Republic Industries Bull's Rebuttal
by Jim Surowiecki ([email protected])

Sorry Louis, but the idea behind Republic Industries isn't exactly the same as the idea behind the Marlins. It's more like the idea behind Blockbuster Video, which was a huge success before Wayne Huizenga sold it to Viacom. And while one can -- as Louis does -- suggest that Blockbuster's recent woes are the inevitable result of market saturation, it's more true that those problems are the result of Blockbuster being stuck with a company that wanted to use it as a cash cow and didn't pay much attention to running it as a real business. The problem isn't in the idea, it's in the execution.

What is that idea? Simply this: aggregation lends value. People like to shop at Wal-Mart and Stop & Shop because they like a wide selection and an easy shopping experience. For the same reason, Republic thinks that they'll like buying cars from AutoNation. But aggregation lends value to producers as well as consumers. In that sense, Republic attempting to show that economies of scale apply not only to capital-intensive factories, but also to retail operations. Wal-Mart has put the same principle in action. As Republic continues to grow in size, it will be able to raise its margins by paying less for the new cars it buys and by lowering costs on reconditioning the used cars it accepts as trade-ins. It's very easy to see the virtuous cycle that is already developing between Republic's new- and used-car businesses. The dramatic improvements in the company's first-quarter results were not a fluke, so much as a real sign that Republic is reaping the benefits of its strategy of aggregation.

Louis questions the move out of waste management, pointing to the fact that this division provided most of Republic's operating income, and its highest profit margins, in the last year. But the move was a necessary one. For Republic's strategy to work, it needed to focus its energies and its resources on its core competence, which is selling cars. And low margins are not necessarily endemic to the retail industry. If they were, independent auto dealers wouldn't be so prevalent. Typical operating margins in auto retailing are somewhere around 11%, and Republic will continue to improve on those as its acquisition strategy pans out. To be sure, the company hit a few bumps in its early days, accounting for the restructuring charges and for its tendency to acquire too much inventory. But Republic has solved the inventory problem, and its doubled EPS in the last quarter suggests that it has also figured out how to integrate new dealers without slowing its overall growth.

Finally, it's important to remember that while margins do tell you a lot about a company, they don't tell everything. What really counts about a company, after all, is earnings, and earnings are equal to profit margin x turnover. In other words, even if you're only making a little on every transaction, if you can do millions of transactions, that can add up to a lot of money. (Do you really think Wal-Mart is cleaning up on every box of diapers it sells?)

The genius of Republic's aggregation strategy is that it gives the company a cut of an ever-increasing number of car sales in both the new and used markets. That cut is going to be bigger for Republic than it will be for most dealers, because of the reasons I've already mentioned. But what really matters is how many sales the company will get to take a cut from. In evaluating a company's long-term worth, it's the bottom line that really matters. And five years from now, Republic's bottom line is going to be many times as valuable as it is today. Home Depot, Staples, Wal-Mart: superstores work, and Republic will be the latest company to prove it.

Next: The Bear Responds