Pep Boys (PBY) Breakup is Likely Scenario - Sterne Agee CRT

Sterne Agee CRT analyst, Ali Faghri, thinks that the Pep Boys (NYSE: PBY) bidding process will continue into the new year, culminating with the break-up of the service and retail operations and Monro Muffler (NASDAQ: MNRO) or O'Reilly Auto Parts (NASDAQ: ORLY) as potential buyers. A deal with either company would be a positive catalyst as they both have a strong historical track record with acquisition integration.

At a takeout price of $18.10 per share, the current deal valuation of ~12.5x TTM EBITDA shows the strength of the auto aftermarket industry, justifying MNRO's premium valuation (~14.0x 2016 EBITDA) and underscoring the deep discount which AAP trades at (~9.0x 2016 EBITDA).

Whether Icahn Enterprises (NYSE: IEP) or Bridgestone (BRSO) ends up winning the PBY bidding process, it should result in the break-up of the service and retail segments, with different outcomes based on the buyer. Press reports and PBY's 14D-9 filed in November point to ORLY and MNRO as potental buyers in a second transaction. IEP has only expressed interest in the PBY retail assets to add to their existing 240 Auto Plus stores acquired earlier this year from Uni-Select (UNS), but is willing to acquire the entire company to gain access to them. An IEP acquisition of PBY would likely result in a sale of the service operations and we view MNRO as a potential buyer given they were the highest bidder in the earlier negotiations (rejected by PBY as it was a stock based offer).

Should BRSO prevail, PBY's retail business would be viewed as non-core and the roughly 560 stores would be sold. In this scenario, ORLY is the mostly likely buyer of PBY retail given geographic synergies (1% of ORLY stores in NE, where PBY has highest density) and prior experience with a service/retail carve out acquisition (VIP in 2012). If MRNO or ORLY ends up participating in a secondary deal , they believe it would be a positive catalyst for shares given both companies have a strong historical track record with acquisition integration.

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