Over the last decade or so, one of the faster growing niche fund areas within private equity has been the roll-up/bolt-on strategies. The idea is to identify a fragmented industry which has nice economics on a store level basis, create scale via M&A and greenfield expansion, build out a technology and marketing platform to help drive sales and either take the company public or sell it to cash out.
There are numerous industries that this is playing out in, however we came across an interesting play after they started acquiring car washes (an industry we have always had an interest in and have various family friends who own or have previously owned local car wash brands with multiple locations) which is actually engaged in this strategy across multiple fronts and having success in each category. The name of the company is Driven Brands Holdings (NASDAQ:DRVN).
So What Is The Story?
Driven Brands is probably more relatable on its consumer brand level where the company owns names such as Maaco, Meineke, Take 5 and Carstar. These brands span various portions of the automotive service market, and in recent years the company has focused on building out a platform to help it attract large accounts on the fleet and insurance side of the business. While the collision business opened the door for them on this front, the management team has done a nice job of identifying complementary lines of business to expand into that then enable them to go to the fleet and insurance companies and offer additional services.
This “bundling” is attractive to fleet managers and insurance companies because it creates a one-stop shop in a sense; one service provider can take care of numerous needs which helps streamline the process of getting vehicles serviced and back out on the road.
While the additional business lines have enabled the company to grab additional recurring revenues on scale, they have also paved the way for future growth. Driven Brands estimates that the total addressable market, or TAM, for their businesses is $350 billion and currently they have a market share in the low single digits. As the company expands their brands to new territories (while also adding density to current areas) they become more attractive as a vendor for insurance and fleet companies and realize more economies of scale at the retail level.
Why Do We Like The Story?
We like this story for a number of reasons, but the main points are that the company has essentially created a private equity fund or incubator for the automotive service sector and is competing to dominate not one specific area of that business but at least five separate ones. While that last sentence may sound absurd, or at the very least like the management team is possibly spreading itself too thin, we would point out that they continue to perform what appears to be solid M&A transactions and build out businesses to scale while grabbing significant market share.
A prime example would be the recent acquisition of Auto Glass Fitters, which added to Driven’s East Coast markets while also making the company’s auto glass repair segment the second largest player in the country. It only took a year for the company to reach this point in the auto glass repair market, and we would suspect that further expansion will occur in order to reach all 50 states.
While the auto glass business’s growth is exciting, it is a $5 billion+ industry which is not going to be the driver moving forward. It will certainly help when trying to pitch services to large companies but the reality is that Driven has quite a few other levers to pull to drive market share gains and revenue growth moving forward, specifically with the maintenance, paint/collision and car wash businesses.
In the second quarter, the company continued to grow its store count and focused on their long-term plans for the car wash business; specifically how they wanted to brand their locations moving forward. Based on the market testing that occurred in the Nashville market, it appears that the company is going to extend the Take 5 brand into the car wash industry. While margins are already strong on the car wash side, even as the company runs a hodge-podge of assets accumulated recently via M&A, we believe that they will be able to increase margins as they optimize each location and catch up on deferred maintenance.
Once the company starts cranking out greenfield locations or redevelopment projects using standardized locations, we suspect that improvements will be seen in what is already a great business and that the company could move to the franchise only model at that time to be more asset-light in the car wash segment. We would also note that as the business expands within markets and to new geographies, it opens up the possibility of more expensive membership options, such as ones that would allow use of unlimited car washes at any location in a state, region or the country.
The beauty of this entire exercise that the company is going through is that they are deploying a franchising model against the private equity roll-up model with both utilizing a small portion of their own capital while getting others to deploy the lion’s share in order to share in the profits. While private equity is a tough opponent, utilizing franchisees to continue to gain market share should lead to higher margins, a more profitable business and one that is able to grow faster than smaller niche players or private equity names (everyone else is limited to their balance sheets, the franchise model introduces outside capital for expansion while still allowing for strong margins).
What Will Growth Look Like?
Growth is set up to look pretty strong over the next few years. The company has been touting a plan, ‘The Dream Big Plan’, to get to at least $850 million in Adjusted EBITDA by 2026. The five-year plan has them more than doubling the 2021 baseline Adjusted EBITDA of $350 million, and based off of the most recent quarterly results conference call, management seemed pretty comfortable that $850 million in Adjusted EBITDA will be achieved but would not move up the timetable when pressed by analysts who thought that the company appeared to be well ahead of schedule.
As you can see by the above chart, Driven’s management team expects a mix of organic growth and M&A to drive EBITDA growth. With where the company is now (management raised full-year Adjusted EBITDA guidance to $495 million) it certainly appears that the $850 million target is conservative, as the company is delivering about 50% more Adjusted EBITDA growth than one would expect when modeling a linear path for growth. Usually in these cases there is a ramp up period, where the first few years of a plan see the smallest growth due to companies ramping up their capabilities and if that is the case here, we might see management deliver investors $650 million in Adjusted EBITDA growth which would put Driven’s Adjusted EBITDA at a very impressive $1 billion+ level.
How We Would Play The Stock
The current investing environment is brutal, however we think that there are always a few bright spots in bear markets. Even in the worst of markets there are certain names worth adding exposure to and with this level of growth that Driven Brands is projecting, as well as the growth that they have been able to deliver on already, we think this is a prime candidate to deploy capital to on pullbacks.
While nibbling on the current pullback is fine, we see the best value here in the $26/share to $27/share range. We think that the growth is there to underpin the stock price moving forward at those levels, and the worst-case scenario we see is Driven Brands growing into some of its multiples during a recessionary environment.