The retail revolution in automotive retailing, according to some, was begun with soldiers who couldn't shoot straight. After several years of what might be described as a standoff, at least as far as the public markets are concerned, it looks like General Roger Penske has been drafted to lead one of the most severely battered divisions. Penske has accepted the assignment of resurrecting the Army of the Hudson, otherwise known as United Auto Group, Inc., the country's second largest dealership group.
Penske will become the chairman and, for all practical purposes, assume control of the company. If all goes well and the necessary approvals are received, an affiliate, Penske Capital Partners (PCP)-owned only partially by Penske-could invest $83,000,000 or more. From now to at least the end of the year, Penske will try to reorganize and rebuild UAG. If he is successful and the public market rewards his effort with a higher stock price, he will have won the battle and added yet another success to his growing collection, not to mention reaping huge profits in the process. Should the battle be deemed hopeless, he can retreat, take his money back, and live to fight another day.
To understand how this could be possible, you need to understand the deal structure.
The plan calls for two separate investments. Only $33,000,000 will be anted up initially. And that could turn out to be no more than a short-term loan. The reason is that, come the end of the year, Penske will have three choices-and one of them, at least as we understand the deal now, will be to get PCP's money back.
Option one will be to invest the second installment of $49.5 million, for which PCP will receive convertible preferred stock for the entire $83 million, exchangeable for common stock at $10 share irrespective of actual market price at the time of the conversion. For the first two years, interest of 6.5% will be paid in stock. There will also be a sweetener of 5,000,000 warrants. The warrants give Penske the right over the ensuing 30 months to buy 5,000,000 shares of common stock for an "exercise" price of $12.50 per share. For example, if the market price of UAG were $20 a share at the end of 30 months, Penske would be able to buy stock for $12.50 a share and make an immediate profit of $37,500,000, at least on paper.
There is one more catch, though: Penske has the additional alternative to postpone the exercise of the warrants at the end of the first thirty months. He would then get another 30 months to make the exchange, but the conversion rises to $15 per share. Consequently, should the stock price be less than $12.50 at the end of the first 30 months, he would receive another 30-month opportunity to buy the stock but at the higher price of $15 a share.
Option two will be to stand pat with the original investment and not go forward with the $49.5 million second installment. In that event Penske will receive the preferred stock from the original installment convertible to common stock at $9 share.
Option three will be, believe it or not, to possibly get his money back. In other words, the initial investment could in reality turn out to be no more than a loan.
If the first option is selected, Penske could theoretically own 38% of the company which would, in addition to the $83,000,000, require another $62,500,000 for the exercise of the 5,000,000 warrants. That would effectively give him absolute control and no one would be surprised to see the name of UAG be changed to "The Penske Automotive Collection" or something similar.
You might ask, How will Penske pick his option? It will depend, of course, on whether the convertible stock is "in the money" at the point when he must make his decision-December 31, 1999-and what he believes UAG's potential for victory is. Here are two possible scenarios: If the market price of UAG is above $10 per share, Penske will most likely go forward with the entire investment since he'll be making market gains by doing so. If it's below, he might walk away and take his $33,000,000 with him.
Is Penske another Patton? One thing is certain. If he is victorious, he has a lot to gain while at the same time protecting his flanks. Should this be a battle that he doesn't win, he will suffer little damage other than maybe a bruised ego. Penske is the first real industry expert with meaningful clout within both the industry and Wall Street to join the fray on the side of the public consolidators. I'm betting on him.
Sheldon Sandler is CEO and a founding partner of Bel Air Partners. Bel Air advises its clients on capital market transactions including Initial Public Offerings, REITs, franchise loans, private placements, and mergers and acquisitions If you have specific questions or require more information about this subject, please check the appropriate box on the reader response form on page 3.# ssandler@dealeronline.com