Breakingviews: UK LBO jalopy offers buyout barons last wild ride

The AA could give private equity one last ride. The UK roadside repair and insurance group is drawing interest again from buyout firms. Previous deals have left it saddled with a 2.7 billion pound debt load and weak growth. A new driver would need lots of cash and elbow grease.

The AA is no stranger to private equity. In 2004, CVC and Permira bought the group from British Gas owner Centrica for 1.8 billion pounds. It was later merged with Charterhouse’s Saga, a travel business. By the time the AA was listed in 2014, it was overindebted, and underinvested, and has since had to boost spending and investment. Revenue has stayed flat, but the EBITDA margin has fallen from 44% in 2015 to 35% last year. Leverage has risen to nearly 8 times 2020 EBITDA, blocking dividends. AA’s shares have now lost over 80% of their value since listing.

The depressed share price has drawn interest from three bidders — a group comprising Centerbridge Partners and TowerBrook, as well as Platinum Equity Advisors and Warburg Pincus. Buying out AA’s shareholders wouldn’t cost much, perhaps 300 million pounds, assuming a 25% premium to the current market capitalisation. The new owner would also need to bring down AA’s debt to a level where it can easily refinance. Cutting borrowing to 2.3 billion pounds, just over 6 times EBITDA, would cost another 400 million pounds. That would also free up cash to turn around the group, say by ploughing money into extra underwriting capabilities, or rebooting its iconic yellow vans.

Assume the new owner can restore EBITDA to say 400 million pounds, up from 350 million pounds in 2019. A less leveraged, more profitable AA might then be valued at perhaps 10 times that figure, in line with its average since listing, or 4 billion pounds. Take off the remaining debt, and the 700 million pound investment would have more than doubled to 1.7 billion pounds.

Such an outcome requires ideal driving conditions, and the road ahead looks treacherous. Electric cars will break down less than combustion engines, and a new generation of young drivers may be less keen on paying for peace of mind. The UK motor insurance market is cut-throat. Private equity should buckle up.