Galloping Consolidation and High Stock Prices Drive Historically High Dealership Valuations
The following is a discussion of business valuations specifically designed for auto dealerships and dealership groups. A print version will appear in the March edition of the Puget Sound Automobile Dealer Association Magazine. Any dealers with questions or comments contact me at firstname.lastname@example.org. For more on that portion of my practice see www.premierperformancegroups.com.
The Blue Sky portion of the price of a dealership historically ranged from a multiple of 1-3 times Adjusted Weighted Average Earnings*. In today’s market, however, it is not uncommon for a dealership with the right franchise(s) to command a Blue Sky Multiple* of 4-5, and exceptional opportunities a multiple of 7+. Will the factors driving this increase remain, or will multiples recede to their historical range? Is this the right time to sell your dealership, or to buy another one? Understanding how dealerships are valued is key to developing an exit plan, or a strategy for growth.
Demand for quality dealerships is historically high and there are fewer dealerships for sale. This imbalance drives transaction prices higher. In the last decade the industry lost many brands, among them: Oldsmobile, Pontiac, Mercury, Plymouth, Saturn, Suzuki, Hummer and Saab. The loss of brands, and the shakeout of sub-optimal dealerships during the 2008-2009 recession, continued an historical consolidation into fewer, more profitable dealerships. Not since its infancy, has the US automobile industry had as few dealerships and as few dealer-owners as it has today, and this shift is accelerating.
From a high of 47,500 in 1951, the number of US dealerships dropped steadily. Dealership count had dipped by more than half to an estimated 22,800 by the mid-1990s when public dealership groups like United Auto Group (now Penske), AutoNation, Asbury, Sonic, Lithia and others found acceptance and went on a buying binge, snapping up many of the highest volume dealerships and further reducing the number of dealer-owners. Strong, privately-owned dealership groups accelerated their buying as well. After a brief respite during 2008-2009, consolidation is galloping again. Today, there are an estimated 17,760 dealerships representing 31,376 franchises, and many are already part of public or private dealership groups. Generally, surviving single-point dealerships emerged from the 2008-2009 recession leaner, more profitable, with wider market opportunity, and able to choose whether and when to sell, thereby commanding higher prices. Demand comes from Wall Street’s almost insatiable requirement that public auto companies continue to grow by acquisition, plus the growth strategies of privately-owned dealership groups. Both increase the likelihood that a seller will discover multiple qualified buyers, instead of experiencing the single-buyer OEM “arranged marriage” so prevalent in the past.
Obtaining a valuation during a Buy-Sell is almost universal, but a determination of Fair Market Value may also be required for capital financing, estate planning, succession planning, shareholder agreements etc. A thorough valuation uses multiple methods and often the Capital Asset Pricing Method is among these. This method requires systematic development of a risk-return rate called the Capitalization Rate which should entice buyer(s) to a specific investment. When this rate is divided into a company’s Adjusted Weighted Average Earnings, it yields a valuation for a company as a whole (excluding real estate).
Twenty years ago there were no publicly-traded auto retail stocks in America. Today, the market’s valuation of these stocks provides a means to calculate the underlying risk factor we use developing a Capitalization Rate for dealerships and dealership groups. For example: the market recently valued AutoNation at 13.3 times Cash Flow. If we were to base our calculation on the value of AutoNation alone (we do not), the first element of our Capitalization Rate would be 1/13.3 = 7.5%. This factor represents a risk-return rate that currently entices investors to buy AutoNation stock. In most cases, an investment in a much smaller dealership or dealership group will be riskier than investment in a larger public auto retailer and investors will expect a higher return. So we systematically evaluate other risk factors, like franchise(s) held and company-specific limitations, to calculate a rate that should entice investment. For example: company-specific limitations and franchise risk might collectively add another 6.5%, bringing the Capitalization Rate to 14%. This rate would value a company (excluding real estate) at just over 7 times its Adjusted Weighted Average Earnings (1/14).
As opposed to a Fair Market Value determined by a valuation, transaction-specific factors will affect an ultimate selling price. For example: a public-company buyer may see no immediate value in a purchase unless its terms lie well within the multiples at which the public company’s stock currently trades. That rationale, however, might unduly discount the desire of another buyer for control of a specific company, in a specific location, and its anticipated cash flows, which is not available investing in public stock.
Using the Capital Asset Pricing Method might seem to suggest that a currently unprofitable dealership cannot command any Blue Sky, since any multiple times zero equals zero. That is not necessarily true, and one reason multiple valuation methods should always be used. A currently unprofitable dealership cannot be valued easily using the Capital Asset Pricing Method, but may still possess elements of Goodwill and Blue Sky.
Historically, new vehicle sales wax and wane on a five year cycle, and the industry is now into its fifth year of recovery. Interest rates are historically low. This drives auto retail stocks higher and holds down floor-plan expense. If new vehicle sales fall and interest rates rise, will auto stocks fall and take Blue Sky Multiples back to historical levels? Whatever the economy brings in the short-term, I believe the acquisitive appetites of dealership groups and public auto retailers will remain strong. Start today to develop (or review) your strategy for growth, or prepare to be gobbled up. Consolidation is coming at a gallop.
*Adjusted Weighted Average Earnings – Earnings for the last five years are “adjusted” for prospective changes in facility expense, excess compensation to owners, unusual one-time expenses and depreciation, LIFO and other factors. They are then “weighted” to place 5 times as much “weight” on the most current year’s earnings, 4 times the previous year’s earnings, and so on, and a “weighted average” calculated.
*Blue Sky Multiple – The amount a buyer pays for a dealership above an adjusted value of company assets (excluding real estate) divided by Adjusted Weighted Average Earnings.
©Copyright 1/21/2014 Pete Grimm– All rights reserved