2017 promises to be another active year for buy/sells with private groups, and more public buyers, eager to put their capital to work. We find a continued flow of sellers coming to market, motivated by current prices and a strong desire to capitalize on today’s buy/sell activity. And, we continue to see transaction sizes increase and multi-dealership groups come to market at a rising pace.
With that backdrop, our firm has identified the following four trends which we anticipate will impact 2017’s buy/sell market.
- Buyers’ return on investment parameters drive franchise buy/sell activity
- Sellers’ pricing expectations rationalize with a plateauing market
- Buyers seek investments in higher margin auto retail business segments
- Dealers are increasingly open to equity and growth capital partners
Buyers Return on Investment Parameters Drive Franchise Buy/Sell Activity
Private and public buyers are increasingly focused on return on investment when considering their acquisition strategies. This is particularly true in a rising interest rate environment. As cost of capital increases, so too does the investment hurdle rate required by buyers.
In this environment, it is not surprising to see domestic franchises increase their share of the buy/sell market. As can be seen in Chart 1, the return on investment of a domestic franchise acquisition is highly attractive, relative to import and luxury franchises. Similarly, the capital required for the average domestic acquisition is 53% less than the average import franchise and 66% less than the average luxury franchise.
In a market focused on return on investment, buyer demand is increasing for Ford, Chevrolet, Toyota, Honda and Subaru. These franchises require less capital than the luxury franchises and less operational risk than the lower-multiple franchises. These five franchises are the most requested by buyers in our national Buyer Database, in which we track the acquisition parameters of hundreds of buyers across the US.
Sellers’ pricing expectations rationalize with a plateauing market
Sellers are keenly aware of auto retail’s sales plateau and the resulting pressure on dealership profits. Most dealers understand that the opportunity has passed to obtain above-market blue sky prices, and instead are satisfied knowing that today’s valuation levels remain very high, particularly on a historic basis.
Today, buyers are finding pricing more reasonable in part because today’s sellers are serious about a sale. The market testers who were seeking above-market blue sky values have primarily returned to operating their businesses, discovering those unrealistic values were not attainable. Top luxury franchises may be the only exception to this trend. The owners of Mercedes, BMW, Lexus and Porsche franchises in certain markets are keenly aware of their short supply and high demand. Some well-funded private buyers are willing to pay a premium price to add one of these premier luxury brands to their portfolio. In most cases, however, the publics are priced out of these opportunities.
“Today, buyers are finding pricing more reasonable in part because today’s sellers are serious about a sale.”
Buyers seek investments in higher margin auto retail business segments
The publics are leading a new investment trend, which we expect will extend into the private market. Specifically, the publics are investing in auto retail’s higher margin segments, including used car platforms and collision centers. This diversification strategy is logical on many levels and presents several financial and economic benefits.
First, the revenue streams from these segments are often much higher margin. Collision centers, for instance, have an average gross margin of 45%, five times higher than new vehicle margins. Second, these businesses trade at lower multiples than new car franchises (see Chart III). As such, buyers can achieve a higher return on investment with these acquisitions. Third, they do not require franchise approval from a manufacturer or the construction of expensive facilities.
We have also found the profit streams from dealership-affiliated collision centers and used car lots can receive new car franchise multiples when they are part of a new car operation. This is because buyers typically value a dealership as a whole, rather than valuing each business segment. In this way, a dealer can arbitrage the market by acquiring these ancillary businesses at lower multiples and ultimately selling them as part of a dealership at much higher multiples – a classic “one plus one equals three” investment strategy.
Dealers are increasingly open to equity and growth capital partners
Growing numbers of dealers are open to partnering with an outside capital source to finance the growth of their group or to provide liquidity to themselves or a family member. Not all dealers are willing to bet their family’s fortune or take on significant debt for an expensive acquisition; however, virtually all dealers feel pressure to grow to achieve economies of scale and scope. Outside capital partners provide alternative capital sources to expand a dealer’s business without “betting the farm.”
We see this development as the next step in the industry’s progression towards consolidation. Manufacturers are beginning to accept the concept of outside capital partners and are starting to revise outdated capital structure expectations and approval processes. As industry consolidation continues and dealership values remain high, most manufacturers recognize the evolution underway in the dealership ownership structure. We expect 2017 to be a notable year in this regard, with private equity, family office and high net worth capital taking minority and majority stakes in existing dealership groups, and committing large sums of capital towards auto retail.
2017 promises to be yet another very strong year for auto retail buy/sells, but the transaction market does continually evolve, as noted here. We believe key trends tied to more emphasis on ROI, plateauing seller expectations, focus on higher margin segments and more partnering with outside capital will shape this year’s transaction market in meaningful ways.
Author: Ryan Kerrigan
Ryan Kerrigan is managing Director at Kerrigan Advisors. Kerrigan Advisors is a leading advisor to sellers of higher value dealerships and dealership groups throughout the U.S. Ryan works with Kerrigan Advisors’ private equity clients advising them on their auto retail investment strategy and works with sell-side clients seeking private equity exit. Ryan has extensive experience in both private equity and auto retail, having run his family’s dealership. He started his career at McKinsey & Company as a management consultant, advising Fortune 500 companies on growth strategies, organizational issues, pricing and business valuation. Email: firstname.lastname@example.org