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 petegrimm3@gmail.com. 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
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