What Does Icahn Do With Pep Boys?

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Billionaire Carl Icahn jumped through loads of hoops to acquire struggling auto parts and repair chain Pep Boys: Many, Moe & Jack (NYSE: PBY) for $1.03 billion. He even outbid Japan’s Bridgestone for the privilege, and his rival got a deal termination fee on Pep Boys’ behalf.

Many on Wall Street, though, are scratching their heads over the latest move by the activist investor. For one thing, the Philadelphia-based company, which is as iconic in the City of Brotherly Love as “Rocky” and soft pretzels, has struggled for years against larger rivals such as AutoZone Inc. (NYSE: AZO), Advanced Auto Parts Inc. (NYSE: AAP) and O’Reilly Automotive Inc. (NASDAQ: ORLY).

Pep Boys is small potatoes compared with its rivals, with only 800 locations compared with the thousands of locations its competitors own. An analyst joked that Pep Boys has been dysfunctional for the 20 years he’s covered it. That’s not much of an exaggeration. Indeed, Pep Boys posted a net loss of $18.85 million in the past fiscal year and has struggled to sell itself for years.

Private equity Gores Group unexpectedly dropped plans to buy Pep Boys in 2012 after it was spooked by the retailer’s poor financial state. Other potential buyers took a pass on acquiring the chain during last year’s sales process, according to media reports. Bridgestone also doesn’t appear to be too broken up about losing out to Icahn. The reason why is simple: Even under the most optimistic of scenarios, this deal will be a bear for the octogenarian to implement.

For one thing, Icahn will need to find a buyer for Pep Boys’ auto repair business, which Wall Street analysts say he has no interest in owning. One problem is that most Pep Boys locations — about 500 or so — have both auto repairs and parts retailing. Icahn will have to find a buyer for the business who will need to separate the service and retail operations with a wall.

Though there is precedent for such a deal in the auto repair industry, any potential buyer realizes that Icahn is in a tough spot because he also owns an 82% stake in auto parts supplier Federal-Mogul Holdings Corp. (NASDAQ: FDML), which has had plenty of its own issues. AutoZone, Advanced and O’Reilly are all big customers of Federal Mogul and are probably none too pleased that Icahn owns a rival, albeit a small one, even when Pep Boys is combined with Auto Plus, an even smaller rival with 270 stores that Icahn’s company acquired in June.