Toyota's Bubble Bursts

For the past decade, Toyota dealerships have been the “prized” operations to own in any market.

These dealerships have been at the very top of the list for any dealer or group looking to expand. A few years back, Toyota dealerships would routinely command a 10-times Blue Sky multiple.

Even throughout last year's economic turmoil, Toyota stores continued to command Blue Sky values that on average were 30%-40% over comparably sized Honda and Nisan stores.

The exceptional value of Toyota dealerships centered on the assumption that their proven exponential growth over the last decade was sustainable for years to come.

Much like the purchasing of stocks in emerging technology companies, buyers of Toyota dealerships in recent years were willing to speculate that the earning of the Toyota brand would outpace the growth of other brands in the market based on comparable multiples.

Prior to the economic crisis hitting, Toyota was predicting annual U.S. sales growth of 20% - 25% annually. Most of these aggressive growth projections were established when Toyota was diving into the truck market with their redesigned Tundra pickup and Sequoia SUV. All of these projections were made before fuel prices began skyrocketing in 2008.

Based on these aggressive growth projections, Toyota compelled dealers to expand their sales and service facilities to meet the impending customer demand.

Dealers who failed to act decisively to meet Toyota's facility image requirement risked having vehicle allocation issues, or worse yet risked having an open-point dealership located in a bordering market.

Toyota dealers had no reason to doubt the continued growth of the company, and much like the rising stock of companies like Google, Intel, and Apple, dealers were committed to ride the wave as far as it would take them.

By many accounts, some Toyota dealers were no different than day traders riding the technology bubble: there was no doing wrong, and many dealers simply became order-takers who would move as much metal as they were provided.

The Toyota brand is strong enough to weather the current recall crisis. But the irrational Blue-Sky multiple premiums that the Toyota brand has commanded over the last decade most likely cannot be sustained for two reasons.

First, the current quality issues will probably not go away quickly. Second, and more importantly, current economic realities are causing a re-evaluation of earlier, over-exuberant valuation approaches to Toyota dealerships.

From what other vehicle manufacturers have faced in the past, quality problems tend to linger. The negative publicity will continue for some time.

Then there will be an army of litigators and Toyota customers who see this situation as an opportunity for personal enrichment, justified or not.

But the effects of the recalls, while significant, will not be the primary cause for the regression of Toyota dealership values.

The impact on Toyota dealership Blue-Sky multiples will have more to do with the departure from irrational exuberance that has in the past accompanied these dealership acquisitions.

We can expect to see a return to objective rationalization that is in line with other brands, something based more on a dealership's merit and less on its speculative ambiance.

With the weakening of Toyota, brands such as Hyundai, Ford, Honda, General Motors, Nissan and Volkswagen are positioned to gain market share.

But when it comes to dealership acquisitions, buyers need to remember that like many things in life, individual franchise success is cyclical, and there are no guarantees.

I'll share a simple rule about dealership acquisitions that the late, great dealer Larry Miller laid out many years ago: If you can't pay off the Blue Sky within five years and have a sensible rent factor, pass on the deal.

Phil Villegas is a Principal at Dealer Transactional Services, LLC. (an affiliate of Morrison, Brown, Argiz & Farra, LLP) in Miami, FL.He can be reached at [email protected] or 305-318-8515.

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