The Covid-19 pandemic turned America—a nation long committed to easy mobility—upside down. The reliance on, and need for, driving has dramatically declined, and new vehicle production has ground to a halt, leaving no doubt that the impact on M&A within this space will go well beyond this black swan event. In particular, the impact on the automotive aftermarket—and the prospects for the industry in the months and years ahead—make for a particularly compelling case study. While the automotive aftermarket space is certainly not immune to the coronavirus, we are seeing that companies with a strong direct-to-consumer (DTC) e-commerce foundation and those catering to enthusiasts are faring better than others. A historically consistent-growth but fragmented sector, the auto aftermarket has been an investment theme for us at Kian Capital Partners and we have been working closely with the management teams at both The Eastwood Company and The Retrofit Source as we collectively navigate this crisis. Three decades of growth Pre-covid, the automotive aftermarket was experiencing a long history of growth and therefore saw quite a bit of attention and interest from investment firms. The long-term expansion of the aftermarket is attributable to the global surge of auto ownership, as well as the fact that cars are being made to last much longer. This spurs consumers to make investments in their older vehicles, driving growth for aftermarket service and replacement parts. In the near term, the sharp drop in miles being driven in passenger cars during the pandemic will certainly mean less demand for light-vehicle replacement parts and service because of reduced wear-and-tear as well as a drop in collisions and related repairs. The outlook is a bit rosier for medium- and heavy-duty parts and service, as the pandemic has meant increased dependence on trucking and other delivery systems. Over the mid-term, as we move to the “new normal,” it seems reasonable to forecast that the global economic disruption and downturn caused by Covid-19 will lead many consumers to postpone planned new car purchases and that demand for service, replacement and upgrade parts will rebound once people start getting back on the road. Auto Enthusiasts are DIYing in their garage The one segment of the aftermarket industry that is actually doing reasonably well in the face of the pandemic is the direct-to-consumer (DTC) auto enthusiast niche. Enthusiasts, who demonstrate real passion for their vehicles, are less price-sensitive than other aftermarket consumers. And like so many others who are using their enforced stay-at-home time to indulge a love of gardening, home improvement or fitness, car enthusiasts now have carte blanche to socially distance in the garage and spend quality time on their favorite hobby. Because many brick-and-mortar retail outlets are currently closed or offering only curbside pickup, companies with a well-developed online presence have a real advantage because they can showcase their offerings online and conduct business over the Internet without their customers ever having to leave home. E-commerce no longer optional Automotive aftermarket retailers are currently scrambling to launch or improve their e-commerce offerings. However, many DTC aftermarket companies were early online adopters and have developed a strong digital platform that engages, inspires and converts browsers into buyers, which is an advantage that is highly visible in this environment and will not go away once the world re-opens. Pre-Covid-19, a well-developed e-commerce strategy and a reliable platform were, and have proven to be, market-expanding differentiators for enthusiast businesses. This is further supported by what will be a likely step function leap forward in the e-commerce adoption curve. Not only will it be months or years before many consumers become comfortable shopping for pleasure, but the pandemic experience has also finally moved even the most stubborn e-commerce holdouts online. For DTC enthusiast retailers, that means moving every aspect of the shopping and buying experience online: · Reaching and engaging customers via e-mail, social media platforms and websites; · Developing a world-class website to differentiate the customer experience; · Using every asset in the digital toolbox—videos, webinars, online demos and instructional how-tos—to inspire customers early and often in their buying journey; and · Adopting a “customer success” approach after a purchase is made—making sure a happy customer now feels like he or she is part of your online “tribe.” M&A in the auto aftermarket Pre-coronavirus and for three decades now, the automotive aftermarket industry has been highly regarded by investors (including our firm) for its steady growth and, in particular, its consistent resilience in the face of recession. It is a highly fragmented space of both mom and pop operators and innovative entrepreneurs turning ideas into sought-after solutions. Once the M&A markets re-open, we anticipate attractive opportunities will remain to execute careful add-on acquisition strategies for the right platform company. DTC enthusiast platforms whose strong and established e-commerce approaches have withstood, and in some cases thrived, during the pandemic, will be of particular interest. However, given the severe economic dislocation that economists are projecting, we need to temper our enthusiasm by considering certain factors that could weigh against the sector: · If the economic shock is sufficiently broad and deep to depress discretionary spending in the enthusiast market; · If the pandemic proves deeply disruptive to aftermarket supply chains, limiting availability, increasing lead times and driving up freight costs; and · While investors might be open to and actively looking for acquisitions, if the challenges experienced across the entirety of the M&A world continue (e.g., how to properly conduct due diligence and execute deals without personal contact, how to model post-coronavirus demand scenarios). Preparing for the long drive ahead Even with this tremendous uncertainty, there is reason to believe the broad aftermarket will rebound strongly once the U.S. economy re-opens, particularly if economic disruptions motivate consumers to postpone new car purchases and instead opt to repair or upgrade their current vehicle. But even amid the shutdown, one bright spot is the space within the aftermarket that caters to auto enthusiasts. Right now we are seeing promising demand within the DTC e-commerce enthusiasts’ segment of the automotive aftermarket and our current investments. Platforms that are already knowledgeable in using digital channels to nurture and cultivate enthusiast customers will be best-positioned to thrive in the pandemic and its aftermath. Investors who understand digital strategy and can execute a digital transformation playbook will be able to build compelling platforms amid widespread buying opportunities. However, supply chain issues, rising costs and decreases in discretionary spend present real threats. The length at which the economy remains in some form of shutdown will drive the magnitude of impact.