Dying Dealerships

On Steven Landry's desk sits a folder with paperwork of Chrysler-branded dealerships close to going out of business.

Landry, Chrysler LLC's vice president-North American sales, calls it his SOS folder. These are dealerships in the critical stage, he says. “They need surgery.”

Just before the credit crisis exploded, the folder included only 75 dealerships, a number Landry admits surprises him.

“I thought it would be higher — at least 100,” he says.

That number undoubtedly is higher — much higher — today. The tsunami that is the credit crisis is obliterating many of the rules by which dealers have operated the last 60 years.

Since the modern automotive retail system was put in place following World War II, franchised dealers have proven to be resilient. They have repelled threats from manufacturers, the Internet, sales downturns and even publicly owned dealer groups.

The latest, and perhaps the most dangerous threat is appearing in the form of unavailable credit — not just financing for consumers — but the floor-plan financing that lets dealers run their businesses, buying the vehicles from manufacturers, meeting payroll and advertising to drive new traffic to showrooms and the service departments.

As a result, dealerships are going out of business in droves. Estimates of what the final tally will be once the current crisis is over vary wildly.

The National Automobile Dealers Assn. says approximately 700 of the nation's 20,700 dealerships will close this year, taking with them approximately 37,000 jobs and millions of dollars of local tax revenue. That 700 number probably is conservative. Paul Taylor, the trade group's chief economist admits the carnage likely will be more intense next year.

Publicly, NADA maintains a brave face, but privately there is growing concern.

The group is trying to develop creative lending solutions to take some of the floor-plan pressure off their dealers but those take time. Meanwhile, one member laments options are limited, saying, “We really can't force the banks to start lending.”

Michael Jackson, CEO of the nation's largest dealer group, AutoNation Inc., estimates nearly 1,000 stores will close this year with another 1,000 closing in 2009.

Mark Rikess, an automotive retail consultant and analyst believes the industry will lose close to 2,500 dealerships by the end of 2009.

A study by Grant Thornton LLP Corporate Advisory and Restructuring Services concludes nearly 3,800 stores will have to close just for dealerships to maintain the industry's 2007 average of selling 750 units per dealership in 2009.

Some dealers tell Ward's they think nearly 8,000 dealerships could be wiped out. Watching that many dealerships disappear is unlikely, but the fact some dealers are thinking it describes the uncertainty many of them have regarding their survival.

Declines in dealership numbers are nothing new. Large numbers of dealers have gone out of business in previous downturns. From 1979 to 1981, approximately 1,800 dealers exited the market as new car sales declined by 3.2 million in the same period. Much of the sales decline happened in 1980 when the industry saw an 18.5% drop.

The biggest sales drop since 1970 occurred in 1974 with a 20.8% decline in new-vehicle sales resulting in almost 1,600 stores closing their doors.

A reduction in the number of dealers has to happen because there are too many to support the current level of car sales. “We are completely overdealered,” Paul Melville, a partner with Grant Thornton says.

“We saw this in January 2006 when we were 25%-30% over-dealered,” he says. “Dealers had no real incentive to consolidate the last 18 months, but now everything has changed.”

Meanwhile, vehicle sales are projected to drop to 13.5 million in 2008 — a decline of 15.5% — the third biggest decline since 1970. The downturn in dealerships the next 12-18 months could dwarf anything the automotive industry has seen in years because dealers no longer can rely on sales from existing operations, says one public dealer group executive.

“Without credit today, and strong operating capital, some guys are not going to survive,” he says.

Why is it so bad now?

The signs were there early in 2008. Chrysler Financial began requiring dealers to meet their obligations in the loan covenants, such as maintaining a certain level of operating capital, keeping vehicle and parts inventory lean and hitting their minimum sales responsibility (a complicated formula Chrysler uses to determine how many vehicles a dealer should be selling each month).

A Chrysler-brand dealer in Idaho complained to Ward's in March that he thought Chrysler had found a way to circumvent state-franchise laws and was using Chrysler Financial as the tool to close dealerships.

However, following Chrysler Financial's summer pullback from leasing — a move required by the banks for Chrysler to obtain the additional $24 billion in funding earlier this year Chrysler Chairman and CEO Robert Nardelli tells Ward's — it appears Chrysler Financial's actions aren't part of some nefarious plot to close stores. Rather, they are being dictated by Cerberus Capital Management and the credit crisis.

Through the first half of 2008, the industry realized sales would decline, but most estimates pegged the year to finish at 15.5 million unit sales or higher.

Sometime in the second quarter, housing foreclosures began to spread across the country. Then gas prices spiked to $4 a gallon. Toward the end of May, new-car sales began to decline in a big way foreshadowing what was to come.

On Sept. 15, the venerable investment bank Lehman Brothers declared bankruptcy creating all sorts of uncertainty in the world markets.

Banks stopped lending to each other, not knowing which banks would be solvent the next week or next day. The credit spigots were turned off.

“Credit is the life blood for the dealer,” says Andrew Parkin, CEO with Global Marketing Enterprises Inc., a firm that helps dealers with buying and selling stores. “We've taken it for granted for years. It's amazing where we find ourselves because of mortgage-backed securities.”

Dealers got caught in the fallout the next week as the Bill Heard Organization, General Motors Corp.'s biggest seller of Chevrolets, shut the doors on all 14 of its dealerships after GMAC Financial Services yanked the group's floor-plan financing because of an over-exposure in the subprime market, heavy inventory and a terrible customer reputation.

Since then, GMAC announced it was funding loans only for customers with credit scores 700 or better. According to data from Experian's proprietary ScorexPlus, from January through August, 58.9% of auto loans financed scored above 700 for new and used transactions for franchised dealerships only.

A chief financial officer with an Ohio-based dealer group tells Ward's GMAC's move affected 50% of his GM customers.

The biggest problem is that lending institutions are pulling their floor-plan financing from many dealers.

In the past, dealers knew they could rely on their brand's captive finance firms to support them, help them finance inventory purchases and fill in the gaps.

GMAC sent letters to several dealers in late October requiring them to pay off loans on inventory 180 days old.

Unfortunately, Chrysler and GM's captive arms are no longer captive to them. Instead, it's Cerberus that's making the decisions, because that firm owns controlling interest in Chrysler Financial and GMAC.

Nardelli admits the credit crisis has “certainly put a strain,” on Chrysler's relationship with its dealers.

“Captive finance is one of the most important arrows in your quiver,” he tells Ward's. “I can understand the dealers' angst…the funds just aren't there.”

Independent banks are starting to follow suit. “We're coming across several lending institutions that are looking harder at dealership operations,” Melville says.

Chrysler and GM dealerships are under increased pressure because banks are waiting to see whether a much-reported potential merger between the two manufacturers happens.

As of press time, no announcement had been made, but latest media reports indicate a deal is close. A merger probably will prolong the banks' unwillingness to loan money to dealers selling those brands, because there's no way to know which dealerships would survive a merger.

If sales continue at the projected level throughout 2009, several brands could be in trouble (See Troubled Brand Chart). Many of the dealers selling those brands could be in trouble also as banks are increasingly unwilling to provide financing to them.

Several domestic dealers are looking to sell, but are finding no buyers. Right now, there is little value in a domestic store. At least two public dealer groups in the third quarter took write-down charges surpassing $51 million due to declining value of their domestic brands.

Group 1 Automotive, the nation's fourth largest dealer group, wrote down $30 million and thus took a $20.6 million net loss for the quarter because of its Detroit brands.

Sonic Automotive, meanwhile, wrote down $21 million because of seven unprofitable domestic dealerships and declining real-estate values at eight of its stores.

The problem for domestic dealers is that many of them are trying to hang on waiting for either the market to come back or for a buyer. They could run out of money before either happens.

There could some surprise closures in the next several months of prominent regional dealer groups. Bill Heard might not be the only dealer forced to exit the market.

Melville agrees, saying there could be some regional players who are in trouble.

For dealers that survive the news is good. One dealer tells Ward's he has competitor who wants to sell. “I'm not going to buy,” he says. “I'm just going to wait him out. These closures are only going to make me stronger.”

Meanwhile, experts advise dealers to try to hoard as much cash as possible — having a strong level of operating capital is the best way to survive the next year. That means not paying down the principal on their inventory if at all possible; cutting until it hurts and if someone comes along wanting to acquire, take the money and run.

The only certain thing about this market is that how this industry will look this time next year is anybody's guess.