Description

Mekonomen is the leading automotive parts distributor and service chains in the Nordic region (Norway, Sweden), and, through its recent purchase of FTZ and Inter-Team, which almost doubles the size of MEKO SS, it is expanding its reach into Denmark and Poland.  The business has come under pressure in recent years.  A perfect storm of terrible weather, currency pressures (sek vs eur down 5%-7% over past 2 yrs), reduction in digital radio product sales that soared ’16-’17, cost pressures and a shift to electric vehicles impacting their offerings at their stores and service centers.   The shares are trading at their lowest level since the financial crisis as a result of the poor performance, a recent acquisition to expand into new geographies, as well as the technical selling pressure due to a recent rights offering and the subsequent cutting their dividend immediately thereafter.   MEKO SS currently trades with a 355mm Euro mkt cap, 760mm Eur EV and on 2020 estimates (post restructuring & synergies) 8.5x EV /’20 EBIT, ~7x EV/EBITA and 15% LFCF Yield (~9.5% UFCF yield).

Background of Recent Events:

In Sept 2018 MEKO closed on the FTZ + Interteam acquisition, which was its largest, financed via a rights offering (at 79 sek/sh; trades at 69 sek today) and debt.  FTZ in Denmark was founded in 1962 has 300 mm EUR in sales, attractive 11% EBITDA margin and is the market leader in workshop concepts and dealer concepts.  Similar to Norway + Sweden, Denmark grows ~ 1% - 2%, and FTZ has 50 branches and 10 DCs throughout Denmark.  Interteam in Poland was founded in 1967, has 200 mm EUR, grows more rapidly at 5%+ in sales and has ~2% EBITDA margin (3 mm EUR EBITDA).  Interteam plans to take share in a faster growth market of Poland as parts move to private label.  As a result of the combination, MEKO now has 466 stores and 3,410 affiliated workshops across their Nordic and E European regions and employs 3100 people.   MEKO acquired these businesses for 400mm EUR (paying ~8x ev/ebitda post synergies, 9.7x pre-synergies) and expects them to drive growth in excess of their legacy markets’ growth.    

While revenue growth has been mediocre in their local markets (with Sweden struggling in particular offset by growth in Norway, Finland, Poland), margins have been pressured as the company has invested in streamlining their logistics/warehouse/distribution infrastructure, fx transaction headwinds around purchasing, and training their workforce particularly in Norway around repairing the car of tomorrow (ie electric vehicles, vehicles with more electronic / technical components).   They have laid out a plan for 50mm SEK central warehousing savings as well as 65 mm SEK restructuring plan, totaling ~11mm EUR savings by 2020 (10-15% of ebita).  Additionally, they have put in place pricing increases across their 150K SKUs + services to offset the inflationary and fx pressures they have encountered the last couple yrs.  

Today MEKO has a number of underperforming assets (ie workshop equipment vehicles, shops in Finland, car leasing solutions) within their portfolio of parts distribution centers and affiliated workshops and the management team is on a short leash.  In the next 12-18 months the company is undergoing a plan to raise prices (has passed through price since Jan ’19 to offset FX headwinds + inflation), cut costs that should generate 6-7mm Euro, drive 15mm eur of synergies and prune of its portfolio of assets to focus on profitable and growing businesses + markets.  All of this should drive meaningful margin recapture.

Management seems to be quite confident in this plan as indicated by their insider buying.  In the past 6 months insiders have purchased 5mm SEK (~0.5 mm Eur) worth of shares at prices roughly 50% greater than today’s price (they also purchased shares yesterday after their terrible report).  On top of this, the largest owner of MEKO with ~26% ownership and the Chairman seat, is US-based LKQ, the leading provider of after market parts in the US.  LKQ purchased the stake at roughly 2.5x where the shares currently trade, and they did so as part of their strategy to build out a pan-europe mechanical + collision car parts distribution empire.  LKQ is down over 65% on this investment and given their former CFO is the Chairman who just oversaw their transformative deal to expand into Denmark + Poland, it is reasonable to think they may take advantage of the depressed price and purchase the remaining 74% of MEKO. LKQ could pay a 30% premium for MEKO and it would be accretive and not a substantial burden to their balance sheet ($8bn mkt cap, $12 bn ev and levered 2.8x).

The thesis is that there are multiple ways to win:

1)      They right the ship by passing along fx and inflationary impacts thru pricing (which mgmt. says have been sticking since by); the execute on cost cuts, deal synergies (purchasing, warehouse consolidation), and we can see EBIT growing 40% from ~75mm Eur in ’19 to ~105mm Eur in 2021.  Note, this does not assume any improvement or divestitures of underperforming segments which would be upside.

2)      LKQ acquires the company at a premium and folds MEKO into their growing European segment.  Note that beyond their historical investment, LKQ participated in the recent rights offering at 79, and likely approved of the transaction & its synergies

3)      Strategic consolidation.  In Europe there is ongoing consolidation in the spare parts market, as leading co’s get larger and larger in pursuit of purchasing and logistics synergies and capabilities to service a changing fleet of cars (ie electric vehicles and vehicles with increasingly more technologically advanced parts).  Anyone who wants to get into the scandanavian market for after market parts would see MEKO as the most logical target.  Today MEKO trades at <7x EBITDA, and most strategic transactions have been done at 9x to 14x ev/ebitda.

Our base case model below assumes stagnant market growth of 0% to 1.5% in all markets except Poland (growing 4%-5%) and assumes they are not able to fix or sell non-core segment that is driving losses.  If nothing happens, on our base case we think shares will be worth 9x ev/ebit by 2020, or 100 sek, or 45% upside.  Re downside, we assume Management isn’t able to correct the trajectory of the business, margins decline 150 bps, they only get 50% of the synergies and cost saves and multiple shrinks to 8x ev/ebit, we can see downside to 60 sek/sh, or 13% downside.

Catalyst

realization of synergies

eventual deleveraging/dividend reinstatement

sale of co to LKQ