By Gina Cocking

The vehicle service contract (VSC) industry totals $29.4 billion at retail and comprises a large and important component of automotive F&I sales and profitability. The industry value chain includes direct-to-consumer marketers, auto dealers, administrators, payment plan providers and specialty insurance carriers. This large group of firms provides many compelling investment opportunities. The industry has been growing and generates strong returns and earnings growth to investors. Recent M&A activity indicates strong investor demand.

  • Direct-to-consumer marketers price VSCs to absorb high cancellation rates and can generate margins in excess of 25%. These companies require little upfront capital to get into business but demand ongoing investments in marketing to drive sales. Some of the best players invest in their own branded products. Growth in this channel has been driven largely by the proliferation of the payment plan providers. Automobile dealers also market VSCs to consumers at the point of sale and in the service department of the dealership.
  • The VSC administration market is estimated at $11.8 billion with over 100 industry participants. VSC administration involves program design, pricing, underwriting, billing and claims administration. Administrators maintain reserves to pay claims, provide ongoing actuarial analysis of their programs and manage program loss ratios. A well-managed VSC administrator can generate EBITDA margins in excess of 20%. Most VSC administrators back their reserve pools with reinsurance from highly-rated insurance carriers.
  • The market for VSC payment plan providers and finance companies is estimated at $9.1 billion. Payment plans generate short duration receivables with high yields and low losses. Large, successful payment plan providers require transaction processing expertise and deep access to low cost capital. Pretax margins can exceed 30%.

M&A activity in the VSC industry has accelerated. VSC sellers, administrators and payment plan providers are selling at robust values because strong demand exists among financial and strategic buyers for high growth, high margin services business.

Since early 2012, nearly 20 companies in the VSC industry have changed ownership. We anticipate further consolidation over the next few years as entrepreneurs decide to exit, private equity firms seek to harvest the value of their VSC investments, companies consolidate to benefit from increased customer relationships and expense synergies, mono-line firms vertically integrate to enhance margins and insurance companies that underwrite VSCs acquire administrators to capture or preserve books of business.

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