Car-breakdown group The AA is set to join the stock market — giving it a headstart on rival RAC, which is also said to be gearing up for a float.
The AA is owned by private equity firms Charterhouse, CVC and Permira, the same group that brought over-50s insurance and holidays firm Saga (LSE: SAGA) to market last month.
Under the bonnet
The AA claims that over 50% of households subscribe to at least one of the group’s products. Brand visibility is high, thanks to 3,000 iconic yellow patrol vehicles, which attend around 10,000 breakdowns every day.
The AA is the market leader in roadside assistance by some distance, with a 40% market share. This business contributes over 70% to the company’s revenue.
The remaining 30% of revenue comes from driving schools — the AA Driving School and the British School of Motoring make it the market leader here, too — and insurance services.
Another Saga?
The AA shares a number of characteristics with Saga (indeed, the two companies were at one time merged by their private equity owners): a strong brand, repeat business, earnings visibility and good cash conversion.
I’ve calculated what the AA’s valuation will be, immediately after the admission of its shares to trading. And compared it with Saga.
| Â | AA | Saga |
|---|---|---|
| Share price | 250p | 185p |
| Number of shares | 554,000,000 | 1,110,705,405 |
| Market cap | £1,385m | £2,055m |
| Net debt | £2,946m | £700m |
| EV* | £4,331m | £2,755m |
| EBITDA** | £422.8m | £222.4m |
| EV/EBITDA | 10.2 | 12.4 |
| Net debt/EBITDA | 6.9 | 3.1 |
* EV = enterprise value (market cap + net debt)
** EBITDA = earnings before interest, tax, depreciation and amortisation (year ended January 2014)
Now, you may recall that Saga was priced at the very bottom of an initial 185p-245p price range. The sellers weren’t able to persuade the City to buy in at a higher price; that’s to say, at an EV/EBITDA well into the teens. As you can see from the table, at 185p Saga’s EV/EBITDA was 12.4. Furthermore, the market seems to have decided that even that was a little rich, because the shares are currently trading at 174p, which brings the EV/EBITDA down to 11.8.
As you can also see, the AA is being offered at a markedly cheaper EV/EBITDA of 10.2. However, one thing I’m not going to overlook is that the AA has almost £3bn of net debt (more than double the market cap of £1.4bn), and a net debt/EBITDA ratio of 6.9. High by any standards.
The less-than-robust balance sheet not only increases risk, but also has another implication. While Saga is planning to pay a dividend at the end of its current financial year, “the AA does not anticipate paying any material cash dividends in the near future”.
It looks to me like it will take the AA a good few years to reduce debt sufficiently for the restrictions of its lenders to allow the company to pay dividends.
Beware the bull trap
While Saga offered shares to customers and other retail investors as well as institutions, the AA is doing a “fast-track flotation”, which involves only institutions, at the fixed share price of 250p.
This means retail investors who want to buy into the AA will have to wait until the shares are trading in the open market, later this month. I won’t be one of them: the high level of debt and the lack of a dividend have failed to start my engine.