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

The Home Depot of automotive retailing -- or was it the Wal-Mart or the Staples? What Jim is offering is basically a vision of a would-be giant in an industry of midgets -- a giant with the opportunity, ultimately, to leverage its size to get better deals from car manufacturers and better ad rates from media outlets. Meanwhile, centralizing these and other functions should help maximize profits by lowering expenses. And imagine, just 7% of the U.S. car market is $70 billion in revenue!

The vision is reasonable enough and achieving it might even be possible. I personally think that a high percent of used-car buyers avoid dealers because they're especially price sensitive, making AutoNation's strategy seem out of step with a huge chunk of the market, but customer friendly used-car sales probably will gain a following. Also, I don't doubt that Republic will do a better job of managing its retail car unit than it has done so far. I mean, those former Blockbuster execs did have a pretty steep learning curve! Also, though I dumped on Huizenga, it's clear that Wall Street and other lenders will cut him a good bit of slack on the performance end, and that's undoubtedly a huge asset.

My problem is that the road to achieving Jim's vision -- Huizenga's vision -- looks as long and bumpy as our republic. At its heart, selling cars is a messy, service-oriented, consumer business that also requires huge capital expenditures. It's just a heck of a lot more complex than a video rental business, which even I would have some decent idea of how to run well. Yet retail car sales are nearly as prone to faddish consumer preferences as video rental, and they're even more susceptible to economic downturns.

Also, while Detroit has been relatively receptive to rationalizing the retail car market, automakers have some control over the scale of Republic's acquisitions. Yes, Republic could end up with nice discounts from car manufacturers, but there's little chance the Big 3 (or is it now 4?) will allow Republic more clout than they want to a give it.

Moreover, Huizenga's growth by acquisition strategy requires that Republic's stock remains a strong currency. Looking at the average price Republic seems to be paying for it acquisitions reinforces this point. Last year, the company issued 83.5 million shares in pooling of interest transactions. Valued at $27 a share, those deals were worth $2.255 billion. For that, Republic picked up $1.379 billion in revenues and $47.9 million in operating income. So its deals went off at 1.6 times revenue, which in turn produced operating income with 3.5% margins. Either these deals were quite generous, or Republic itself is undervalued. I'm voting for the former. If it took such generous stock packages to pry car dealers lose from their long-standing businesses, imagine the dilution from future deals if Republic's stock fell and stayed down.

With these huge uncertainties surrounding a currently very low-margin business, I want a risk premium. Yet while Jim echoed my own discomfort regarding the current lame profits, he didn't offer any specific targets for long-term margins or share price. So it's a bit hard to know what our bull thinks this company is really worth today even if it achieves the vision thing five years from now. Frankly, I don't blame Jim for not guessing, since that's about all it would be at this point.

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