Could the Waste Management-Blockbuster Graybeards Finally Have Gotten it Right at LKQ?
We like tech stocks because, ideally, they’re growth stocks, and the companies grow because they offer customers something previously unavailable -- an innovation and frequently one that improves business or personal productivity.
Oracle’s (ORCL) database software and Salesforce.com’s (CRM) cloud computing are viewed by business customers as productivity aids, and LinkedIn (LNKD) is viewed by individuals and businesses as a faster way to network and discover people one might want to do business with.
Executives in non-tech, more established industries look on with envy, wishing their businesses would grow. One way to do that, of course, is to become an acquisition machine, consolidating an industry. Often known as rollups, these companies have at times produced rapid revenue growth. And, convincing Wall Street that they were also turning a formerly inefficient industry into a sleek productivity machine, lofty PE ratios have at times resulted.
Waste Management (WM), the granddaddy of rollups, made hundreds of acquisitions of tiny trash haulers and dump operators over the years, and periodically persuaded investors that the sum was worth considerably more than the parts had been. Here during the period it combined with another huge waste concern, one sees the euphoria in a lofty PE ratio:
Truth is, the economies of scale in the trash business are very limited. Within a 200 miles radius, or so, of a very large dump, a hauling operation will grow increasingly profitable as it adds customers and thus density to its collection routes. And has a nearby place to offload the stuff. But piecing together many such regional operations, beyond giving the company the ability to extract discounts from suppliers of trucks and such, didn’t do much for Waste Management.
To keep up the fiction that it was in fact increasingly productive, Waste Management engaged in the 1990s in some kinky accounting that required a $3.5 billion charge once the shenanigans were uncovered.
The early organizers of Waste Management were Dean Buntrock, who became its long-time CEO; Wayne Huizenga, who left early and went on to build and then brilliantly sell Blockbuster, and also become a pro sports franchise owner; and Don Flynn, who was CFO and left to help form Blockbuster. The three also invested in other businesses and the companies were often rollups.
Rollups in most instances promised a lot more than they could deliver, like Waste Management, and have been thoroughly discredited, though hope springs eternal and if you can name a fragmented, dreary industry (funeral homes, septic tank pumpers), it has likely been targeted by a rollup promoter.
Flynn, the least known of the early Waste Management crew but perhaps the most interesting of the three, died late last year. But he left behind what has the potential to be the rollup that works, LKQ (LKQ), which has been consolidating the auto dismantling industry. Go figure.
What tech entrepreneur wouldn’t be happy to call this stock chart (and revenue and net income chart) his or her own? Nice work, Don. (Buntrock and Huizenga were early major investors in LKQ, as well.)
The market for non-OEM (original equipment manufacturer) auto parts is about $57 billion, LKQ figures, and is incredibly fragmented. Thousands of sellers and thousands of buyers. Ripe for consolidation and rationalization, goes the rollup argument.
Another Waste Management old-timer, Joe Holsten, was the LKQ CEO until January 1 of this year, and when I spoke with him late last year after Flynn’s death, he told me about two advantages LKQ (the name stands for Like, Quality and Kind, a term used in the auto parts business) had developed over its thousands of mom-and-pop competitors that set the company apart from past rollups.
One, Holsten said, was based on sheer scale. With their limited inventory of parts, a small one-location auto dismantler will bat about 35% when an auto-body shop or independent mechanic (there are about 53,000 and 76,000 of them respectively) calls looking for a part. That’s inefficient for the customer, and for the seller.
LKQ, based on its enormous inventory, was batting about 65%-to-70%, Holsten said. A huge leap forward.
The other advantage sounds cool, but it’s less certain that it brings huge value to LKQ. The company developed its own database of what cars totaled by insurers -- and thus for sale at junked-car auctions -- are worth, and LKQ sends its buyers to auction with a handheld computer so that their bids are based on the latest data. LKQ bought 228,000 totaled, late-model autos last year and 352,000 mostly older cars that were junked. The cars are stripped for their parts.
Given the past poor performance of rollups, skepticism is warranted. Organic revenue growth, akin to same-store sales, was a more modest 7.9% last year at LKQ and the company is projecting organic growth of 5%-to-7% this year. That’s not much a growth company. But acquisitions – more than 130 so far – goose growth nicely. The share aren’t cheap, as seen in this stock chart:
But if the advantages Holsten described to me are real, and continue to be real, LKQ could be that very odd thing, a rollup that doesn’t end up disappointing investors.
Filed under: Company Analysis