Driven Brands: A Promising Deployment Strategy (NASDAQ: DRVN)

Over the past decade or so, one of the fastest growing areas of niche funds within private equity have been deployment/reinforcement strategies. The idea is to identify a fragmented industry that has good economics at the store level, create scale through mergers and acquisitions and expansion of new locations, build a technology and marketing platform to help drive sales and either take the company public or sell it for cash.

There are many industries this takes place in, but we came across an interesting game after we started acquiring car washes (an industry we’ve always had an interest in and have various family friends who own or have already owned local car wash brands with multiple locations) that is truly committed to this strategy on multiple fronts and is successful in every category. The name of the company is Driven Brands Holdings (NASDAQ: DRVN).

So what’s the story?

Driven Brands is probably most relevant at its consumer brand level where the company has names like Maaco, Meineke, Take 5 and Carstar. These brands cover various parts of the automotive services market and in recent years the company has focused on creating a platform to help it attract large accounts on the fleet and insurance side. of the company. While the collision business has opened the door for them on this front, the management team has done a good job of identifying complementary business areas in which to grow, which has allowed them to go to the fleet and insurance companies and to offer additional services.

This “grouping” is attractive to fleet managers and insurance companies because it creates a sort of one-stop shop; a single service provider can meet many needs, streamlining the process of servicing and getting vehicles back on the road.

While the additional lines of business have enabled the company to generate additional recurring revenue at scale, they have also paved the way for future growth. Driven Brands estimates that the total addressable market, or TAM, for their companies is $350 billion and they currently hold a single-digit market share. As the company expands its brands into new territories (while adding density to current areas), it becomes more attractive as a supplier to insurance and fleet companies and realizes more cost savings. of scale at the retail level.

Why do we love history?

We like this story for a number of reasons, but the main points are that the company has basically created a private equity fund or an incubator for the automotive service industry and is competing to dominate not a specific area of ​​this activity, but at least five distinct domains. . While that last sentence may sound absurd, or at the very least the management team may be spreading too thinly, we emphasize that they continue to execute what appear to be strong M&A transactions and develop large-scale enterprises while capturing a significant market. to share.

A prime example would be the recent acquisition of Auto Glass Fitters, which added to Driven’s East Coast markets while making the company’s auto glass repair segment the second largest player in the country. It only took the company a year to reach this point in the auto glass repair market, and we suspect further expansion will occur in order to reach all 50 states.

While the growth of the auto glass sector is exciting, it is a $5 billion+ industry that will not drive the future. This will certainly help when trying to serve large enterprises, but the reality is that Driven has several other levers to pull to drive market share gains and revenue growth in the future, especially with the business of maintenance, paint/collision and car wash.

In the second quarter, the company continued to increase the number of its stores and focused on its long-term plans for the car wash business; specifically how they wanted to mark their locations in the future. Based on the market tests that took place in the Nashville market, it looks like the company is going to expand the Take 5 brand into the car wash industry. While margins are already strong on the car wash side, even as the company manages a hodgepodge of assets accrued recently through mergers and acquisitions, we believe it will be able to increase its margins by optimizing every location and catching up on deferred maintenance.

Once the company starts creating greenfield locations or redevelopment projects using standardized locations, we suspect that improvements will be seen in what is already a great business and the company could transition to the model franchise only at that time to be lighter in terms of assets. the car wash segment. We also note that as the company expands into new markets and geographies, it opens up the possibility of more expensive membership options, such as those that would allow the use of unlimited car washes at any location in a state, region or country.

The beauty of this whole exercise the company is going through is that it is deploying a franchise model versus the private equity model, with both using a small portion of their own capital while incentivizing others to deploy the lion’s share so to share in the profits. Although private equity is a tough opponent, using franchisees to continue to gain market share should result in higher margins, a more profitable business and the ability to grow faster than smaller niche players or names. private equity (all others are limited to their breakeven sheets, the franchise model introduces outside capital for expansion while still allowing for high margins).

What will growth look like?

Growth should look quite strong over the next few years. The company has touted a plan, “The Dream Big Plan,” to achieve at least $850 million in adjusted EBITDA by 2026. The five-year plan has more than doubled their 2021 baseline adjusted EBITDA of $350 million. of dollars, and based on During the last quarterly earnings conference call, management seemed quite confident that $850 million of adjusted EBITDA will be achieved, but would not increase the timeline under pressure from analysts who believed the company seemed to be well ahead of schedule.

As you can see from the chart above, Driven’s management team expects a mix of organic growth and mergers and acquisitions to drive EBITDA growth. With the company’s current situation (management has raised the full-year Adjusted EBITDA guidance to $495 million), it certainly seems like the $850 million target is conservative, as the company is showing adjusted EBITDA growth about 50% higher than one would expect when modeling a linear model. path to growth. Usually in these cases there is a ramp-up period, where the early years of a plan see the lowest growth due to business capacity building and if that is the case here we might see the direction provide investors with $650 million in adjusted EBITDA growth which would put Driven’s adjusted EBITDA at a very impressive level of over $1 billion.

How we would play the stock

The current investment environment is brutal, but we believe there are always some bright spots in bear markets. Even in the worst markets, some names deserve exposure and with this level of growth that Driven Brands is projecting, as well as the growth they have already been able to achieve, we believe it is a prime candidate for deploy capital to pullbacks.

While nibbling on the current pullback is acceptable, we see the best value here in the $26/share to $27/share range. We believe the growth is there to support the share price advance at these levels, and the worst-case scenario we see is Driven Brands hitting some of its multiples in a recessionary environment.