As the Retail Automotive Industry Surges Look Out for Industry Outsiders and Private Equity Firms Driving Up Blue Sky Values
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By Phil Villegas
This is a very attractive time to be a car dealer. Regardless of the franchise or region, sales and dealership profitability are up across the board, manufacturers are producing great and attractive vehicles, and by all indications, this solid trend is certain to last throughout the next few years.
With the economy and automotive industry in full recovery mode, we are once again seeing activity brewing from outside speculators looking to enter and redefine the dealership arena. The flurry of activity we are starting to see is very similar to what we experienced in 2004 through 2007, where individuals and entities that were new to the industry were contending for a foothold in the field.
With interest rates being so low, banks having a heavy appetite to lend, and a shortage of deals in the market, we are very much in a seller’s market. I anticipate the return on double digit blue sky multiples in the upcoming year, and not just in situations where the dealership being acquired is significantly underperforming, but also on healthy and operationally effective dealerships.
These high multiples will not be paid by the publics, mega-dealers or even traditional dealers, rather these high prices will likely be paid by industry outsiders and private equity firms trying to get a foothold in the industry, hence driving up blue sky prices. Because most sellers want a quiet, clean, and expedient buy/sell transaction, many will shy away from possibly selling to those who may not be easily approved by the manufacturers. However, many dealers will still be enticed by the higher prices these outside speculators are willing to pay, and may take their chances with the manufacturers.
The auto retail space is a very attractive sector due to the exclusiveness and high return that it yields. We find that most traditional dealership acquisitions target a 20% return on investment, a rate that’s much higher than other, more speculative investments. These returns can be even greater if the transactions are leveraged to the manufacturer allowed limits. Most outsiders trying to break into the automotive retail space will typically leverage as highly as possible in order to maximize their return. It’s difficult to deny the attraction and desirability of it all.
The largest obstacle industry outsiders and private equity firms encountered in the past, and will likely continue to face in the future, is obtaining manufacturer approval. With few exceptions, manufacturers are predisposed to approve only experienced dealer operators. Industry outsiders and private equity firms are problematic for the manufacturer due to lack of fluidity or decisiveness on key operational matters. Simply put, manufacturers want the ability to call the dealer operator to make a decision on a topic before the call is over. They do not want operational decisions to be inefficiently weighed and evaluated by a committee or board to reach an untimely conclusion.
Despite a manufacturer’s desire, industry outsiders and private equity firms will inevitably find their way to the closing table, often through a minority operating partner who, on the surface, will appear to have full operational autonomy. The operating partner will maintain full autonomy as long as he or she delivers profitability that satisfies the investors’ return on investment model.
Times are so good now that to most outside speculators, the retail automotive business appears easy; easy enough to acquire and run a store with either limited experience or limited resources, and sometimes lacking both. Many outsiders see traditional dealerships failing to operate at their potential and feel they can come in and immediately increase revenues, cut expenses, and boost profitability outside the conventional benchmarks. While this quick turnaround can happen on occasion, this is by no means the norm. This inflated confidence based on their own internal model assumptions will also lead many outsiders to pay current dealers above market prices.
While some dealerships are more inclined than others to be successful due to either their franchise brand or geographic location, the key to success with most dealerships rests with the store’s key management, primarily the dealer operator.
In dealership acquisitions, many outsiders fail to give the appropriate amount of credit to the long term impact that key management can have on the investment. When the industry is benefiting from improving or increasing consumer confidence levels, and sales are increasing year after year, many outsiders take these sales for granted. A problem in times like these is that many marginal operators appear better than they truly are. An issue facing industry outsiders is their inability to properly identify true talent in a timely manner. Truth is, there are a lot of hacks and retreads out there that can talk a good game, yet always seem to come up short when delivering results. It may take an outsider six months to a year (or even longer) before they realize the operator they partnered with was just a mouth piece in a nice suit.
Nonetheless, industry outsiders and private equity firms understand the risks and are not easily deterred from attractive high yielding investment opportunities like retail dealerships. So as we start seeing more transactions coming to the market, do not abandon key acquisition fundamentals and start chasing the ever increasing blue sky multiples. Remember that interest rates are not going to stay at these rates forever (or for even more than a couple of years). And while we have seen double digit increases in sales, this trend will similarly start to level off over the next couple of years. My guess is that many of the outsider deals that close at irrationally high multiples will likely find their way back on the market within a few years, at rational prices, and with a shiny new facility (that the manufacturer required the industry outsider to build).
Phil Villegas is a principal at Axiom Advisors, a boutique automotive dealership consulting firm specializing in Mergers & Acquisitions, Enterprise Management and Litigation Support. He can be reached at firstname.lastname@example.org or 786-472-2800.