MM M&A 019 - Industry Spotlight: Vehicle Service Contract Administrators

This episode continues our series of "industry spotlights," in which we focus on specific trends and opportunities in middle market M&A transactions.

This episode kicks off several episodes around the finance and insurance ("F&I") products industry, estimated at $80+ billion in size at the retail level. Specifically, this episode is all about vehicle service contract ("VSC") administrators.

 

Colonnade has extensive transaction experience in the automotive F&I products industry and has been on the sell side or buy side M&A advisor on many of the significant F&I products transactions that have taken place over the last decade. These transactions are complex and require an investment banking team with deep industry knowledge. Colonnade has insider-level mastery of the drivers of valuation, competitive positioning, business trends, relevant metrics, and the right buyer universe, enabling us to provide superior deal execution to our clients.

In this episode, we answer the following questions:

• What is a VSC?
• What types of car problems are covered under a VSC, and how does it differ from car insurance coverage?
• What is the F&I products ecosystem?
• What are the economics of a VSC?
• What is the value of VSCs to consumers?
• Who are the major players in the VSC administrator industry?
• What are the consolidation trends in the VSC administrator industry? 
• How are VSC administrator companies valued?

 

 

What is a VSC? (02:30)

 

Gina Cocking:  A VSC is like a warranty but cannot be legally called a warranty. OEMs can only offer warranties. Essentially, a VSC is covering any mechanical failures on a vehicle, which can range from problems with the engine, electronics, windows, and others.

 

What types of car problems are covered by VSCs? (02:38)

 

Gina Cocking: Different VSCs cover different car problems. Some have full coverage, and others are more limited. Car buyers may also buy a tire and wheel contract, a key fob contract, or an appearance protection contract. There is a whole slew of products that can cover mechanical failures, which are noninsurance-related problems.

 

What is covered by car insurance versus a VSC? (03:00)

 

Gina Cocking: Collusion damages, such as if a driver gets hit by another car or runs into a stop sign, are covered by insurance. VSC covers all mechanical failures.

 

How often are VSCs purchased with cars? (3:40)

 

Gina Cocking: About 51% of cars sold in the United States through franchise dealerships are sold with a VSC attached to that car.

 

What is the F&I products ecosystem? (03:46)

 

Gina Cocking: Dealerships are the primary distribution channel as they are selling the F&I product to consumers. Third party marketers also sell VSCs.

 

The VSC administrators adjudicate the claims. For example, when a consumer has a mechanical failure, they will contact the VSC administrator, who will work with the repair facility to ensure that the repair facility is paid for any claims. If it is an administrator obligor, they are responsible for the payments for the claims.

 

F&I agents are the intermediary between the administrator and the dealership.

 

What are the economics of a VSC? (05:16)

 

Gina Cocking: VSCs are profitable products for dealerships and other sellers. For example, if a dealership sold a VSC to a consumer for $3,000 (VSC usually costs $2,800 to $3,500), the administrator probably sold it to the dealer for $1,000, and $500 was paid to an F&I agent. Therefore, the dealership is going to make a $1,000 profit on the sale of the VSC. Part of the $1,000 paid to the administrator covers administration costs, and part of it goes into the trust to pay for future claims. VSCs are typically a five-year contract. The funds held at the trust will earn out over five years and will be used to pay future claims. Any excess funds in the trust are remitted back as profits to the dealership or whoever owns the trust.

 

What is the typical F&I product penetration rate on vehicles sold? (08:04)

 

Gina Cocking: Public dealerships have shown F&I product penetration rate greater than 100% on average per vehicle sold last year, which means they are selling more than one product. Penetration rate continues to increase primarily driven by returning customers who have had good experiences with these products and dealerships' increased marketing efforts around these products.