TRASH TO TREASURE
LKQ is putting together an empire from spare parts. Is its strategy built to last?
Twenty miles south of the Loop, past the leafy neighborhoods and historic mansions of Beverly, on the south side of working-class suburb Blue Island, there is a salvage and recycling yard that takes 10 minutes to walk across. At its north end, in a building the size of an airplane hangar, is an operation that has the orderly carnage of a slaughterhouse.
Men in hard hats take drills to dismembered engines. They sort thousands of parts, carburetors and tire rims and undeployed air bags, tagging them for resale and stowing them on orange shelves that stretch to the ceilings. Outside in the junkyard, they mark totaled cars with letters and numbers that denote what’s worth saving. On a black sport-utility vehicle one of them has scrawled, simply: “good motor.”
It’s called A-Reliable Auto Parts. Its wrecked and rusting inventory, like the yard itself, belongs to one of the fastestgrowing publicly held companies in Chicago.
LKQ Corp. owns A-Reliable and more than 320 other wholesale auto parts recyclers in the U.S. and Canada, each of them purchased since the company’s inception in 1998. The relent-
less pace of acquisitions has given the company control of roughly one fifth of the $22 billion used auto-parts industry.
Robert Wagman became chief executive of LKQ in January 2011. From LKQ’s corporate offices above the Ogilvie Transportation Center, he has since overseen the company’s purchase of 50 businesses, almost all of them aftermarket distributors and salvage operations, and steered it to $261 million in profits on sales of $4.1 billion in 2012 — up 24 percent and 26 percent, respectively, from the prior year. Under the 48-year-old Wagman, LKQ’s share price has nearly doubled to a recent $21, lifting its market value to $6.2 billion. The shares trade at a higher price-to-earnings ratio than Apple, Coca-Cola or General Electric.
The U.S. used auto-parts business is as big as farm equipment or convenience stores. Yet Wagman’s firm is the only national player. “LKQ has basically no competition,” says Elliott Schlang, managing director of Great Lakes Review, an investment research firm in Cleveland. “They are a oneof-a-kind company.”
If LKQ is unique in its industry, it’s not alone in its business model. It was founded by veterans of the granddaddy of rollups, garbage hauler Waste Management. It is using the same template that Waste Management followed — and that led it to what was the largest earnings restatement in history, in 1998. So far, investors seem convinced that LKQ will play out differently.
The company’s founders weren’t new to the rollup game — building a company in a fragmented business by acquiring small players, building economies of scale along the way and eventually developing a national brand. It’s a strategy that has gone in and out of favor in American business since the industrial revolution. In the late 19th century, William Moore and Adolphus Green began buying bakeries in New York and Chicago. They merged in 1898 to form Nabisco. Rollups have since gone after everything from day cares to funeral homes. The bigger you get, the thinking goes, the less you pay for diapers or caskets.
The problem: Rollups tend to melt down. A 2000 Booz Allen study of 100 rollups that went public in 1998 found that nearly half lost 50 percent or more of their market value. In the mad scramble for acquisitions, rollups end up overpaying for businesses. Economies of scale often fail to materialize. Some of the failures have been spectacular, none more so than that of Waste Management.
WM’s founders, H. Wayne Huizenga and Dean Buntrock, started buying into the garbage business in the late 1960s. They merged their firm with a rival, USA Waste Services, in 1998, making Waste Management the undisputed king of the trash business. The combined firm had $12 billion a year in sales
and a stock trading at more than 30 times earnings.
But the economies of scale in the trash business proved overrated and profits started to dwindle. On Jan. 29, 1998, Waste Management admitted it had overstated earnings by $1.3 billion. A stock-price collapse and SEC charges followed. None of LKQ’s founders were implicated in the scandal; by then, they’d moved on. A spokesman for LKQ says there is no connection between the firm and Waste Management.
LKQ got its start in 1998, the same year that Waste Management’s accounting problems became public. Huizenga put up much of the funding, and Donald Flynn, WM’s former CFO, took charge of the new company. He recruited former coworkers like Joseph Holsten, who had been chief executive at WM from 1995-97. (Holsten has since become LKQ’s chairman.) In July 1998, Flynn created LKQ by buying five recycled auto-parts businesses with a combined revenue stream of $33 million.
One of those initial acquisitions was Wagman’s employer, Triplett Automotive Recycling. Wagman had been in auto-parts salvage since 1987 and was Triplett’s head of outside sales. He worked his way up the LKQ ranks. By the time Flynn died in October 2011 at 72, Wagman was CEO.
Wagman has stuck with the formula Flynn brought over from WM. “This tends to be a mom and pop industry, so you have entrepreneurs that lack the access to capital to continue to grow the business,” he says. “That’s where we step in.”
In LKQ’s business, there appear to be a number of ad- vantages to scale. Auto-parts recycling has always been an imperfect science. It involves filling orders from small body shops and mechanics searching for a single part. No single customer accounts for more than 2 percent of LKQ’s sales. But, says Kevin Gress, an LKQ plant manager, “the larger network enables you to have more access to inventory,” so when a customer needs an alternator for a 1980 Pontiac, LKQ is more likely to have it than other parts shops. And LKQ’s size lets it invest in technology, like handheld computers its bidders use at auctions. The devices track LKQ inventory and recent prices to determine how much they should bid on wrecked cars.
Meanwhile, LKQ is building out its capacity to extract value from its cars. Last year, it bought a precious metals reclamation business, enabling it to harvest platinum from catalytic converters.
When he’s buying entire salvage operations, Wagman doesn’t have to bid against a direct rival. In 2007 LKQ bought its only major competitor, Keystone Automotive, for $811 million. With few competitors, Wagman says he is free to buy only companies that are already profitable and in compliance with environmental regulation without overpaying. Though LKQ moves at a steady clip — 50 acquisitions in the past two years — the pace is glacial compared with that of other rollups. At its peak, day care chain KinderCare was buying a new center every three days. Tyco acquired more than a thousand companies between 1994 and 2001 as it tried to roll up several industries.
Like those firms, LKQ will keep increasing revenue as long as it’s making acquisitions. But it’s not clear where the growth will come from once the deals dry up. LKQ’s growth excluding acquisitions plunged in 2012, dropping to 4.1 percent from 10.7 percent in 2011. The company attributes the drop to the declining price of scrap and a mild winter, which caused fewer automobile crashes.
But Wagman can keep the acquisition machine humming for a long time. Even after 15 years of acquisitions, the company controls just 19 percent of the market. He doesn’t see any reason to slow down.
“It’s just opportunistic,” he says. “When a deal becomes available we have to jump at it.”