INDUS T RY WATCH
Auto Dealers Becoming a Hot Commodity A LOOK AT THE UPWARD CYCLE BY MIKE GRANDE, SDR VENTURES
Mergers and acquisition activity in the auto dealership market has been growing steadily over the past several years and is likely to continue to grow for at least the next few years. Both valuations and the number of transactions have been on an upward cycle since early 2013. Here are the top five factors contributing to this increased trend of M&A activity. 1. The overall automotive market is currently very strong, as car sales have finally picked up significantly from their lows after the financial crisis. The result has been a sharp increase in revenue and earnings for dealers. According to data compiled by The Presidio Group, earnings growth has been up approximately 28 percent per year since 2008. Stronger financial performance has resulted in higher valuations and more of an incentive for owners to sell. Stronger earnings also create an incentive for buyers to acquire an increased earnings stream. 2. It is often more viable for dealerships to acquire companies as opposed to building new locations. Manufacturers are still restricting the number of new dealerships they will allow to be opened. Additionally, development costs associated with building new dealerships have increased significantly as a result of the economic recovery. 3. Overarching financial conditions, such as the cost of money, financing availability and willingness of financial institutions to lend, are all creating favorable acquisition conditions. Valuation multiples, while high, are still within a
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reasonable historic range, and they are nowhere near the inflated multiples that buyers were paying from 2006 to 2008. 4. There are currently more buyers in the market than sellers, which applies upward pressure to valuations as a result of supply and demand. Nevertheless, there is still a good supply of dealerships for sale, which is fueling transaction activity. Many baby boomers have held onto their stores past their target retirement age due to the unfavorable economic conditions of five years ago, and they are now looking to capitalize on the current M&A upswing to monetize their investment in their company. 5. Since many dealerships were forced to close stores or downsize their operations considerably to survive the downturn, these dealerships are now operating more efficiently, have cash reserves and are looking to gain back a portion of the market share they may have lost. Large national dealership chains, such as AutoNation, Asbury, Group 1, Lithia, Penske and Sonic, generally look to acquire dealerships in large metro areas in the Sun Belt region from Florida west to California. Local and regional dealers are acquiring to gain market share and efficiency. A larger size often allows dealers to gain more attention from the manufacturer as well as spread shared overhead costs across multiple stores. However, despite the ripe market conditions, dealerships will usually still need to possess certain characteristics to be attractive to acquirers. Acquirers are mainly looking for dealerships with a track record of strong profitability and growth potential. They want to know the dealerships they acquire will be able to generate enough profit to recoup their initial investment within a reasonable period, typically three to five years. Dealerships tend to trade on a multiple of “Earnings Before Interest, Taxes, Depreciation & Amortization” (or EBITDA), not including floorplan interest. This multiple is often adjusted for the size of the dealership, growth potential, efficiency and the fairmarket value of net assets, as well as working capital included in the transaction. While there
WHILE THERE ARE MANY ITEMS TO FOCUS ON WHEN ATTEMPTING TO MAXIMIZE THE VALUE OF A DEALERSHIP, EARNINGS WILL ALWAYS HAVE THE BIGGEST OVERALL IMPACT ON VALUATION.
are many items to focus on when attempting to maximize the value of a dealership, earnings will always have the biggest overall impact on valuation. Dealers with high levels of earnings typically focus on their entire dealership. A wellrun service department will contribute significantly to gross profit while increasing store traffic even more than the best advertising campaign. Financing and maintenance contracts should also be a substantial source of gross profit, and they are an integral part of any wellrun dealership. A good portion of the strength in today’s auto market is clearly the result of making up for lost sales during the economic downturn. According to the Center for Automotive Research, auto sales growth is projected to slow down by roughly 3 percent as the auto market returns to more normal sales levels. These conditions help explain why some dealerships are exploring the possibility of a sale or acquisition in the current environment. Mike Grande is a director at SDR Ventures, a Denver-based investment banking firm. Mike specializes in executing mergers and acquisitions for small and medium-sized businesses. Prior to his M&A experience, Mike purchased, operated and sold a number of businesses including a major marine dealership and RV storage and service business. Mike can be reached at 720.221.9220 or mgrande@ sdrventures.com.