IAG controlling about 85 per cent of volumes, the panel repairers that are not accredited by the major two have most likely left their run too late. The options are to either sell to a group such as AMA that has a strong insurer relationship or leave the industry.

At the same time the industry is facing the prospect of fewer accidents, due to improved technology and eventually driverless cars. But this disruption is likely to have a more gradual impact in comparison to other disrupted industries. For the next few years at least, the benefits for AMA from consolidation will far outweigh any decline in industry volumes.  

Earnings impact

Although there was little detail provided on Gemini earnings, revenue of $150m for FY15 was disclosed. Then if the 7.5 EBITDA multiple implies a $100m valuation, it can be seen that EBITDA was approximately $13.3m. This equates to an EBITDA margin of approximately 9 per cent.

In the conference call Ray Malone suggested that with the benefit of cost savings and synergies to be achieved in the next 18-24 months, the 7.5 multiple can be reduced to about 5 times. This appears realistic to us, as a multiple of 5 implies an EBITDA margin of 13.3 per cent. 

In the recent full-year accounts, the previous talk of seamless integration was backed up in the numbers. Underlying EBITDA of $14.9m on revenue of $95.8m gave a margin of 15.5 per cent. Some $85m of this $95.8m was from panel repairs.

Given the proven systems and ability to cut costs, it is the purchase of revenue that becomes more important in this consolidation strategy. With this in mind, we view the acquisition of Gemini as highly beneficial for AMA shareholders; it will allow the broader group to continue growing at a very strong rate with reduced risk.

So for FY15 the group has achieved $28m EBITDA, and 493 shares on issue assuming performance targets are hit. We need to see more details around Gemini's accounts to accurately forecast earnings. Post synergies and cost savings this becomes about $35m EBITDA, and with the current 85 cent share price implies a group EBITDA multiple of 12 times.

Importantly with the recent $45m capital raising, the group's balance sheet will remain in good shape post transaction. The combined company is also likely to get a larger debt facility, and is well placed to take advantage of further acquisitions and growth opportunities.

Summary

Ray Malone has again backed up his guidance with a deal that will provide large scale benefits and a de-risked growth opportunity partly due to taking out a major competitor.

The stock is likely to remain expensive on short term earnings multiples, but taking a one to two year view we believe there remains opportunity for significant further earnings and share price growth.

Although it is easy to see in theory the benefits from consolidation, earnings forecasts are difficult because analysts cannot predict the rate or size of acquisitions and other potential benefits of vertically integrating within the industry.  As such our price target is likely to continue to be proven as conservative when further deals are announced.

Our valuation is increased to 90 cents and after the recent strong run the stock is a buy on weakness.