This is an attractive time to be a car dealer. Dealership profitability is up across the board, automaker are producing great vehicles and the upswing looks like it will last for the next few years.

Accordingly, we’re once again seeing activity brewing from outside speculators looking to enter and redefine the dealership arena. It’s similar to 2004 through 2007 when individuals and entities new to the industry vied to buy dealerships.

With interest rates low, banks eager to lend and a shortage of deals in the dealership buy-sell market, we are very much in a seller’s market.

I anticipate double-digit blue-sky multiples in the coming year, and not just in situations where the dealership being acquired is significantly underperforming, but also in cases of healthy and operationally effective dealerships.

These high multiples will not be paid by the public chains, private megadealers or even traditional dealers in acquisition mode. Rather these high prices likely will be paid by industry outsiders and private-equity firms trying to get a foothold in the industry, and in the process driving up blue-sky levels.

Because most sellers want an expedient buy-sell transaction, many will shy away from selling to those who may not easily gain automaker approval.

However, many dealers still will be enticed by the higher prices these outside speculators often are willing to pay, and may take their chances with the manufacturers.

The auto-retail sector is attractive due to exclusiveness and high yields. We find most traditional dealership acquisitions target a 20% return on investment, a rate that’s higher than other speculative investments.

These returns can be even greater if the transactions are leveraged to the manufacturer-allowed limits. Most outsiders trying to break into auto retailing typically will leverage as high as possible to maximize their return. 

The largest obstacle industry outsiders and private-equity firms faced in the past, and will likely continue to face, is in obtaining automaker approval of their prospective dealership purchase.  

With few exceptions, automakers are predisposed to approve franchises only for experienced dealer operators. Industry outsiders and private equity firms are problematic for a manufacturer because they’re often wanting on key operational matters.

Simply put, auto makers want the ability to deal with a dealer operator who can make a relatively fast decision on an issue at hand. They do not want a board or committee slowly and deliberately deciding a matter.

Nevertheless, outsiders inevitably will find their way to the closing table, often through a minority operating partner who on the surface appears to have full operational autonomy. In truth, operating partners have that as long as they deliver profitability that satisfies the investors’ ROI model.

Times are so good now the auto-retailing business appears easy to outside speculators, even though they may lack experience and operational resources.

Many of them see traditional dealerships as failing to operate at full potential. They think they can come in and immediately crank up revenues, cut expenses and boost profitability beyond conventional benchmarks.

While such a quick and dramatic turnaround can happen, it’s hardly the norm. Inflated confidence based on internal-model assumptions can lead many outsiders to pay above market prices for dealerships.

While some stores do better than others because of their prime locations or the popularity of the brand they represent, success with most stores rests with upper management, primarily the skills of the dealer operator.

In dealership acquisitions, many outsiders fail to give the appropriate amount of credit to the long-term impact that key managers can have on the investment. When the industry is benefitting from improved consumer confidence and sales, many outsiders take these sales for granted, failing to understand the cyclical nature of the car business.

In good times like these, many marginal operators appear better than they are. Outsiders often fail to identify true talent in a timely manner. Truth is, a lot of hacks and retreads can talk a good game yet always seem to come up short in delivering results. It may take an outsider six months to a year (or longer) to realize a dealer-operator partner is merely a faster talker in a nice suit.

Nonetheless, industry outsiders and private equity firms who understand the risks are not easily deterred from attractive high-yielding investment opportunities like auto dealerships offer.

But interest rates won’t stay low forever. And while we have seen strong sales in recent years, this trend probably will start to level off in the next couple of years as pent-up demand eases.

My guess is many outsider deals that close at irrationally high multiples ultimately will result in affected dealerships finding their way back on the market within a few years, with rational prices and shiny new facilities that automakers required the original investor to build.

Phil Villegas is a principal at Axiom Advisors, an automotive dealership consulting firm specializing in mergers, acquisitions, enterprise management and litigation support. He can be reached at PV@AXIOM-AUTO.COM or 786-472-2800.