Vehicle Service Contract Industry Jan 2019...Colonnade Advisors LLC • 500 West Madison Street • Suite 3410 • Chicago, IL • 60661 ... May-18 Automotive Development Group Brown

VEHICLESERVICECONTRACTINDUSTRY MarketCommentary–January2019

ColonnadeAdvisorsLLC•500WestMadisonStreet•Suite3410•Chicago,IL•60661www.ColAdv.com

InvestmentbankingservicesprovidedthroughColonnadeSecuritiesLLC,memberFINRAandSIPC1

VehicleServiceContractIndustry

StrongMarketFundamentals:

GrowthandInvestorInterestContinue

The vehicle service contract (VSC) industry continues to attract significant interest among investors andconsolidators.Macrofundamentalsarecompelling,andtheindustrydemonstratesgrowth,strongmarginsandrecurring cash flow. The industry value chain includes administrators, F&I agencies, direct-to-consumermarketers,paymentplanprovidersandspecialtyinsurancecarriers.In2018,theindustrywas$35billionatretailwithsignificantopportunityforgrowth;therewere132millionvehiclesthatdidnothaveaVSCbutwereeligible.Since2010,morethan60companiesintheVSCindustryhavechangedownership.Weexpectsellersto continue to benefit from strong demand among financial investors and strategic buyers for well-runbusinessesinthesector.Newentrantsandconsolidatorsshouldenjoyindustrytailwindsforseveralyears.

TheVSCindustryisbenefittingfromcompellingmacrotrends:• TheattachmentrateofVSCsonnewcarssalescontinuestoincrease.• Usedcarssalescontinue tobestrong. Thesevehicles typicallyoutlive theirOEMwarrantiesandhave

highermaintenanceneeds,creatingdemandamongconsumersthatareincreasinglyaccustomedtobuyingvehicleprotectionproducts.

• Weestimatethemarketsizeofthe“sweetspot”forpost-OEMwarrantyVSCsaleswillcontinuetogrowto109millionvehiclesby2024fromanestimated87millionvehiclesin2018.

• ConsumerdemandforVSCsissignificant:anestimated40%ofAmericansdonothavecashonhandtopayforanemergencyexpenseof$400ormore.Astheaverageageofvehiclesincreasesanddriversholdtheircarslonger,theneedforprotectionplansisincreasing.

• Dealershipmarginsremainunderpressure,andF&Iproductsprovidesignificantprofitability.• However, there has been increased risk for individual F&I products companies due to dealership

consolidation.

ThepaceofacquisitionsandinvestmentsintheVSCindustryisincreasing,drivenbydemandfromfinancialandstrategicinvestorsandtheavailabilityofcapital.Privateequityfirmsareattractedtotheindustryforitshighmargins,strongcashflow,fragmentationandgrowth.ThereareseveraltrendsinthecurrentM&Aactivityin the VSC industry, including the acquisition of administrators with a strong book of house accounts,companieswithaspecialtyincaptivereinsurance,diversifiedF&Iagenciesandcompaniesthataddressthelargestopportunity:vehicleownersaftertheybuytheircar.

Private equity firms are buying platform companies andmaking add-on acquisitions to existing portfoliocompanies.Moreandmore,industryparticipantsareconsideringverticallyintegrating,potentiallydisruptingmarketdynamicsamongthepureplays.Weexpectstrongdemandforwell-runcompaniesinthisindustrytocontinue.

F&IProductsEcosystemTherearemultiplesegmentsintheVSCindustryandcompaniesusevariedbusinessmodels.




F&IPRODUCTSECOSYSTEM

M&AUPDATEThepaceofacquisitionsandinvestmentintheF&Iproductsindustryisincreasing.Activityisdrivenbypositivemacrotrends,privateequityinterestintheindustryandtheneedforstrategicbuyerstoaccelerategrowthandimprove scale. Industry participants are vertically integrating to lock-in or increase distribution, enhancerevenueandmarginsandincreasescale.

InvestmentsandAcquisitionsbyPrivateEquityFirms

Privateequityfirmsareattractedtotheindustrybythehighmargins,strongcashflow,fragmentation,andgrowthoftheindustry.

PlatformAcquisitions:Privateequityfirmsgenerallyseekplatformacquisitionsofcompaniesthatcangrowboth organically and through bolt-on acquisitions. A recent example is Crestview Partners’ acquisition ofProtectMyCar,averticallyintegratedseller,administratorandpaymentplanprovider.

Add-on Acquisitions: Many private equity-backed F&I companies are seeking acquisitions to diversifyproducts, increase scale, vertically integrate to capturemore of the value chain and enhance distributionchannels. Recent examples include Portfolio Group's (administrator) acquisition of Finance Concepts (F&Iagency), and IAS's (administrator)acquisitionofKingstar (direct-to-consumermarketerandpaymentplancompany).




AcquisitionsbyAdministrators

Administratorsareseekingtogrowthetopline,improvemarginsandlock-indistribution.

• Administrators,themajorityofwhichdonothaveasignificantdirectsalesforce,arechallengedtogroworganically because they do not control the distribution of their products. These administrators aredependentonF&Iagentsanddirect-to-consumermarketers,bothofwhichselltheproductsofmultipleadministrators.TheacquisitionofanF&Iagencyoradirect-to-consumermarketercanaccelerategrowthandlock-indistribution.

• Administratorsareseekingmarginimprovementthroughscaleandbycapturingmoreofthevaluechainthroughverticalintegration.ArecentexampleisProtective's(administrator)acquisitionofU.S.Warranty(administrator).

AcquisitionsbyInsurersandInsuranceAgencies

InsurancecompaniesthatarealreadyintheF&Iproductsindustryhavebeenmakingacquisitionsinthesector.InsurersthatunderwriteVSCsareacquiringadministratorsinordertocaptureorpreservebooksofbusinesswhilenewentrantsareevaluatingadministratorsasalogicalproductextensionofspecialtyinsurancelines.TraditionalinsuranceagenciesareaddingF&Iagenciestoexpandproductofferings.RecentexamplesincludeBrown & Brown’s acquisitions of F&I Resources (F&I agency) and Automotive Development Group (F&Iagency),andiAFinancialGroup’s(VSC)acquisitionofSouthwestRe(administrator).




DATE TARGET BUYER/INVESTOR SUB-SECTORSep-18 F&IResources Brown&Brown F&IAgency

Sep-18 ProtectMyCar CrestviewPartners DTCMarketerandAdministrator

Jul-18 NationalAutoCare LovellMinnickPartners Administrator

May-18 AutomotiveDevelopmentGroup Brown&Brown F&IAgency

Oct-17 AmTrust–FeeBasedBusiness MadisonDearbornPartners Administrator

Oct-17 TheWarrantyGroup Assurant Administrator

Sep-17 DAC/SouthwestRe iAFinancialGroup AdministratorandInsurer

Sep-17 ForeverCar InvestorGroup DTCMarketer

Aug-17 EvergreenDealer&InsuranceServices SouthWestDealerServices F&IAgency

Jul-17 AutomotiveAssuranceGroup AmTrust F&IAgency

Jun-17 FinanceConcepts PortfolioGroup(CapitalZ) F&IAgency

May-17 Mepco SeaburyAssetManagement Finance

May-17 KingStar IAS(Genstar) DTCMarketerandFinance

Apr-17 OmnisureandPayLinkmerger PayLink(Milestone),Ominsure(Fortress) Finance

Dec-16 NitroFill KinderhookIndustries Administrator

Aug-16 AutoAssure EnduranceDealerServices(TRP) DTCMarketer

Aug-16 UnitedStatesWarrantyCorp. Protective Administrator

Jul-16 NationalTruckProtection KinderhookIndustries Administrator

Jun-16 Expresslink/Cartel ConfieSeguros(AbryPartners) F&IAgency

Jun-16 ThePortfolioGroup CapitalZ Administrator

Apr-16 UnitedInsuranceGroupandOlympicDealerMarketing

SouthWestDealerServices(SpencerCapital) F&IAgency

Feb-16 AutomotiveDevelopmentGroup APCO(OntarioTeacher'sPension) F&IAgency

Jan-16 APCO OntarioTeachers'PensionPlan Administrator

Jun-15 EnduranceDealerServices TRP AdministratorandMarketer

BoldIndicatesColonnadeClient

ACQUISITIONTRENDS

AcquisitionTrend:AdministratorswithaStrongBookofHouseAccounts

F&Iagentslargelycontrolthedistributionofproductsintodealershipsandmostadministratorsaredependentonthisnetwork.Administratorsthathavedirectrelationshipswithdealershipsthatbypasstheindependentagents(“houseaccounts”)aremorevaluablebecausetheyarenotdependentonathird-partyfordistribution.Thesehouseaccountrelationshipsaretypicallyatthedealer-ownerlevelandaregenerallyquitepersistent.Weseeadministratorslookingtobypassthirdpartyrelationshipsbyacquiringagencies.




AcquisitionTrend:AdministratorsandF&IAgentswithaSpecialtyinCaptiveReinsuranceSolutions

Dealerreinsuranceprogramsaremaintainedatthedealership-ownerlevelratherthanattheF&Iofficelevel.These relationships are sticky as reinsurance is often a wealth management tool for dealership owners.Companiesthathavethecapabilitytostructurecaptivereinsurancesolutionshaveacompetitiveadvantageasitisdifficultforotheradministratorsandagentstounseattheincumbent.

AcquisitionTrend:F&IAgencieswithEnterpriseValue,DiversifiedClientsandLong-TermRelationships

The most valuable agencies are those with diversified dealership clients and long-term relationships.DiversificationisimportantasM&Aactivityamongdealershipshasaccelerated(seeThreat:ConsolidationofDealerships).WeseestronginvestorinterestintheF&Iagencysectorgivenitslowcapitalintensityandhighrecurringrevenuecharacteristics.

AcquisitionTrend:CompaniesthatAddressOwnersAfterthePurchaseoftheVehicle

ThelargestmarketopportunityforthesaleofVSCsisafterthevehiclepurchaserleavesthedealership. AsdealershipsandOEMsstruggletoincreaseprofitability,theyarefocusingonthe“missedopportunities,”the55%ofvehiclebuyers,representing9.5millionvehiclesin2018,whodidnotacquireaVSCatpointofsale.Therearefewcompaniesthataddressthismarketsegment.Othercompaniesaddressthe87millionvehiclesthatarepost-OEMwarrantybymarketingdirectlytoconsumersonlineandthroughdirectmail.

Therehavebeensomedealsinthissegmentincluding:

• Crestview’sacquisitionProtectMyCar,adirect-to-consumermarketerandadministratorofVSCsand• TRP’sacquisitionofEnduranceVehicleServices,adirect-to-consumermarketerandadministratorof

VSCs

Weexpectmore interest in acquiring companies that address thepost-OEMwarrantyvehicles, as it is thelargestmarketopportunity.

THREAT:CONSOLIDATIONOFDEALERSHIPSThe most significant challenge to administrators and F&I agents is dealership consolidation. Dealershipmergersandacquisitionsareatarecordlevel,withtransactionvolumeincreasing20%in2018over2017.Over1,500dealershipshavebeen sold since2012.Additionally, thebigkeepgettingbigger, as the top50dealerswereestimatedtohavebookedmorethan$175billioninrevenuein2018comparedto$144billionin2014.

DealershipconsolidationposesasignificantthreattoadministratorandF&Iagents’booksofbusiness.TheF&Irelationshipisoftenattheownerlevel,andwith2,855fewerownersthanin2008,theuniverseofrelationshipsisgettingsmaller.Thenumberoftimesatbatisdiminishingasthereare1,675fewerrooftopsthanin2008.Asdealershipschangehands,thebuyerislikelytoeliminateduplicativeproducts,movetheacquireddealershipstoitsexistingadministratorandF&IagencyrelationshipsandpotentiallysqueezemarginsfortheF&Iprovider.Agentsandadministratorswithmorethan15%ofrevenuesfromasingledealershipgroupcanexperiencesignificant volatility in earnings when one of its dealership clients is sold. Customer concentration cannegativelyimpactvaluationinasaletransaction.




DEALERSHIPCONSOLIDATION

Source:NADA

CONCLUSION

Weanticipatefurthermergerandacquisitionactivityoverthenextfewyearsas:

• Industryfundamentalsremainstrong.Themarketisgrowingduetoincreasedconsumerdemand,• Entrepreneursdecidetoexitorachieveliquidityinastrongmarket,• PrivateequityfirmsseektoharvestthevalueoftheirVSCinvestments,and• Companies consolidate to benefit from enhanced customer relationships, diversification and expense

synergies.

Colonnade has advised on sixteen M&A and financing transactions in the F&I industry and maintainsrelationshipswithownersandoperatorsacrossthevarioussegmentsaswellasinvestorsseekingtoenter.Ifyouareabusinessownerandwouldliketodiscussvaluationandstrategicalternatives,pleaseemailorcallusdirectly.

EmailustomeetatNADAinSanFranciscoinJanuary,LeadsConinLasVegasinMarchorAgentSummitinLasVegasinMay2019.




Appendix

StrongMacroTrendsareDrivingAcquisitionsandInvestmentsintheVSCIndustry

U.S.consumersspentanestimated$35billiononVSCsin2018.VSCsaretypicallymarketedatthreepointsinthelifecycleofanautomobile:(i)atoriginalsale(thenewvehiclesegment–extendedwarranties),(ii)nearorafterexpirationoffactorywarrantyprimarilyviadirect-to-consumersales(theend-of-warrantysegment)and(iii)atresale(theusedvehiclesegment).TheVSCmarketbenefitsfromhighnewandusedcarsalesandincreasingpenetrationrates.ConsumersvalueVSCsastheyhavelimitedfundstopayforrepairbillsandtheyare owning vehicles longer. Dealerships focus on VSC sales to enhance margins. F&I products provideincreasingincrementalprofitabilityandrepresent25%oftotaldealershipgrossprofit,comparedto15%in2009.Weexpectthesedynamicstocontinue.

TheVSCmarketsizehasgrownby6.9%to$35billionsinceColonnade’slastwhitepaperinAugust2017.Thegrowthisattributedtothreetrends:1)theincreaseinattachmentratesonnewvehiclesales,2)theincreaseinusedcarsalesand3)theincreaseinvehiclesoutoftheOEMwarrantyperiod.

RETAILMARKETFORVSCSIN2018COMPAREDTO2017

Source:Colonnadeestimates

NewcarssalesultimatelydrivesalesintheVSCmarket.Newcarsaleswere17.3millionunitsin2018,aslightincreasefrom2017.However,VSCattachmentrates,orthepercentofnewvehiclessoldwithaVSC,haveincreasedsignificantlyinthelastyearcausingthenewvehicleVSCmarketsizetoincreaseby5.9%to$16.2billion.

$33BillionMarketSize

$35BillionMarketSize




VEHICLES SOLDTHROUGHDEALERSHIPS(unitsinmillions)

NEWVEHICLEVSCATTACHMENTRATE

Sources:NIADA,ManheimUsedCarReportsandColonnadeestimates Sources:NADA&BakerTillyAutomotiveBenchmarkSurvey

Usedvehiclesalesareatanall-timehigh levelandaredrivingthepurchaseofVSCs. OldervehicleshavetypicallyoutlivedOEMwarrantiesandhavehighermaintenanceneeds,factorsthathaveapositiveimpactonconsumerdemandforVSCs. Therehasbeenaninfluxoflate-modeloff-leasevehiclesreturningtodealerswhichareolder,highermileageandoutsideofthemanufactureswarranty,therebyincreasingtheneedforVSCsonusedvehiclesales.Colonnadeestimatesthat42%ofusedvehiclesalesthroughfranchisedealershipsand20%ofusedvehiclesalesthroughindependentdealershipshaveaVSCattached.Theestimatedfranchiseattachmentrate increased frompriorColonnadeanalysesbasedonsurveyscompletedbyBakerTillyandNIADA.

Thenumberofvehiclespost-OEMwarrantyhasincreasedtoanestimated87millionvehiclesfrom86millionin2017.ThesevehicleswerepostOEMwarrantyandlessthantwelveyearsinservice,the"sweetspot"foraftermarketVSCs.Year2017representsthefewestvehicles inthesweetspot inthelastsevenyears,asaresultofthelownumberofnewvehiclesalesduringtherecession.Ourresearchindicatesthatlongervehiclelifecoupledwithcontinuedhigh levelsofnewcarsalespost-recessionwillgenerateacontinuedgrowingmarketforpost-OEMsalesofVSCs.




INCREASINGNUMBEROFVEHICLESOFFOEMWARRANTY(unitsinmillions)

Source:NADA,Experian,andColonnadeestimates

Ofthe276millionvehiclesontheroad,48%areeligibleforaVSC.Thisgroupincludesnewvehiclesales,usedvehiclesalesandpost-OEMwarrantyvehiclesthatarelessthantwelveyearsold.

VEHICLESONTHEROADIN2018(eachcarrepresentsonemillionvehicles)

Source:Colonnadeestimate

9591 87 86 86 87 90

96101

105 107 109

'13 '14 '15 '16 '17 '18 '19E '20E '21E '22E '23E '24E

VEHICLESOFFOEMWARRANTY

16.5 16.1

13.2

10.411.6

12.714.4

15.516.4

17.4 17.517.1 17.3

'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18

NEWVEHICLESALES2018 Off OEM Warranty = 87mm




IncreasingConsumerDemandforVSCs

ConsumerdemandforVSCsisincreasingasthevehiclesontheroadareolderandhighermileagevehicleshaveheightenedmaintenanceneeds.U.S.consumersareholdingontotheircarsforlongerthanever,partiallyduetothehigherqualityofvehicles.

Theaverageageofpassengervehiclesontheroadwas11.7yearsattheendof2017,upfrom9.6yearsin2002. Oneofthereasonsfortheincreasewasthe40%dropinnewvehiclesalesin2008and2009. Therecordnumberofnewvehiclespurchasedin2015and2016willslowtherateofincrease,resultinginanaverageestimatedageof11.8yearsin2020,accordingtoIHSAutomotive.

AVERAGEAGEOFPASSENGERVEHICLES

Source:IHSAutomotive

LENGTHOFVEHICLEOWNERSHIP

Source:EstimatedfromIHSAutomotive,Colonnade

Vehicleownersareincreasingtheirlengthofownership.Newvehiclebuyersnowowntheirvehiclefor6.6yearscomparedtoanaverageof4.3yearsin2006,accordingtoIHSAutomotive.Usedvehiclebuyersnowowntheirvehiclesfor5.5yearscomparedtoanaverageof3.3yearsin2006.Thistrendisduetolongerloanterms and the higher quality of vehicles. By using longer-term loans, consumers can reduce monthlypaymentsandaffordmoreexpensivevehicles.Over85%ofnewvehicleand53%ofusedvehiclepurchasesare financed, and six to ten-year loans are becomingmore popular. As a result of the extended terms,borrowersarenotinanetequitypositionuntiltheirfourthyearandfrequentlybeyondthemanufacturer'swarranty.Toincreaseaborrower'sabilitytopayonloans,lendersincludethevalueofF&Iproductsinloan-to-valuecalculationsasaborrowerismorelikelytostaycurrentonafunctioningcar.ThesetrendscreatetheopportunityforhigherVSCpenetration.




AVERAGELOANTERMS(months)

Source:Experian

Theincreasingnumberofoldercarsiscreatingmorevehiclesthatneedrepairsandmaintenance;repairsgenerallybecomemoreexpensiveasvehiclesage.Manyconsumersareunabletoaffordrepairsasthegrowthincostsisoutpacingwagegrowthand40%ofAmericansdonothave$400inemergencyfunds.ThesetrendsaredrivingdemandforVSCs.

AVERAGEVEHICLEMAINTENANCEANDREPAIRCOSTS(dollarsinactual)

Source:AAA"YourDrivingCostsStudy",basedon15,000milesdriveninayear

F&IFocusatDealerships

Despite improved auto sales, dealership margins remain under pressure, and F&I products providemeaningful incrementalprofitability.DealershipshavebecomemoredependentonF&Iproducts, as theyrepresent 25% of total dealership gross profit compared to 15% in 2009. This trend will continue as




dealershipmarginsonvehiclesalesmaybesqueezedincomingyears.Inadditiontoincreasingvehiclesalesmargins,F&Iproductsimprovelong-termprofitabilitybyenhancingcustomerloyaltyandretentionbysettingthestageforrepairs,routineservicingsalesandsubsequentcarpurchasesatthedealership.

F&IDEPARTMENTCONTRIBUTIONTODEALERSHIPGROSSPROFIT

Source:NADA

Growthinthenumberofoldervehiclesisapositivetrendforaftermarketrepairs.However,dealershipswillfacestrongcompetitionfortheseincreasedrepairrevenues.Longerperiodsofownershiptakeconsumersfartherawayfromthesellingdealershipservicelanetolessexpensivenon-dealershiprepairfacilities.DealersseektocounterthistrendbysellingVSCsandprepaidmaintenanceplanstoincreasethelikelihoodofdriversreturningtothedealerships.




COLONNADEISTHELEADINGFINANCIALADVISORTOTHEF&IPRODUCTSINDUSTRY

FormoreinformationontheVehicleServiceContractIndustry,pleasecontact:

GinaCockingManagingDirector312.425.8145

[email protected]

ChristopherGillockManagingDirector312.870.6212

[email protected]

JeffGuylayManagingDirector208.726.0788

[email protected]

Colonnadeisanindependentinvestmentbankfocusedonthefinancialservicesandbusinessservicessectors.Colonnadeprovidesexpert,objectiveadviceonmergersandacquisitionsandcapitalraisingforprivatelyheldbusinesses,publiclytradedcompaniesandfinancialsponsors.Ourseniorbankersbringextensivetransactionexperience,industryexpertise,a

processorientationandasenseofurgencytoeachengagement.




©2019ColonnadeAdvisorsLLC.

CopyrightandOtherImportantInformation

This document, including text, graphics, logos, icons, images and the selection and arrangement thereof, is the exclusive property ofColonnadeAdvisorsLLCanditisprotectedbyU.S.andinternationalcopyrightlaws.Colonnadeherebypermitsyou,unlessyouareaninvestmentbankorotherfinancialadvisor,todownload,copy,distribute,publish,reproduce,cite,linkorpostthisdocumentoritscontentssubjecttothefollowingconditions:1)youretainonanymaterialallcopyrightandotherproprietarynotices;2)youdonotmodifythisdocumentoritscontentsinanywayand3)youdonotuseorotherwiserelyuponthisdocumentoritscontentsforanyrestrictedpurposesuchasthosedescribedbelow.Colonnadereservesallrightsnotexpresslygranted.

ThisdocumentandtheinformationthatitcontainsareproducedbyColonnadeAdvisorsLLCsolelyforgeneralbackgroundinformationonthemattersdescribed.ColonnadeAdvisorsLLCdoesnotprovideinvestmentbankingservicesandhasnoknowledgeofyourspecificinvestmentobjectives,financialsituationorparticularneeds.Innocircumstancemaythisdocumentoranyofitsinformationbeusedforinvestment,valuationoraccountingpurposes.NoneofColonnadeoritsrepresentativesoraffiliateshasagreedtoorhasassumedanyresponsibility to provide youwith investment advice,whether in a fiduciary capacity or otherwise. By accessing this document, youacknowledgeandagreewiththeintendedpurposedescribedaboveandfurtherdisclaimanyexpectationorbeliefthattheinformationconstitutesinvestmentadvicetoyouorotherwisepurportstomeetyourinvestmentobjectives.

Documents

Vehicle Service Contract Industry Jan 2019...Colonnade Advisors LLC • 500 West Madison Street • Suite 3410 • Chicago, IL • 60661 ... May-18 Automotive Development Group Brown