Dealer Insights - May June 2014 - What’s the current state of the dealership M&A market?
After several slow years in the aftermath of the financial crisis, auto dealership merger and acquisition (M&A) activity picked up substantially in the United States last year. According to data compiled by The Presidio Group, an advisor to buyers and sellers of auto dealerships, 55 private buy-sells were announced through November of 2013 (year to date), compared to only 30 private buy-sell announcements during the same period a year earlier.
On the public side, $133 million was spent on U.S. dealership acquisitions during the first half of 2013, up 8% from a year earlier. Experts attribute this M&A increase to robust dealership earnings growth, which is up 28% per year since 2008, according to NADA data and an analysis by The Presidio Group.
Good news for sellers
All of this is potentially good news for owners of U.S. automotive dealerships who are thinking about selling their businesses. Not only is deal volume up, but dealerships are currently priced at all-time highs, according to public dealership group data compiled by Presidio. A number of factors are driving this trend:
- There are currently more potential buyers than sellers (supply vs. demand) as many owners hold onto their dealerships past the traditional retirement age.
- The market is flooded with capital and many buyers are currently willing to pay a premium for attractive dealerships.
- Dealership profits are at record levels.
- Attractive acquisition financing terms are generally available from lenders.
- More favorable economic conditions — especially growth — mean less potential risk for buyers.
In short, while the national economic recovery continues to be rather uneven, dealerships are generally doing well — and this is reflected in robust dealership M&A activity.
Types of dealership buyers
Because of the need for manufacturer approval of dealership owners and GMs, acquirers of automotive dealerships tend to be strategic buyers looking for the right fit rather than financial buyers looking for passive investments. There are two broad categories of automotive dealership buyers: public buyers and private buyers. The largest public buyer groups in the United States include AutoNation, Asbury, Group 1, Lithia, Penske and Sonic.
Generally, public buyers are looking to acquire dealerships in large metro areas, primarily in the Sun Belt, from Florida west to California. Many large private buyers, meanwhile, are seeking dealerships in metropolitan and rural areas that can provide scalability. These buyers want to centralize financial and accounting functions that are spread across multiple dealerships and, thus, reduce overhead.
Whether public or private, acquirers are mainly looking for dealerships with a track record of profitability, strong cash flow and growth potential. They want to know whether the dealership will be able to generate enough cash and profits to recoup their initial investment within a reasonable period. A typical dealership buyer today is seeking a minimum return on investment of 15% within one to two years of the purchase date.
The value of any business is based primarily on the present value of future projected cash flows. For automotive dealerships, value also is calculated based on:
- A multiple of pretax, pre-LIFO earnings excluding depreciation,
- The fair market value of fixed assets, and
- Working capital.
Right now, value is also driven by the sale’s timing. Since early 2013, the automotive dealership M&A market has been in an upward cycle, with rising dealership values and multiples (as noted earlier) and attractive valuations. In this environment, even underperforming dealerships may be attractive to buyers because of their strong upside potential.
Window of opportunity
No one knows how long today’s strong M&A cycle will last. Indeed, automobile sales growth is projected to slow down as the automobile market returns to more normal sales levels — between 2% to 3% — next year from the torrid pace of nearly 14% as recently as 2012, according to the Center for Automotive Research. So ready-to-sell dealers, who are holding out a little longer to grow earnings, run the risk of missing the window of opportunity that currently exists.
Sidebar: Potential returns beckon dealership buyers
In today’s low-yield investment environment, many automotive dealership buyers see acquisitions as an opportunity for high return on investment. An analysis performed by The Presidio Group compared the returns a buyer could achieve by acquiring a low-multiple (for example, Chevrolet) and a high-multiple (for instance, BMW) franchise to the estimated returns on stocks and bonds. They were:
- 10-year Treasury bond: 2.7%,
- U.S. investment grade bond: 3.3%,
- S&P average 20-year return: 8.3%,
- Estimated return on high-multiple dealership: 11.1%, and
- Estimated return on low-multiple dealership: 22.2%.
Given these kinds of potential returns, it’s not too surprising that dealership M&A activity is on the rise — and that many owners may now be looking to sell in order to capitalize on the opportunity.
Dealer Insights - May/June 2014