2020 Tailwinds May Lead to Turbulence in Years to Come
By Phil Villegas
The apparent exuberance by which some buyers are approaching dealership acquisitions in the current market leaves me scratching my head as to what I may be missing.
Yes, I fully understand the last 5-6 months have been some of the best profitability months dealers have seen. There has been a convergence of factors that have fueled dealer profitability the last few months and while it’s currently a great time to be a car dealer, there are some serious considerations that need to be given to anyone currently contemplating a dealership acquisition from now through 2021.
It does not escape me that we live in a free market where the value of an asset is determined by what a buyer is willing to pay for such an asset. Though I can give allowances for some irrational pricing of assets that may be considered limited, exclusive or even abstract, items the likes of art, wine, classic cars and watches for example that can drive passionate collectors to drive up prices, but I cannot subscribe to this model of thinking when it pertains to dealership assets.
Even though dealerships are currently a hot commodity, this is by no means indefinite. Please keep in mind this is the same industry that no less than a year ago was being written off by many experts due to the emerging mobility movement, manufacturer margin compression, facility demands, impact of vehicle electrification on profitability, antiquated retail sales model and threats by direct to consumer sales. While I have never bought into the apocalyptic view some experts had for dealers, like many others I was cognizant of some of the headwinds to come over the next decade. While I am still very bullish on the retail automotive industry and the role dealers will play for decades to come, I am struggling with the valuations of dealerships over the past few months.
Despite the excess liquidity that appears to be available, I would be hard pressed to use 2020 net profits to serve as the exclusive basis by which any multiple is applied to in calculating the goodwill value. There are several elements currently bolstering net profitability in 2020 that are certain to not be present in 2021 or years to follow. Factors that I would be advising our clients to consider and likely discount in the valuation of any transaction in the coming months would be as follows:
Sustainability of current New and Pre-Owned Gross Profit Levels: Current low supply of new and pre-owned inventory levels that have boosted grosses are likely to correct themselves in the coming months.
Sustainability of current low flooring expense: Low inventory levels combined with faster inventory turns has most dealers netting income in flooring. As inventory days’ supply levels increase to normal the net expense will inevitably increase.
Special Lender and Vendor Discounts: In the midst of the pandemic lockdown, most major banks, DMS providers and other vendors provided expense reductions/deferrals over a period of a few months which helped improve dealer profitability.
Personnel and Compensation Levels: Many dealers used the pandemic lockdown to cut pay-plans and personnel. Many of these dealers have not returned to full staffing or pay levels and likely will.
Low Interest Expense: While we expect rates to remain low for a few years, it is not realistic to plan on having these rates through the entire acquisition loan period.
A focal point in any acquisition valuation is to forecast how that individual store will likely perform under new ownership. Often new owners can bring a combination of energy, selling approaches, economic synergies that will allow them to boost the profitability of an acquisition. While this still remains the case, a diligent buyer will also recognize the strong tailwinds that have impacted dealers in 2020 and the inevitable turbulence that is likely to come in 2021 and later as things return to normal or even worse, slide into a recession.