Republic Industries Bear's Den
by Louis Corrigan ([email protected])

As an Atlanta boy, I measure entrepreneurs by Ted Turner. Wayne Huizenga is no Ted Turner. Fighting words? Maybe, but they should matter to potential Republic Industries investors because the main reason anyone has given this company a second's thought or a dollar of capital is because it's a Wayne's world concoction.

For fun, let's compare Turner's Atlanta Braves with Huizenga's Florida Marlins. The Braves are the most successful baseball franchise of the '90s, a veritable dynasty given the sport's current economics. Although Turner is often blamed for initiating those economics with wild bids for pricey free agents, the Braves only succeeded once Turner got serious and actually built a deep farm system. Last year, the New York Times magazine highlighted the dozen or so major league ball players that had actually been with the same club for at least ten years. There were four Braves among that group, three of whom had come up through the farm system. Ace pitcher John Smoltz, the only outsider, joined the Braves as a young, low-salary nobody.

Now compare that to the one-hit wonders that were the Florida Marlins last year: a great team built almost wholly on expensive mercenary talent that was sent packing as soon as the World Series celebration ended.

Or consider CNN. Turner actually created the news network from scratch, defying the nearly universal belief that it would never succeed. CNN didn't take over other news bureaus; it created new ones where they didn't exist before.

Turner has been a builder, a creator, an intrepid entrepreneur. Huizenga is a consolidator not a builder. He'd rather buy a Kevin Brown than nurture a Tom Glavine. There's nothing wrong with that. Mom & pop outfits trade their businesses for shares of the consolidator's rising stock. The industry becomes a bit more efficient, with the consolidating company maxing out the industry's potential profits and usually keeping prices high thanks to the reduced competition. Yet consolidators eventually run out of growth. Somewhere along the way, their stock cools, putting an end to the nifty practice of using inflated shares to acquire real assets. If that happens too early, the whole house of cards can collapse.

With Waste Management and Blockbuster, Huizenga's solution was to bail out when the stocks were pumped up by past success without being too weighed down by the limited growth opportunities ahead. Both businesses started to implode not terribly long after Wayne's departure. Blame that on mismanagement as an effect of market saturation and the concomitant hubris that goes along with that. But put another way, the Huizenga mystique is great if your name is Wayne Huizenga (or you buy into one of his veritable shell games early enough), but it's a siren call to investors who aren't. Look out for the rocks!

Enough talk. Let's look at the FY97 numbers. Well, let's try to look at the numbers, which defy easy explanation. Republic reported net income of $440 million, or earnings per share of $1.02. But $240 million of that was after-tax income from its discontinued electronic security services business and the gain from the sale of that business. In addition, most of the $114 million in "other" pre-tax income came from the sale of ADT Corp. shares last May. Republic also took $244 million in restructuring and other charges to combine its new-car dealers with used-car megastores and to integrate the company's car rental divisions. Backing out all these "one-time" items gets us net income of $300 million or $0.70 per share. Leaving in both the charges and the ADT sales, we get income from continuing operations of $200 million, or $0.46 per share.

Confused yet? No wonder. A one-time stock sale represents income from continuing operations? Right! And a consolidator's cost of consolidating its operations gets bracketed out when figuring net income? I don't think so. If we back out all but real continuing operations and put back the restructuring costs, we get actual income of $127 million, or $0.30 cents a share, taxed at 36.5%. That's a net profit margin of 1.2%. That may lowball actual operating results, but with Republic planning continued expansion via acquisition, these restructuring charges aren't one-time deals.

Even more interesting is the contribution of Republic's three business units. Auto retail (new-car dealers plus its AutoNation used-car superstores) accounted for 59% of total revenue in FY97, auto rental (Alamo, National, etc.) for 30%, and solid waste services for 11%. Yet of Republic's $474 million in FY97 income from operations before subtracting corporate expenses and restructuring charges, 45% ($211.5 million) came from waste services, 38% ($180.7 million) from car rentals, and just 17% ($81.6 million) from auto sales. That means the largest part of Republic's business had razor thin 1.3% operating margins, the smallest part had terrific 18.8% margins, and the middle part (car rental) had middling 5.9% margins. Republic's biggest and fastest-growing unit is its least profitable. Sign me up. Not!

The good news for Republic shareholders is that first quarter results showed some improvement. The addition of some 76 new franchises and another AutoNation store led to continued strong growth in auto sales, which rose to 69% of the company's overall revenues. Even better, the retail auto unit saw operating margins jump to 2.4%, allowing that unit to contribute 41% of overall operating income. As a result, Republic nearly doubled EPS to $0.17 versus $0.09 a year ago.

Even so, the overall U.S. car industry continues to see pricing pressure and special discounts owing to massive industry overcapacity, a weak Yen that's made Japanese cars cheaper, and a steady flow of good quality used cars coming off three-year leases. So a low-margin business has gotten even tougher in these good economic times.

In a price conscious environment, it's hardly surprising that AutoNation's sales have been below target. Huizenga wants to charge more for "good housekeeping" approved used cars with warranties and no-haggle prices. Yet used-car buyers don't seem to want to pay extra for good service. They also don't mind haggling. Plus, many of AutoNation's existing stores are too large and carry way too much inventory that's depreciating by the day (while sales rose 69% last year, inventories more than tripled). Even with better inventory management, this is a hugely capital intensive business.

While the cash flow from waste disposal services is helping finance some of this trial-and-error, a sensible investor has to wonder why anyone would want to take money from a high-margin unit to become the king of the low-margin auto retail biz. And Huizenga dreams next of conquering the even more cutthroat auto parts market!

Republic trades at 35 times trailing 12-month earnings of $0.78 per share -- or 71 times my adjusted $0.38 per share in trailing earnings. After recent upgrades, however, analysts are looking for Republic to deliver $1.22 per share this year and $1.54 per share in FY99. So the stock is trading at 22 times forward estimates, a discount to the 32% long-term growth projected by a group of Huizenga-enamored analysts. Yet taking the enterprise value (market cap minus year-end cash plus debt: $12.38 billion - $0.15 billion plus $2.33 billion = $14.56 billion) and dividing it by the trailing 12-month revenues ($11.9 billion), we get an EV/S ratio of 1.2. For a company whose major unit is in a mature industry and delivering at best 2.4% operating margins, or about 1.5% net margins, investors are already paying quite a Huizenga premium.

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