Company: Advance Auto Parts (AAP)
Business: Advance Auto Parts is an automotive aftermarket parts provider, serving professional installers and do-it-yourself customers. Its stores and branches offer a selection of brand names, original equipment manufacturers and brand-owned automotive replacement parts, accessories, batteries and maintenance items for a range of vehicles. It operates roughly 4,770 stores and 316 branches within the United States, Canada, Puerto Rico and the U.S. Virgin Islands.
Stock Market Value: $4.19B ($70.50 per share)
Activist: Third Point and Saddle Point Management
Percentage Ownership: 8.04% economic exposure
Average Cost: n/a
Activist Commentary: Third Point is a multi-strategy hedge fund founded by Dan Loeb, that will selectively take activist positions. Loeb is one of the true pioneers in the field of shareholder activism and one of a handful of activists who shaped what has become modern-day shareholder activism. He invented the poison-pen letter in a time when a poison pen was often necessary. As times have changed, he has transitioned from the poison pen to the power of the argument. Third Point has amicably gotten board representation at companies like Baxter and Disney, but the firm also will not hesitate to launch a proxy fight if it is being ignored.
Third Point has formed a group in this investment with Saddle Point. This group has a collective economic ownership to 4,781,557 shares (8.04%) of AAP stock, which is a combination of common stock and derivatives, a vast majority of which is owned by Third Point. Saddle Point is an investment firm run by Roy Katzovicz, the former chief legal officer of Pershing Square Capital Management.
What’s happening
On March 11, Third Point and Saddle Point entered into an agreement with Advance Auto Parts, pursuant to which the following three directors were appointed to the board of directors: (i) Tom Seboldt, president of Seboldt Consulting Services and a former executive at O’Reilly Automotive; (ii) Gregory Smith, EVP, global operation and supply chain of Medtronic and former EVP, supply chain of Walmart; and (iii) Brent Windom, former president and CEO of Uni-Select.
Behind the scenes
Third Point and Saddle Point are not the first activists in this stock. Starboard Value had an activist campaign at Advance Auto Parts from September 2015 through May 2020 and exited their investment in the first quarter of 2021 when the stock was trading at approximately $185 per share. In late 2021, the stock peaked around $240 a share, but fell over time to about $120 a share by May 2023. After reporting a significant Q1 of 2023 earnings miss of 72 cents per share, 68% lower than the same quarter in 2022, compared to a consensus estimate of $2.57 per share, the stock price plummeted to $72.89 on May 31, 2023. This is when it really got interesting as an entry point for investors who have been watching the stock.
Advance Auto Parts effectively has two businesses: its core retail auto parts business and Worldpac, the company’s wholesale auto parts distribution business. Worldpac is in a similar line of industry – it distributes automotive parts – but it’s a completely different business with its own supply chain and own distribution network. The first opportunity to create value here is by selling Worldpac. Advance Auto Parts does not separately report Worldpac’s financials, but it is considered by many to be the company’s crown jewel and the sell side estimates its value at approximately $1.5 billion. But with approximately $2 billion in revenue and earnings before interest, taxes, depreciation and amortization margins estimated to be at least high-single digits, Worldpac could fetch at least $2 billion at a conservative 10x multiple. A sale would enable management to sell down debt, immediately stabilize the company’s balance sheet and upgrade its S&P rating of junk debt.
Just as importantly, this would allow management to focus on the core retail business, which trades at a value significantly below its peers. After backing out the Worldpac business at $2 billion, Advance Auto Parts’ 4,770 stores are valued at approximately $1.25 million per store, whereas peers O’Reilly and AutoZone have per store valuations of $11 million and $8 million respectively. While part of this valuation discrepancy is the estimated value of Worldpac and part is the balance sheet issues, the real problem is sales and margins. O’Reilly generates sales of approximately $2.5 million per store versus AAP at $1.8 million. This is not a marketing issue, a pricing issue or a sales personnel issue. Rather, it is a supply chain and stocking issue. There is little, if any, brand loyalty in the auto parts business. Customers go to stores that have the part they need. AAP’s biggest problem has been keeping parts in stock for sale, so customers go elsewhere. Solving this problem would not only increase their revenue closer in line with peers, but it will significantly improve their EBITDA margins. With a 50% gross profit margin, virtually half of every incremental sales dollar goes to the bottom line just by having the parts in stock.
The good news is that Advance Auto Parts has a relatively new CEO who is extremely competent and up for the job. Shane O’Kelly became CEO in September 2023. He has a solid retail background and is a West Point grad with the leadership abilities to manage a team and the discipline to manage costs. The one thing he needs is industry expertise and support at the board level. That is what Third Point and Saddle Point is providing with the recent settlement. On March 11, the two activists settled for board seats for Thomas Seboldt, Gregory Smith, and Brent Windom, all industry executives with a mix of automotive industry and supply chain experience. Seboldt spent most of his career with O’Reilly Automotive. Windom is an experienced automotive industry executive who most recently served as president and CEO of Uni-Select. Smith, is a proven supply chain expert with experience at Medtronic, Walmart and Goodyear. Finding the right directors to support a good CEO is a way many activists, including Third Point, create value for portfolio companies. In fact, when Third Point has received three or more board seats in activist campaigns, it has averaged a return of 49.79% versus 37.77% the S&P 500 over the same periods.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.