Strong Demand, Surging M&A Activity Across Vehicle Aftermarket Sector and Powersports Segment

Despite ongoing supply chain challenges, Vehicle Aftermarket sector performance is expected to remain strong in the foreseeable future, benefitting from consistent improvement in demand indicators including rising average vehicle age, traffic levels, and quantity of miles driven since the onset of the pandemic. In May 2022, the average age of automobiles and light trucks in operation in the U.S. reached 12.2 years, increasing 2% from 2021, according to S&P Global Mobility.¹ Along with the continued decline in vehicle scrappage, the microchip shortage has supplemented rising vehicle age due to the limited supply of new vehicles. This trend is expected to uphold demand for automotive parts and services as older cars require frequent maintenance. The growing vehicle fleet, represented by an increase of 3.5 million light cars and trucks on the road in 2022, will also contribute to automotive repair and parts demand as elevated traffic levels correlate with higher accident rates.

While the Vehicle Aftermarket sector is expected to witness continued revenue growth, prevalent headwinds pose significant challenges to companies in the space. Capstone forecasts that supply chain issues, including rising raw material prices, will strain part manufacturers and suppliers through 2023. Higher input costs can materialize in margin compression if companies are unable to pass costs onto customers. The ability to negotiate raw material prices with upstream providers and adjust the price of final goods will be critical for margin protection among sector players. Additionally, rising gas prices could limit vehicle usage until energy price volatility normalizes. In spite of these challenges, overall consumer spending on specialty equipment parts and accessories jumped 6.3% in 2021 year-over-year (YOY) with Specialty Equipment segment sales reaching $50.9 million (Specialty Equipment Market Association),² providing a favorable outlook for aftermarket company performance in the near-term.

Powersports Segment Benefits from Strong Demand

Due to COVID-19 restrictions, consumers increasingly pursued outdoor hobbies resulting in a 21.8% increase in U.S. motorcycle sales in 2021 compared to 2019 (2020 performance comparisons are misleading due to the disruptions that occurred during the pandemic), according to the Motorcycle Industry Council.³ In addition, the desire for personal transportation contributed to ridership, and consumers are expected to acquire transportation vehicles that reduce fuel usage amid elevated environmental concerns and rising gas prices. These tailwinds have expanded the total addressable market for motorcycle dealerships and repair providers with people increasingly considering motorcycles as a method of everyday transportation.

Notably, Harley-Davidson (NYSE:HOG) reported momentum across its business with Q1 2022 revenue up 5% YOY to $1.5 billion driven by strong demand and pricing, according to its Q1 earnings call.⁴ However, Harley-Davidson's operating margin of 15.6% in Q1 2022 fell short of its Q1 2021 level of 18.5% as the margin benefit from pricing was offset by cost inflation across the supply chain. The company anticipates its performance to improve throughout the year as it continues to utilize global pricing actions to offset input cost headwinds. In addition, the expansion of the addressable market for motorcycles is anticipated to largely benefit the company in the future as consumers increasingly pursue premium bikes.

In January 2021, Harley-Davidson introduced The Hardwire, an overhaul of the business that aims to set a strong foundation for the future via a new five-year strategic growth plan, according to a press release.⁵ The plan establishes a commitment to build on the legacy of Harley-Davidson as the leading premium motorcycle provider and increase the desirability of its vehicles by placing an emphasis on performance, focus, and speed. In addition, the plan introduces a new operating model and organizational structure across every function, while prioritizing markets with the highest potential. The plan also puts in place efforts to bolster Parts & Accessories and General Merchandise sales, rebuild its go-to-market efforts with a streamlined product portfolio, and protect the value of its products.

Merger and Acquisition Activity Moves at Exuberant Pace in Vehicle Aftermarket Sector

Merger and acquisition (M&A) activity in the Vehicle Aftermarket sector has surged year-to-date (YTD), with 169 deals announced or closed through June 10 compared to 106 in the prior year period. Acquirers continue to demonstrate a strong appetite across virtually every segment of the Vehicle Aftermarket sector. Private equity (PE) add-on acquisitions have comprised the largest share of YTD deals (38.5%) as PE firms have employed buy-and-build strategies to expand the geographic reach and product mix of portfolio companies. This is evidenced by TruckPro's acquisition of the operational assets of Young's Gear Denali Drivelines, a leading undercarriage, drivetrain, and suspension service shop (April 2022, undisclosed). Through the acquisition, TruckPro, a Platinum Equity-backed heavy-duty truck and trailer parts distributor, has strengthened its footprint in the Alaskan market and expanded upon its offerings. Private strategic buyers have also been highly acquisitive, accounting for 34.3% of deals to-date, consolidating competitors of scale. Aftermarket companies that have established a strong presence in lucrative geographies are expected to continue to attract elevated buyer demand, especially if the target's product mix or service offerings complement the acquirer's portfolio. In line with strong consumer demand, companies in Enthusiast categories, including Powersports, continue to attract acquisition opportunities as financial and strategic buyers aim to enhance penetration in these growing segments.

Notable Powersports Transactions

Due to pandemic tailwinds and strong growth potential, the Powersports segment has attracted significant acquisition interest from strategic and financial buyers. Outlined below are notable transactions that recently occurred in the Powersports space.

• Navigant Oak acquires Calculated Risk Motorcycle Group (May 2022, confidential) - Headquartered in Bedford, Texas, Calculated Risk owns and manages six Harley-Davidson dealerships and has launched the Lucky Penny Cycles pre-owned motorcycle brand, and was acquired by Navigant Oak, a private holding company for a Michigan family's portfolio of businesses and investments.

Capstone advised Calculated Risk on the sale, representing one of the first dealership acquisitions by a financial buyer in the Harley-Davidson space—bucking a long-standing trend. Terms of the deal are confidential. Capstone anticipates that the acquisition will spur other large powersports dealers to follow suit. Harley-Davidson has historically prevented family offices and private equity investors from acquiring dealership franchises, but recently the parent company has loosened ownership restrictions to help facilitate growth. Included below is an exclusive Q&A with Adam Smith, President & Owner of Calculated Risk.

We are honored to have advised and served Calculated Risk on a very important transaction, symbolizing both the investor interest and strong outlook for powersports dealerships. Adam is an outstanding leader who built an exceptional business and culture at Calculated Risk. This culture combined with Navigant Oak’s resources and capabilities results in a powerful partnership, unlocking significant future growth opportunities for the company.

Yogesh PunjabiSenior Director, Capstone Partners

• Lithia & Driveway (NYSE:LAD) acquires Pfaff Harley-Davidson Dealership (November 2021, undisclosed) - Lithia & Driveway acquired Pfaff Harley-Davidson in Toronto, Canada for an undisclosed sum, marking its entrance into the North American Powersports market. Based in Medford, Oregon, Lithia is a personal transportation solutions provider retailing a wide variety of products and services to serve the entire vehicle ownership lifecycle through a variety of consumer channels. The acquisition brings Lithia's total expected annualized revenue in 2021 to nearly $6.3 billion, positioning the company ahead of schedule to exceed its plan to reach $50 billion in revenue and $50 of earnings per share by 2025, according to a press release.⁶ In addition, Harley-Davidson's premium product lineup complements Lithia's current offerings and aligns with its business model.

• RumbleON (Nasdaq:RMBL) acquires Freedom Powersports (November 2021, $130 Million) - RumbleON, a technology-based omnichannel platform providing pre-owned vehicles in Irving, Texas, completed its previously announced acquisition of new and used motorcycle dealer Freedom Powersports for an aggregate consideration of ~$130 million. Freedom currently operates 13 retail locations in Texas, Georgia, and Alabama representing 15 manufacturers, according to a press release.⁷ Through the acquisition, RumbleON has expanded its footprint to over 55 locations and strengthened its omnichannel offering. Freedom was particularly attractive due to its history of unit growth, revenue expansion, and EBITDA profitability. Notably, Freedom recorded more than $220 million of revenue and over $25 million of adjusted EBITDA in 2021.

"We are transforming the Powersports industry and remain singularly focused on offering unparalleled choice and unmatched experience to our customers both online and in our retail locations. The opportunity set and our business fundamentals remain strong. Adding Freedom to our portfolio further strengthens our consumer offering, expands our national footprint, and deepens our leadership position in Powersports," said Marshall Chesrown, RumbleOn’s Founder and CEO, in the press release.

• John Elway Dealership Group acquires Greeley Harley-Davidson and Wild West Motorsports (December 2021, undisclosed) - John Elway Dealership Group, an owner and operator of dealerships based in Englewood, Colorado, acquired Greeley Harley-Davidson and Wild West Motorsports in Greeley, Colorado for an undisclosed sum, marking its first acquisition of a Harley-Davidson dealership. Founded in 1968, the store hosts a wide variety of Harley-Davidson, Honda, Polaris, and Yamaha vehicles."This is a great addition that will complement our other two powersports dealerships in Northern Colorado. By adding Harley-Davidson, Polaris, and Yamaha, Elway Powersports now represents eight of the top brands in the industry," said Michael Maledon, Partner at John Elway Dealership Group, according to a press release.⁸

Client Q&A: Calculated Risk

Following Capstone’s advised sale of Calculated Risk to Navigant Oak in May, the firm interviewed Adam Smith, President & Owner of Calculated Risk, to discuss the acquisition, Harley-Davidson, and trends in the Powersports sector.

Adam Smith, President & Owner of Calculated Risk

Adam has been in the Harley-Davidson business for more than 30 years. He was born and raised in the Dallas-Fort Worth area and joined the Harley-Davidson Motorcycle business in 1991. In 1996, Adam opened his first Harley-Davidson dealership in Grand Prairie, Texas, making him the youngest person to own and operate a Harley-Davidson dealership at the age of 22.

Under his leadership, Calculated Risk has grown to own and operate six Harley-Davidson dealerships and two pre-owned motorcycle dealerships under the brand name Lucky Penny Cycles.

Calculated Risk is clearly the premier Harley-Davidson dealership in Texas. Can you please share a few key differentiators between your locations and competitors? How did Calculated Risk become number one?

Well, it always starts with team members. You can buy a Harley anywhere, but it's the people inside the buildings helping you that make the difference. The key differentiator would be our team at each of the locations. Also having multiple stores in Texas helps because that's one inventory for all the stores to sell from, and we can streamline processes and procedures, resulting in a better experience for our customers and team members.

What are your thoughts on the Hardwire 2021 – 2025 strategic plan? How will this impact dealerships and how do you think Harley-Davidson competitors will react?

For the most part, it's a good plan. I agree with the direction because being premium always means better margins and scarcity. Jochen Zeitz, the CEO of Harley-Davidson, has made it clear that we're going to be a premium brand and that we are going to focus on the products that make money for the company and more importantly, the dealer.

Regarding dealerships, you're going to have to spend some money on your facilities because of the changing retail landscape and evolving customer expectations. Going forward, there will be multiple channels that dealers need to focus on expanding. Some consumers do all their shopping online. Some consumers do all of it brick-and-mortar, and then there are hybrid preferences. Dealerships will have to adapt and spend more time shaping customer experiences for different profiles, which the Harley-Davidson Motor Company is already investing in and spending time on as well. That said, I am not concerned about competition between the two—the dealership framework is a crucial component to the brand.

How did COVID impact your dealerships and the industry overall?

At first, we asked “what are we going to do? We can't be open.” So, we made a bunch of hard decisions that we didn't have the guts to make before. It was an excellent discipline exercise and some of the changes had exceptional results for our organization.

Overall, the impact of COVID on the industry was positive, and it gave Jochen Zeitz and Harley-Davidson cover to go back to producing lower volumes of sought-after models—the brand went back to its roots.

What do you expect consumer demand for motorcycles to look like through the rest of 2022 and beyond?

Industry-wide, most dealers are on a 10-day or less supply of motorcycles. Demand and supply are at a very interesting point. Everybody is winning, the consumer wins because the product they are buying maintains a higher residual value; the dealer is winning because they are getting a larger margin for the motorcycle; the manufacturer is winning because their brand is perceived as more premium; and the shareholder is winning because the company is making more money after they have rightsized the business. So, this is a win all around.

What made Navigant Oak a great partner for Calculated Risk?

First, they're good human beings and a group that shares my values. Second, they are trustworthy, and they understand our brand. They are genuinely interested in building a legacy together with our team members. Looking ahead, I’m excited about what we can accomplish together.

Do you expect the partnership with Navigant Oak to spark a domino effect in the Powersports sector?

There's a lot of action out there with a couple of public groups and some private auto groups. There’s also a handful of private equity firms and family offices looking at some dealerships, so I suspect there will be a few more dominoes to fall by the end of the year. This deal may be the first big one of the year, but it won't be the only one if everything stays the way it is now.

Do you have any advice for dealerships contemplating a capital raise or sale?

Three years prior to starting the sale process, start getting the business ready to go. One item I would stress to groups contemplating a sale is to get their financials audited. Second, I would advise the group to start practicing as if it had already sold—you may ask yourself what you are going to do, especially if it’s your entire existence. Overall, this is actually a good time to start prepping so you can catch the next cycle in a good position.

To discuss sector M&A activity, provide an update on your business, or learn about Capstone's wide range of advisory services and Vehicle Aftermarket sector knowledge, please contact Senior Director Yogesh Punjabi.

Watch The ReCap

For additional insights on this topic directly from Capstone Senior Director Yogesh Punjabi, watch The ReCap—a new video series where Capstone's senior investment bankers address important market updates and top-of-mind concerns among business owners, investors, and acquirers in the middle market.

Endnotes

1. IHS Markit, "Average Age of Vehicles in the US increases to 12.2 years, according to S&P Global Mobility " https://ihsmarkit.com/research-analysis/average-age-of-vehicles-in-the-us-increases-to-122-years.html?ite=1007063&ito=1276&itq=2b52f336-42fa-4e55-a4a6-4ed99d18ade5&itx%5Bidio%5D=778589667, accessed June 13, 2022.

2. EMA Market Research, "2022 SEMA Market Report," https://sites.sema.org/market-research/#:~:text=The%20SEMA%20Market%20Report%20provides,parts%20and%20accessories%20in%202021., accessed June 14, 2022.

3. Motorcycle Industry Council, "MIC Retail Sales Report," https://www.mic.org/#/statistics,
   accessed June 13, 2022.

4. The Motley Fool, "Harley-Davidson (HOG) Q1 2022 Earnings Call Transcript," https://www.fool.com/earnings/call-transcripts/2022/04/27/harley-davidson-hog-q1-2022-earnings-call-transcri/, accessed June 13, 2022.

5. Harley-Davidson, “Harley-Davidson Successfully Completes The Rewire and Announces Date to Reveal New 2021-2025 Strategic Plan, The Hardwire,” https://investor.harley-davidson.com/news-releases/news-release-details/harley-davidson-successfully-completes-rewire-and-announces-date, accessed June 14, 2022.

6. Cision, “Lithia & Driveway (LAD) Enters North American Powersports Market with Addition of Pfaff Harley-Davidson Dealership,” https://www.prnewswire.com/news-releases/lithia--driveway-lad-enters-north-american-powersports-market-with-addition-of-pfaff-harley-davidson-dealership-301419550.html, accessed June 14, 2022.

7. Business Wire, "RumbleOn Completes Acquisition of Freedom Powersports," https://www.businesswire.com/news/home/20220221005480/en/RumbleOn-Completes-Acquisition-of-Freedom-Powersports, accessed June 14, 2022.

8. PowerSports Business, "Elway Group acquires first Harley-Davidson dealership," https://powersportsbusiness.com/top-stories/2021/12/14/elway-group-acquires-first-harley-davidson-dealership/, accessed June 16, 2022.