We’re seeing renewed interest and optimism in the buying and selling of auto dealerships.
Many prospective buyers are putting out feelers and looking for opportunities. This is increasing blue-sky multiples. But there is a risk of overpricing, which leads to problems because there is a limited number of prospects who actually qualify as legitimate buyers.
While the basic principles of supply and demand are easy to understand, how blue-sky multiples are arrived at is a different matter. In its most basic form, they are the numbers by which dealerships’ normalized earnings are multiplied to determine intangible values.
When dealerships exchange hands, they normally are asset sales (stock sales are very rare), where the buyer will buy only the assets of the company, and not the stock.
In a typical dealership sale, the assets that are sold are real estate, new cars, used cars, parts, furniture, fixtures, equipment, open repair orders and goodwill/blue sky.
The latter is the only asset in the group that is truly an intangible or an item that lacks a physical substance. In other words, the buyer is paying for the figurative “blue sky” above the dealership.
In a more conventional manner, look at it as franchise rights, the value that is proposed for that particular franchise and its reputation in that particular market.
To make sense of multiples for dealerships, we should contrast them against multiples for other businesses.
As an example, service-based businesses sell for one to two multiples of earnings, while more established businesses with historic sustainable profits will sell for upwards of five times earnings.
The retail automotive industry is mature and more stable than other industries due to the exclusivity of auto maker outlets and the franchise laws that govern them. Since geographic areas and markets can be protected by certain franchise agreements, future revenues and earnings can be considered more sustainable than other sectors that do not command the same level of geographic or market protection.
Multiples for most dealerships currently range between three to seven times earnings, which places the midrange dealership multiple at about five times earnings. This can be considered high for most small to medium-size businesses but, given what may be considered less volatility and risk, dealerships are a prized acquisition target.
Another factor that builds on the appeal of dealerships and inherently raises the multiple is the exclusivity of the individuals who are able to buy them. Just having the cash to buy a store is not enough. Today, auto makers require actual retail-automotive expertise for approval.
As I’ve told would-be investors without dealership experience, auto retail is a very exclusive sandbox and just because you have the toys (cash) does not mean you can play in it.
While there are creative partnership structures that try to bypass this requirement, the manufacturers’ control of the approval process generally ensures candidates are qualified in the auto-retail business and protects the industry from massive consolidation either by public companies or private-equity firms.
In today’s market, brands such as, Volvo and are at the low end of the multiple range. Conversely, brands such as , Lexus and Mercedes are high-end.
What creates confusion is when these multiples are used casually. Often disregarded are the fundamentals of how these multiples are reached. When broad multiple ranges are used to describe dealership blue-sky values, these are generally intended to describe facility-compliant, well-operated stores that are medium to large in size and in stable or growing markets.
The problem with some sellers and brokers is that these guideline multiples, which are very conditional by design, are applied as a baseline from which stores are valued. That, in turn, inappropriately drives up the pricing of stores.
From a seller’s and broker’s perspective, they are simply trying to maximize the value of the asset being sold by pricing it at the high end of the market. However, what occurs is a listing that many real buyers will pass up.
It’s similar to a sales manager who has overappraised a trade-in and is convinced he or she can retail it for a good gross. That car will sit on the lot for months, priced incorrectly, waiting for the right buyer who may never come in.
In some cases, a buyer will surface, but more often than not that car’s price ultimately will be reduced, or the vehicle will be spiffed or taken to auction.
However, unlike sitting on a used car for 100 days, excessively prolonging the sale of a dealership can really hurt the seller.
Damage includes passing up of best buyers (who often will not take a second look at a store, even with a price reduction), straining relations with an auto maker, losing key employees and dealing with the stress of window shoppers.
Window shoppers cause the dealership buy-sell market to go off track; many individuals expressing interest are not real buyers. While they may have the wherewithal to close a transaction, all they seem to do is to look at deals for sale, in hopes of finding a no-brainer steal in the market. These deals rarely exist. These people are opportunists who distort the market. Since there are so many of them, a certain undertow is created, which tends to drag both sellers and brokers out from shore and into higher pricing.
The appearance of a surplus of buyers paired with pent-up demand unfortunately drives prices higher without heeding basic tenets or comparables.
Real buyers should stay focused on the fundamentals of a transaction and how it applies to their organization.
Know the minimum return on investment you are seeking, the capital you are willing to invest and the due-diligence steps you are prepared to take.
While in the current market environment there appears to be a shortage of viable deals and an abundance of buyers, don’t get caught in the rip current of apparent over-demand. Remain calm, swim parallel to shore and you will find calm waters under clear skies.
Phil Villegas is a principal at Axiom Advisor, an automotive dealership consulting firm. He can be reached at PV@AXIOM-AUTO.COM.