Session 2 - David M. Dodson

GRADUATE SCHOOL OF BUSINESS
STANFORD UNIVERSITY
E-33
September, 1997
DAVID M. DODSON
It was the night of February 5, 1995. David Dodson, President of Falcon Capital
Corporation, had just flown into Baltimore for an important meeting with representatives from
Rite Aid. Dodson was in the middle of negotiating the acquisition of Auto Palace (ADAP), a
subsidiary of Rite Aid. It had been a fast, yet difficult, negotiation process to date and Dodson
had many questions about what to do and how to proceed in tomorrow’s meeting.
Dodson had been pursuing the acquisition for two months, and although he had been
originally told by Rite Aid representatives that the sale would be a “race” among the bidders,
lately he had gotten the impression that Rite Aid was trying to hold up his progress. It took a lot
of effort to get Rite Aid even to agree to tomorrow’s meeting. He knew of at least one other
serious bidder and had been told that there were up to two more. He was afraid that if the “race”
finished as a tie, he would lose to another bidder because of Rite Aid’s persistent concerns about
his ability to finance the acquisition.
He had conducted a lot of due diligence, but knew there was more he needed to do. He
was also in the middle of negotiations with his investment banker and needed to make a decision
as to how to raise the money for the acquisition of ADAP. Finally, he had asked a lawyer to
attend the meeting and wondered what roles he, the lawyer, and his investment banker should
assume during the negotiations.
This case was prepared by Nick Mansour under the supervision of H. Irving Grousbeck, Consulting Professor of
Management, Stanford University Graduate School of Business, as the basis for class discussion rather than to
illustrate either effective or ineffective handling of an administrative situation.
This case was made possible by the generous support of Robert Denzil Alexander.
Copyright © 1997 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
This document is authorized for use only in Prof. A. Kanagaraj's Mergers, Acquisitions and Corporate Restructuring (MACBJ20-4), Term - IV, BMJ 2020-22 at Xavier Labour Relations Institute
(XLRI) from Jun 2021 to Oct 2021.
David M. Dodson S-SB-185 2
BACKGROUND
David Dodson graduated from Stanford Business School in 1987. He was anxious to get
into business for himself, and in order to pursue that interest, he took a job as a casewriter for the
Entrepreneurship courses at Stanford. A year later, he left that job and put together a search fund
to buy a business.
The search resulted in the $17 million acquisition of Smith Alarm Systems in Dallas,
Texas in February of 1990. At the time of the purchase, Smith Alarm had $11 million in sales
and 138 employees, ranking 16th in the nation out of 14,000 firms in the industry. The company
grew under Dodson’s direction, eventually acquiring its largest local competitor. By 1994,
Smith had grown to $17 million in revenues and 150 employees. Dodson felt it was time for a
change.
We decided to sell Smith because we had some concerns about the marginal rate of return going
forward. The two ways to grow an alarm company would be to either buy other ones or go into
some mass market formula where you advertise at low rates and try to get people to subscribe.
We didn’t like the acquisition route, because the targets were small and required a fair amount of
due diligence. There’s nothing wrong with the mass market. We just thought there were other
people who were established and doing a better job and it would be hard to differentiate
ourselves. We had a good story to tell about growth to potential buyers - there were still things
left on the table that buyers could get their arms around and say, ‘Yeah, I can make something
out of this company’ - and thought the story looked better in 1994 than it might in 1996.
And then, I had some pretty strong career reasons why I wanted to sell the company. There was
no challenge at all left in the business for me. Even pursuing one of those growth strategies
would have kept me busy for about six months and then I would have been back to a part time
job.
In the Spring of 1994, Smith Alarm Systems was sold for $35 million to Tyndall Venture
Capital, a subsidiary of a large East coast bank. The investors realized an internal rate of return
(IRR) of over 40% on their capital.
Dodson took time off to relax and decide what to do next. Within a few months, he
decided to raise a second search fund and buy another company.
I liked what I was doing. I hadn’t maxed out my capabilities and I wanted more challenge -to see
if I could in fact buy and run a larger company. I wanted to see if it had been luck or if I was
O.K. at this. I hadn’t reached all my financial targets either.
In late October, he formed Falcon Capital and raised a $350,000 fund from seven investors
(including himself). Each investor had the capability to invest at least $1 million later. His
search focused on industries with companies that could grow into a big business, industries that
were out of favor, and industries where he would be likely to get a deal done. His acquisition
target was a company with sales of $50-100 million.
Dodson spent November researching potential industries and decided to focus his initial
search on funeral homes, pawn shops, assisted living, electric energy, furniture manufacturing,
and retail. On December 5, Dodson read an article in the Wall Street Journal about Rite Aid’s
failed attempt to sell ADAP, its retail auto parts subsidiary, and was immediately interested (See
Exhibit 1).
AUTO PALACE AND RITE AID

Auto Palace was founded in 1976 and focused on the “Do-It-Yourself” (DIY) automotive
retail parts market. It finished fiscal 1994 with $108 million in sales, about 1,200 employees,
and nearly 100 retail outlets. It was the leading automotive parts retailer in the New England
area. All of its stores were located in Massachusetts, Connecticut, Rhode Island, New
Hampshire, and New York. Auto Palace was wholly-owned by Rite Aid.
The automotive aftermarket in the United States totaled $148 billion in retail sales in
1994, split almost equally between parts and service. The DIY market was estimated at $30
billion. In 1994, the number of automobiles in operation in the U.S. was at an all time high and
the average age of automobiles was the highest it had been since 1948. The market was growing
at 6.5% annually, but analysts worried that sales in the DIY market would begin to decline
because of the increasing complexity of new automobiles. Public competitors in the DIY market
included AutoZone (originally a leveraged buy-out by KKR), Pep Boys, Discount Auto Parts,
Hi/Lo Automotive, and O’Reilly Automotive (See Exhibit 2 for competitor information). Only
Pep Boys had any operations in the New England area, with eleven stores in New York, one in
Rhode Island, and one in Massachusetts. ADAP had yet to experience any serious competition,
but this would likely change as the industry continued to consolidate.
Rite Aid is a large retail drugstore chain. In 1994, it had over $4 billion in revenue and
nearly 37,000 employees. The company was led by Alex Grass and his son, Martin. In addition
to the retail drugstore business, Rite Aid owned Sera-Tec Biologicals, Encore Books, Concord
Custom Cleaners, and Auto Palace. In 1994, Rite Aid decided to sell these subsidiaries in an
effort to re-focus on its drugstore business.
An investment banking firm was engaged to conduct an auction of these subsidiaries.

After contacting several bidders, GL Capital, Inc. offered the winning bid of $75 million for
ADAP in the Spring of 1994. GL Capital was owned by Alex and Martin Grass. Alex and
Martin Grass had also previously purchased Sera-Tec Biologicals through another investment
company. Although the ownership of GL Capital made the sale awkward for Rite Aid, the deal
proceeded until late October, 1994. At that point, improprieties in ADAP’s operations led to the
resignation of ADAP’s president and senior vice president of operations. The two managers had
been improperly charging personal expenses to ADAP. Subsequently, GL Capital halted its
acquisition of ADAP and the subsidiary remained under Rite Aid’s ownership and without a
president.
INITIAL CONTACT
I saw this Wall Street Journal article and what intrigued me about it was that it was in the
automotive aftermarket, which I had some opinions on, and it was retail. Probably more than
anything else, it just looked like something wasn’t right. The two top guys were gone, Rite Aid
was selling to its chairman, and, you know, it just looked intriguing.
Dodson called Mike Hammer, an investment banker who worked for Donaldson, Lufkin, and
Jenrette (DLJ), and asked him if he knew anything about the sale of ADAP. Hammer soon
discovered that another DLJ investment banker, Peter Bartlett, was representing Rite Aid in the
sale. Bartlett was senior to Hammer in the DLJ hierarchy. Hammer contacted Bartlett to get
information on the sale of Auto Palace.
Peter Bartlett was skeptical of Dodson as a serious bidder for the company. Hammer
learned through numerous conversations with Bartlett that the primary issue was Dodson’s ability
to raise the amount of capital necessary to finance the deal. Though Dodson had potential equity
investors from Falcon, Bartlett thought Dodson was unlikely to raise the $20-25 million that
Bartlett estimated would be required. Hammer said:
When you’re auctioning a company, you get lots of calls from flaky people who really aren’t
credible. It’s embarrassing to bring someone without credibility to Rite Aid and have the deal
blow up.
Furthermore, Rite Aid was hesitant to enter into negotiations. They were embarrassed by the
previous failed deal and wanted to be absolutely certain not to let that happen again. Through the
persistence of Hammer and only after a DLJ investigation of Dodson’s investors, Bartlett gave
Hammer and Dodson a copy of ADAP’s “sell book” in late December, 1994 (See Exhibit 3 for
excerpts).
At his parents’ house over the holidays, Dodson had a conference call with Bartlett and
Hammer to discuss the business and the possibility of an acquisition. Bartlett wanted to
determine the seriousness of Dodson’s interest before getting Rite Aid involved, and requested a
letter from Dodson indicating an initial valuation.
Dodson worked with Hammer on the valuation. They knew the amount of the original
deal, but the performance of ADAP had slipped since that time. In addition, a lower valuation
meant a better return for Falcon’s investors and Dodson himself. They did some financial
calculations assuming an 8% IRR for senior debt, 20% for subordinated debt, and 35% for
equity. It was also important that Dodson get Rite Aid’s attention and prove he was a serious
bidder. He also wanted to leave himself “a little wiggle room.” He sent a letter to Peter Bartlett
on January 2, 1995 indicating a $60-70 million valuation (See Exhibit 4).
“THE RACE”
Within a week of mailing the letter, Dodson talked with Bartlett about the acquisition
process. Dodson reflected on the conversation:
“They were not going to do a full auction. They told us that it was a race to the finish line. And
there was essentially a requested price out there and whoever gets there first gets the deal.”
Bartlett indicated that there were two or three other bidders. Each bidder would be given a two
hour management presentation during the week of January 23 and would be expected to submit a
bid within ten days of the presentation. Dodson asked what was expected in terms of the
structure and mechanics of a bid.
Peter Bartlett thought I meant price. He responded by saying they were expecting something
close to the $70 million. That said to me and Mike Hammer that a bid in the high $60’s was
what they were expecting.
On January 11, Dodson was given access to DLJ’s information about ADAP to continue
his due diligence. Though he had yet to sign a contract with DLJ, Hammer provided him with an
analyst to assist in the due diligence process. The day was spent collecting store-by-store profit
and loss statements, a detailed balance sheet, leases, fixed assets, workers’ compensation claims,
union agreements, pension and health benefit plans, and employee severance agreements. But
with almost 100 stores, the volume of material filled seven boxes. Dodson also learned that
ADAP used Rite Aid’s management information systems (MIS) and that ADAP would need to
develop its own system after the company was purchased. He explained this phase of the due
diligence process and his reactions:
The information was reasonably well organized because they had the auction. There was just a
bunch of files of mostly legalistic due diligence. And there were people representing Rite Aid
whom I could question.
I was very encouraged. The data and discussions indicated an undermanaged situation and some
hidden value on the books in terms of land and notes receivable. The bad news was that there
were few opportunities to close stores and create instant EBITDA value. It was also an
overwhelming amount of data for me to review.
Mike Hammer very much wanted to represent Dodson in his efforts to buy ADAP.
Hammer described the situation:
David Dodson was trying to do this all by himself. He was trying to negotiate documents with
Rite Aid, conduct due diligence on ADAP, and negotiate with his equity/subordinated debt
partners. We had proposed that DLJ raise senior debt, subordinated debt and equity for fees of
1%, 2.5%, and 5%, respectively, with certain minimum fee guarantees. From day one, Dodson
said he wouldn’t need DLJ’s help with the equity/subordinated debt money, but would want us to
work on the senior debt.
Hammer was also due to be promoted to managing director and bringing in a client for the firm
would certainly help get the promotion. Hammer met with Dodson on January 12, to discuss
DLJ’s involvement in raising the capital. They agreed that the deal would require approximately
$30-35 million in senior debt, $10 million in subordinated debt, and $20-25 million in equity.
Hammer stated that the equity investors whom DLJ brought into the deal would need one Board
seat and one “non-voting ‘observer’ seat”. He also thought that while Peter Bartlett would ask
tough questions about Dodson’s financing, in the end Bartlett would be persuaded by Hammer’s
assurances.
Peter Bartlett called Dodson early the next week to confirm the bidding schedule.
Dodson was scheduled to attend the management presentation in one week, on Monday, January
23. Bartlett indicated that there was only one other bidder who would meet the management team
later that week. Dodson got the sense that Falcon was the only serious bidder. He pressed
Bartlett about the wisdom of submitting a “preemptive bid,” but Bartlett felt that was
unnecessary. Bartlett also committed to warning Dodson if the other bidders were close to
making a proposal.
During the conversation, Dodson asked if Bartlett could send him a “purchase and sale
agreement.” In prior conversations, Bartlett had told Dodson that Rite Aid would not consider a
bid without Dodson’s comments about the “purchase and sale agreement.” According to
Dodson:
If the selling investment bankers are doing their job right, a lot of times they will write the
purchase and sale agreement for the buyers to comment on. They not only have a price, they also
have what issues the buyer may or may not have in the contract which could kill the deal. So, I
was waiting for that.
DLJ continued to delay sending Dodson the agreement, effectively holding up his progress.
Dodson wondered why DLJ should delay sending the purchase and sale agreement if this was
really “a race to the finish line.” He thought that it might not be a race, or perhaps that Bartlett
wanted the other bidder to win the race.
Bartlett also discussed the $42 million in lease obligations that Rite Aid had guaranteed
on behalf of ADAP. If ADAP went bankrupt or was unable to fulfill the lease obligations, Rite
Aid would still be responsible for this $42 million even after the sale of ADAP. According to
Bartlett, this would be a big issue with the Board of Rite Aid, and Dodson would need to assure
them that Falcon could meet these obligations.
Dodson knew that Bartlett still had questions about his experience and financing sources.
Following their discussion, he wrote Bartlett another letter trying to assure him and Rite Aid of
Falcon Capital’s capabilities and commitment to the deal (See Exhibit 5).
Dodson began to worry about who would accompany him to the management
presentation. He commented:
I was just a suit, so I needed to look like I had some ‘meat’ to me. So I called in some favors. I
asked Richard Tadler of TA Associates to come to the management presentation and to bring a
warm body if he could. So there were a couple of people from TA. I called a banker at Bank of
America and asked if he could come and if he could find another person to join him. And then I
brought one of my investors.
On January 23, 1995, Dodson and his group met with the management committee for two
hours and visited a few Auto Palace stores. Representing Rite Aid and ADAP were the Senior
Vice President of Finance, the Vice President of Purchasing, the Director of Store Operations, the
Vice President of Distribution, and two junior investment bankers from DLJ. Dodson explained
his reactions:
We all arrived at the office. It was just a dog and pony show. I was disappointed that Alex and
Martin Grass didn’t show up for the presentation as we had been told they would. Not only that,
the senior DLJ people from the sell side weren’t there. Though it wasn’t that important, you
would like to see more of a serious commitment from Rite Aid or DLJ. So that concerned me.
On the other hand, I thought ADAP was worth pursuing. So, I wanted to schedule a meeting
with the principals at Rite Aid -Alex or Martin Grass - to negotiate a deal.
GETTING TO THE NEGOTIATING TABLE

After the management presentation, Dodson also learned from Tadler that TA Associates
had considered buying ADAP in the first auction. TA ultimately decided not to bid for the
company because of ADAP’s inflated wage rates, high real estate costs, and poor information
systems. Dodson was concerned and knew that he needed to do more due diligence.
Michael Hammer sent Dodson a proposed engagement letter the day after the
management committee meeting. The terms covered the senior debt, subordinated debt, and the
equity funding and were largely as had been discussed previously. Although he had decided to
use DLJ to raise the senior debt, Dodson was uncertain about using DLJ to raise the other money.
Dodson still believed that he would be able to raise the equity and subordinated debt
himself. All of Falcon’s investors were individuals who could invest at least $1 million in equity
in this deal. In addition, TA Associates had been an investor in the Smith Alarm acquisition and
Tadler had sat on Smith’s board. Dodson hoped he could bring TA Associates and other private
equity groups into an acquisition of ADAP. And he hoped he could raise some capital from
business associates of the Falcon investors.
Hammer argued that DLJ should help with the equity and subordinated debt financing as
insurance. If Dodson was wrong about his ability to raise these funds, the deal would fall
through unless DLJ helped. Furthermore, Hammer told Dodson that Rite Aid would be more
comfortable with Falcon if DLJ was assisting. The proposal also excluded from DLJ fees “any
amounts invested by Falcon Capital Corporation or any of its investors and affiliates.”
Another important issue was determining management’s equity stake in ADAP after the
acquisition. DLJ proposed that 12.5% of the total equity be set aside for management, with 7.5%
for Dodson. Dodson thought that 25% should be set aside, with his stake being 15-20%.
Hammer thought that these amounts would make the financing difficult. Although investors
would want Dodson to have an interest and performance incentives, there was a reasonable range
and Dodson’s proposal was aggressive. After all, this was a leveraged deal and Dodson was
young and had no experience in this industry nor with this size company.
Even more troubling was the disagreement over ADAP’s Board of Directors. Hammer
thought that the Board would serve a financial oversight function and that the investors should
have proportional Board representation. Dodson wanted “operators and business people who
could help run the company.” He did not care who the members represented. Dodson also
believed that DLJ incorrectly viewed the Falcon investors as “Dodson pawns, rather than
committed and independent investors.”
Dodson was beginning to think that DLJ was really working for the investors it intended
to bring into the deal rather than for him. Also, if Dodson engaged DLJ, then they would be
representing both the buyer and the seller of ADAP. Dodson saw advantages and disadvantages
to this. Rite Aid paid DLJ millions of dollars in fees each year and DLJ might favor Rite Aid
over Falcon. On the other hand, DLJ would earn fees from both parties and Dodson might get
preferential treatment over the other bidders. Also, Hammer had helped immensely with the
negotiations so far and DLJ had assisted in the due diligence process. Dodson felt he owed them.
Later that week, Dodson learned by chance from a business school classmate that the
other serious bidder for ADAP was Tyndall Venture Capital (TIC), the group that had purchased
Smith Alarm Systems, and that TVC’s bid in the first auction for ADAP was $71 million. Since
he still served on Smith Alarm Systems’ Board, this made the situation awkward for Dodson.
It continued to be difficult to schedule a meeting with Peter Bartlett and Alex or Martin
Grass. Dodson was beginning to think that the “race” really wasn’t a race, but an auction. He
thought:
Maybe what they are doing is trying to hustle us along. What they want is for three or four to
finish at the same time, then they can pick. They really don’t want a race. They want to pace the
process so that everybody finishes the ‘race’ at the same time.
Dodson was concerned that Falcon Capital would not prevail in such a process. Peter Bartlett
would soon be required not only to give Rite Aid an opinion of the bid Falcon Capital offered,
but also to give an opinion on the credibility of Falcon Capital. Dodson knew that Bartlett was
uncertain about Falcon Capital and that Rite Aid would proceed extremely cautiously into a new
deal to sell ADAP. If Falcon finished the race at the same time as the other bidder, Dodson
feared that Rite Aid, under Bartlett’s advice, would choose the other bidder, even if Falcon’s bid
was higher. Dodson decided that it was imperative to get Rite Aid to the negotiating table. On
January 29, Dodson faxed Bartlett a letter asking to enter substantive negotiations before
February 3 (See Exhibit 6).
The next day, Hammer and Dodson informed Bartlett that they knew who the other
bidder was and what their original offer had been. A series of phone conversations followed.
Bartlett was clearly upset that Dodson had that information, and tried to paint a picture of several
other bidders. Bartlett also continued to express doubts about Falcon’s financial backing.
Dodson began to believe that Bartlett was stalling to allow TVC to perfect its offer.
Hammer pressed hard for a negotiating meeting and indicated that Dodson wouldn’t
proceed any further until one had been scheduled. He also asked that Dodson be given
exclusivity on the deal. This would ensure that Falcon would be the only bidder for ADAP,
which in turn would help raise the capital from investors. Bartlett insisted that he could not
recommend an exclusive arrangement without more information about Falcon.
Finally, Bartlett said that he had sent Dodson’s letter to Alex Grass and against his better
judgment, had recommended a negotiating meeting. Bartlett also said, “Who knows, if Alex
likes this guy he might just sign him up.” In order to prepare Alex Grass for the meeting, Bartlett
wanted to know what to expect for Falcon’s bid. Hammer said it would be in the $60-64 million
range. Bartlett wanted to know if Falcon could go to $65 million and recommended that Falcon
not offer their best price because Alex Grass wanted to “get something” through the negotiations.
Dodson made it clear that this had better be a serious meeting and hung up feeling that a lot
would depend on his rapport with Alex Grass.
The meeting was set for February 6. Over the next five days, Dodson, Hammer, and
Bartlett had numerous discussions. Bartlett was still concerned about Falcon’s ability to finance
the deal and asked for assurances. Dodson continued to press Bartlett on the price and learned
that it made little difference to Alex Grass if the final price was $63 million or $65 million and
that there were in fact three other bidders. Rite Aid continued to refuse Falcon exclusivity on the
deal, but agreed not to let any more bidders into the process. Discussions about Dodson’s due
diligence, particularly about the lease obligations and ADAP’s inventory, also occurred.
On advice from a Falcon investor, Dodson contacted Dick Floor and asked him to attend
the meeting. Floor was a Boston lawyer with 30 years of experience specializing in securities,
finance, mergers and acquisitions, and general business law. His clients included venture capital
firms, brokerage firms, mutual fund companies, investment advisers, and small corporations.
Although he knew very little about the company or the deal, Floor agreed to attend. He
explained the situation:
I didn’t have a lot of time to work with David before the meeting. I think I asked him to send me
some background material and I think we chatted a little bit on the plane going from Boston to
Baltimore. I knew basically two things: he really wanted to do the deal and he wanted to get it
at the best price possible.
FEBRUARY 5, 1996
Dodson, Hammer and Floor flew to Baltimore on February 5. They were scheduled to
meet with Bartlett, Alex Grass, and Rite Aid’s lawyer the next day. Bartlett was tired of the deal
and looking forward to concluding it. Rite Aid was also anxious to have this troublesome deal
closed.
Dodson had several questions in his mind. He felt comfortable with his due diligence to
date, but knew more needed to be done. Although Rite Aid continued to insist that ADAP would
hit its financial targets, he knew that performance had slipped since the previous Spring. Should
he be buying a company that Alex Grass had just decided not to buy? ADAP had been operating
without a president and senior vice president since October and he wondered who was going to
operate ADAP. What did he know about a large retail organization? He knew that inventory and
the lease obligations would require adjustments and that the company would need to develop its
own MIS system. But he had not read a single lease, knew very little about developing an MIS
system, and needed to have his accountants review ADAP’s financial records. He had just
learned of TA’s concerns and wondered if there were other serious problems he had yet to
discover. He had only talked with one industry analyst and had done no analysis of competitors.
Then there was the issue of the other bidders and their levels of commitment. Should he push to
finalize the deal in tomorrow’s meeting or wait until he had conducted more due diligence?
He was also concerned about financing the deal. He was certain he could raise the equity
and subordinated debt himself, but what if he was wrong? Should he structure an agreement
with DLJ involving unrecoverable up-front costs of $100,000-150,000 that would act as
“insurance” as Hammer suggested?
There were several ways he could approach the meeting. A lot depended on his rapport
with Alex Grass and he had to carefully decide what role he should play. He wondered who
should lead his team. Although Floor was experienced, he knew very little about the company
and the difficult negotiations to date. Dodson debated whether he should give specific
instructions to Floor and Hammer before the meeting.
Exhibit 1
Agreement Is Terminated On
Sale of Auto Supply Unit
Rite Aid Corp. said a contract for the $75
million sale of its ADAP Inc. unit to GL
Capital Inc. has been terminated, and it is
seeking a new buyer for the automotive supply
chain.
GL Capital, an investment company whose
owners include Rite Aid Chairman Alex Grass,
called off the purchase after ADAP’s President
and Senior Vice President of Operations
resigned in late October.
GL Capital considered the resignations “a
material adverse change in the business,” Rite
Aid said in a statement. The company added,
however, that ADAP’s current sales and
earnings “are in accordance with ADAP’s
business plan.”
Rite Aid, Camp Hill, Pa., is still trying to
fill the President’s post at ADAP and said it is
continuing with its plan to dispose of all non-
drugstore businesses.
Rite Aid also said it has completed the sale
of its Sera-Tec Biologicals unit for $70 million
to AG Capital Inc., an investment company
also partly owned by Mr. Grass, who will retire
from Rite Aid in March.
Source: Wall Street Journal, December 5, 1994.
Exhibit 2
Discount Hi/Lo O’Reilly

AutoZone Auto Parts Automotive Automotive Pep Boys
Company Profile
Number of Stores 848 192 150 145 386
Customers Mainly DIY 100% DIY 65% DIY 50% DIY 90% DIY
SKUs per Store 13-17,000 10-14,000 19-23,000 22,000
Stock Information
Recent Stock Price ($) 55.75 25.88 12.75 27.25 29.25
Shares Outstanding (000) 74,375 13,957 10,690 8,602 61,891
Market Value ($000) 4,146,406 361,137 136,298 234,405 1,810,312
Last 12 Month Data (000)

Revenues 1,348,057 198,221 205,235 137,164 1,241,133
Gross Profit 542,562 72,977 78,786 53,062 335,318
EBIT 157,752 24,795 13,378 12,570 120,608
Net Income 96,741 13,651 6,712 8,278 65,512
Valuation Ratios
Market/Last 4Q Revenue 3.1 1.8 0.7 1.7 1.5
Price/Book 9.2 3.9 1.3 4.1 3.3
Market/EBIT 26.3 14.6 10.2 18.6 15.0
Retail Performance
Avg. Store Size (Sq. Ft.) 5,764 6,100 7,813 4,500 20,132
Avg. Sales/Store ($000) 1,590 1,032 1,368 946 3,215
Avg. Sales/Store Sq. Ft. ($) 276 169 175 210 160
Exhibit 3
I. EXECUTIVE SUMMARY
ADAP, Inc. (“ADAP” or the “Company”) is New England’s leading specialty retailer of automotive
parts and accessories serving the “Do-It-Yourself” (“DIY”) customer. In several locations the Company
also provides automotive maintenance, repair services and installation of parts. The Company began
operation in 1976 and currently operates 96 stores located in six states in the Northeastern United States.
The Company’s operations are supplied by a single distribution center located in Avon, Massachusetts.
Each store contains an extensive product line including (i) hard parts such as new and rebuilt starters,
alternators, transmissions, and brake pads; (ii) automotive accessory items such as floor mats, seat covers
and windshield wipers; (iii) maintenance items such as antifreeze, oils, batteries, protectants and waxes;
and (iv) in its four service center units, a broad selection of tires.
In 1991, the Company improved upon the ADAP concept by converting almost all of its stores to the
current Auto Palace format. Such conversion included (i) an increase in its product selection from
approximately 10,000 SKUs to 13,000 SKUs; (ii) shifting its pricing strategy from high/low pricing to an
everyday low price strategy; and (iii) undertaking a chainwide remodeling program focused on making
the stores brighter, arranged more efficiently, and utilizing improved interior and exterior signage. The
conversion to the Auto Palace concept was rolled out over the latter part of fiscal 1990 to fiscal 1991,
1992 and 1993 respectively. Over the past year, the Company has further developed the concept by
adding service bays in four new units (“Auto Palace Service Center”). The Company believes the
addition of service centers satisfies a need for reliable, quality service centers in its markets. In addition,
the increased traffic of the service bays has greatly enhanced its retail sales operation by approximately
20%.
ADAP has experienced strong growth as a result of its new store opening program and impressive
comparable store increases. Revenue has grown at a compound annual growth rate of 15.2% over the
past five years from $61.5 million in fiscal 1990 to $108.3 million in fiscal 1994. Approximately 38% of
this growth is attributed to increases in comparable store sales. In addition, the number of stores
increased from 74 in fiscal 1990 to 96 in fiscal 1994. A major component of the Company’s growth
strategy is to expand its new Auto Palace Service Center concept, in both new and existing markets. The
Company expects to open 15 units in fiscal 1995, increasing total store count to 106, net of closings. All
but one of such locations are expected to be Auto Palace Service Centers.
ADAP’s typical store is 10,000 square feet in size, with 3,000 square feet dedicated to a hard parts
counter and inventory. The new Auto Palace Service Centers are approximately 18,000 square feet in
size with 10,000 square feet dedicated to retail space and approximately 8,000 square feet dedicated to
the automobile repair service center. ADAP stores are designed to have a strong visual impact, utilizing
bright, colorful signs to easily direct the customer to a product area. The stores are typically located in
areas with high automotive traffic and utilize large, highly visible exterior signs to attract customers.
Although the competition varies by individual market, the Company believes that it has a competitive
advantage with respect to both its depth and breadth of merchandise and price.
On January 7, 1994 Rite Aid announced a plan of reorganization which included the planned sale of
all non-drugstore assets. Such assets include Rite Aid’s Retail Division, consisting of ADAP, Concord
Custom Cleaner, Encore Books and its Medical Services Division which is comprised solely of Sera-Tec
Biologicals.
-1-
Exhibit 3 (Continued)
II. KEY INVESTMENT CONSIDERATIONS
x Strong Operating Results. The Company has experienced strong growth over the past five years.
From fiscal 1990 to fiscal 1994, revenues have grown by over 76.1% from $61.5 million to $108.3
million. This growth has been attributed 62% to the addition of 22 new stores (net of closures) and
38% to comparable store growth. Over the same period average sales per store has increased from
$819,000 to $1,134,000. In addition, EBITDA (defined as earnings before interest, income taxes and
depreciation) has grown 183% from $4.1 million to $11.7 million during the same period. The
Company currently plans to open 15 stores in fiscal 1995 which should result in strong continued
growth in sales and profitability.
x Dominant Competitor in New England. The Company’s primary competition includes small local
operators as well as several regional chains. The Company believes it offers a broader selection of
merchandise, and that its everyday low prices are highly competitive. The Company’s operating
expenses as a percentage of sales have improved over time as the Company has grown its store base
without substantial increases in fixed and overhead costs. The resulting increase in revenue has
created attractive purchasing opportunities which has allowed the Company to profitably offer prices
which are consistently lower than its local competition.
x Significant Growth Potential. The Company believes there exist significant growth opportunities to
continue expanding its store base in both existing and new markets throughout New England and the
Northern Mid-Atlantic Region. Management has successfully expanded the business while
maintaining strong profitability. Management has added 22 net new stores since fiscal 1990,
growing revenues in excess of 76% (revenues from comparable store sales grew 29%). The
Company anticipates expanding primarily with its new Auto Palace Service Center concept. The
service center satisfies a need for reliable, quality automotive service centers in its markets as local
gas stations and repair centers find it more difficult to afford the required sophisticated equipment of
service today’s automobiles. In addition, the increased traffic resulting from the addition of a service
center has a significant impact on retail sales. The average total sales per service center unit has been
$2.7 million to $3.0 million; of which $1.3 million to $1.4 million are retail sales excluding tire and
service sales, versus sales in the ADAP retail concept of $1.1 million. The Company’s expansion
plan for fiscal 1995 is to open 15 new stores, 14 of which are in the new service center formats.
x Favorable Industry Trends. Market
Growth: The automotive aftermarket industry possesses strong economic fundamentals which are
expected to drive its growth in the future. The average age of motor vehicles in operation is currently
at an all-time high, averaging 8.4 years in 1993 versus 7.4 years after the last recession in 1983. The
total number of vehicles in operation is also at an all-time high, totaling 184 million in 1993
compared to 147 million a decade ago. In addition, Americans are adding an increasingly larger
amount of mileage to their cars each year. These factors contribute to the expected growth in
demand for aftermarket auto parts and auto service. Competitive Requirements:
The recent development in automotive technology and the increased number of car models available
has changed the industry’s competitive landscape. Automotive technology has become significantly
more sophisticated, requiring a significantly greater investment in advanced diagnostic machinery
and training by commercial repair outlets. Furthermore, the increase in automobile models in the
U.S. market requires greater investment in inventory levels to service the market. These entry
barriers benefit large chains, such as ADAP, which can afford such investments in equipment,
inventory and technical training at the expense of smaller, independent auto stores and repair shops
that will be forced to exit the industry.
x Excellent Chainwide Store Condition. Since fiscal 1990, 87 of the Company’s 96 stores have either
been renovated or are newly opened units. The remodeling program focused on making the stores
brighter, more efficiently arranged, and adding new interior and exterior signage.
-2-
III. SUMMARY FINANCIAL INFORMATION
ADAP, Inc.
(dollars in thousands)
Nine Fiscal
Fiscal Years Ended Months Ended Years Ended
Feb. 29, Feb. 27, Feb. 26, Nov. 27, Nov. 26, Mar. 4, Mar. 2,
1992 1993 1994 1993 1994 1995E 1996P
Revenues 84,805 96,893 108,610 81,639 97,354 130,131 138,474

Gross Profit 36,520 40,983 45,470 34,175 39,725 53,318 57,862
EBIT 5,657 6,625 7,737 7,259 5,624* 5,969* 8,086*
Net Income 2,108 2,851 3,381 3,316 2,318* 2,447* 3,315*
Comparable
Store Sales Growth 5.7% 4.9% 5.7% 3.8% 8.0% 7.1% 5.0%
Total Growth 16.6% 14.3% 12.1% 9.3% 19.3% 19.8% 6.4%
Total Stores 89 95 96 95 97 98 98
Capital Expenditures 2,862 6,111 8,288 5,110 7,743 8,483 (1,000)
Balance
Sheet Information
Inventory 34,714 38,739 45,606 42,997 44,297 44,143 42,278
Total Assets 68,055 74,830 85,885 81,065 89,422 88,597 81,127
Accounts Payable 4,098 4,127 6,962 6,032 4,762 6,426 7,721
Working Capital 31,377 35,898 39,723 36,747 40,377 39,139 35,442
*Decrease from historical averages due to write-offs for store closings.
-3-
Consolidated Balance Sheets

($000)
Nine Months
Fiscal Years Ended Ended
Feb. 29, 1992 Feb. 27, 1993 Feb. 26, 1994 Nov. 26, 1994
Assets
Current Assets:
Cash 423 341 386 445
Accounts Receivable 718 1,216 1,312 1,460
Inventory 34,714 38,739 45,606 44,297
Income Taxes 302 261 137 137
Prepaid Expenses 485 614 510 636
Total Current Assets 36,642 41,171 47,951 46,975
Net PP&E 14,872 18,450 23,476 28,533

Intangibles 14,535 13,700 13,062 12,710
Other Assets 2,006 1,509 1,396 1,204
Total Assets 68,055 74,830 85,885 89,422
Liabilities & Stockholders’

Equity
Current Liabilities:
Accounts Payable 4,098 4,127 6,962 4,762
Taxes Payable 386 550 560 1,399
Accrued Liabilities 358 255 320 (8)
Total Current Liabilities 4,842 4,932 7,842 6,153
Deferred Taxes 994 937 890 890

Total Liabilities 5,836 5,869 8,732 7,043
Total Stockholders’ Equity 62,219 68,961 77,153 82,379
Total Liabilities &

Stockholders’ Equity 68,055 74,830 85,885 89,422
-4-
Exhibit 4
January 2, 1995
Mr. Peter Bartlett
Managing Director
Donaldson, Lufkin & Jenrette
2121 Avenue of the Stars
Suite 3000
Los Angeles, CA 90067
Dear Peter:
You had asked that I give you a preliminary indication of our interest in ADAP, Inc. We have
reviewed the information contained in the March 1994 information memorandum as well as the
supplement. Based on that information, we are estimating an enterprise value between $60
million and $70 million.
In order to narrow that range, we would need to conduct on site due diligence and spend time
with the management group. We estimate that we will require approximately two weeks for this
process, and during this time we would work toward getting you a firm proposal.
We will likely structure our proposal as a management buy-out with employee participation.
What this means to ADAP is that the company will remain intact and the employees of ADAP
are likely not only to remain in place, but to participate financially in the success of the venture.
Therefore, we are very interested in getting to know the senior managers of the company.
I should note that we have already completed our industry due diligence relating to the
automobile aftermarket. This is an industry that we had a strong preexisting interest in, and so
our time will be spent reviewing ADAP.
Falcon Capital represents seven private investors who have extensive experience with
acquisitions of a similar size and larger. Our equity capabilities exceed those required to
adequately finance this transaction, and we foresee no problems financing a well structured
proposal.
This letter is an indication of interest, not an offer to purchase. Any offer to purchase ADAP
will require approval of our Board of Directors. Thank you for permitting us to review ADAP,
and we hope that we can structure a transaction that will be mutually acceptable.
Regards,
David M. Dodson
Exhibit 5
January 19, 1995
Mr. Peter Bartlett

Suite 3000
Dear Mr. Bartlett:
Thank you for allowing us to participate in the sale of ADAP; your team has been responsive
to our requests and allowed us to proceed very quickly on our due diligence and arrive at the
decision to make an offer for the assets of ADAP.
We have approached this process with the understanding that Rite Aid is looking for a
qualified buyer who can meet the price expectations they have for the company, as opposed to
conducting an auction. We believe we have met those price expectations by making an offer that
is at the high end of our original indication of interest.
I hope that you will also find us to be a qualified buyer. In a very short period of time we
have conducted extensive due diligence which includes on site review of locations. In addition,
our lenders have responded favorably and expeditiously to this transaction knowing full well
that Rite Aid is looking for a party that will conclude the transaction quickly. The pace that we
have operated under for the past 30 days will continue until we have closed this transaction.
100% of the resources and attention of Falcon Capital will be devoted to this acquisition.
I have attached a list of the principals of Falcon Capital. We are experienced at buying and
selling companies and have the financial capability to carry out our intentions. Since each of us
has been on the "buy side" and "sell side" of transactions as principals, we know what to expect
going forward -- you won’t be getting any surprises from the way we operate.
Peter, in the past 30 days we worked aggressively on this transaction in an effort to

demonstrate to you and your client that we are serious buyers, ones that you can count on to
complete this sale. I trust that we have demonstrated that to you, and that our offer will be duly
considered.
Regards,
David M. Dodson
Exhibit 6
January 29, 1995
Mr. Peter Bartlett

Suite 3000
Dear Peter:
Thank you for giving us the chance to review ADAP, Inc. We view it as an attractive
opportunity that we wish to pursue.
However, there are other opportunities that we must focus our attention on if the prospects of
completing a transaction with ADAP are not high. I’m sure you can understand this position.
Therefore we need to enter into substantive negotiations with the sellers no later than February 3,
1995. These negotiations should be in person and with individuals from Rite Aid who are in a
position to commit to terms subject only to board approval. We should meet at a mutually
convenient location -- I recommend the Philadelphia offices of Donaldson, Lufkin & Jenrette.
At that time we will make a purchase proposal in the price range indicated in our initial
indication of interest, however not at the high-end of the range. We will also be in a position to
answer any questions you or your client might have regarding our financing including the
establishment of a timeline for financing commitments. Falcon intends to capitalize the equity
portion of this investment with an amount in excess of $20 million. Arrangements could be
made for you to discuss this investment with any of the shareholders of Falcon Capital.
If your client views us as a serious buyer of ADAP, and is agreeable to negotiating with us,
please contact myself or Mike Hammer by Tuesday January 31, 1995. Otherwise, thank you for
allowing us to review ADAP, and I wish you luck in completing a transaction with another
buyer.
Regards,
David M. Dodson
This document is authorized for use only in Prof. A. Kanagaraj's Mergers, Acquisitions and Corporate Restructuring (MACBJ20-4), Term - IV, BMJ 2020-22 at Xavier Labour
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GRADUATE SCHOOL OF BUSINESS

AUTO PALACE AND RITE AID

An investment banking firm was engaged to conduct an auction of these subsidiaries.

GETTING TO THE NEGOTIATING TABLE

Source: Wall Street Journal, December 5, 1994.

Discount Hi/Lo O’Reilly

Last 12 Month Data (000)

III. SUMMARY FINANCIAL INFORMATION

Revenues 84,805 96,893 108,610 81,639 97,354 130,131 138,474

Capital Expenditures 2,862 6,111 8,288 5,110 7,743 8,483 (1,000)

*Decrease from historical averages due to write-offs for store closings.

Consolidated Balance Sheets

Net PP&E 14,872 18,450 23,476 28,533

Total Assets 68,055 74,830 85,885 89,422

Liabilities & Stockholders’

Deferred Taxes 994 937 890 890

Total Stockholders’ Equity 62,219 68,961 77,153 82,379

Total Liabilities &

January 19, 1995

Mr. Peter Bartlett

Dear Mr. Bartlett:

Peter, in the past 30 days we worked aggressively on this transaction in an effort to

Mr. Peter Bartlett

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