Dealership buy/sell activity increased 60% in the first quarter of the year (see Chart 1). The increase is attributed to a rise in the number of sellers entering the market. Buyers, both public and private, have reported an increase in the number of acquisition opportunities being brought to them. Interestingly, the rise in sellers has yet to have a negative impact on blue sky pricing, which remains very high.
Public Acquisition Activity Q1 2014
The publics’ increased their spending on dealership acquisitions in the first quarter of 2014 as compared to 2013, growing their total U.S. and international acquisition spending by 40%. However, their spending on U.S. dealerships increased by just $8 million in the first quarter, a meager 9% improvement over the first quarter of 2013. The $96 million spent on U.S. acquisitions in the first quarter was for just eight dealerships. This spending level is still much lower than pre-recession levels. In fact, the publics have even sold a few dealerships over the last 12 months. International spending continues to garner a significant share of the publics’ acquisition capital, 22% in the first quarter.
I continue to be surprised by the lower than expected acquisition activity by the publics, particularly given their record access to capital for acquisitions (see Chart 3). As you can see in Charts 4 and 5, in the first quarter of 2014 the publics reduced their capital allocation to dealership acquisitions and significantly increased their allocation to stock buybacks. Collectively, the public spent $163 million on stock buybacks in the first quarter, 70% more than what they spent on U.S. dealership acquisitions. For example, AutoNation, the largest of the publics, acquired $116 million of its own stock in the first quarter and made no acquisitions. In effect, AutoNation chose to invest in their own dealerships, rather buying new ones.
The increase in public stock buybacks may reflect a recent decline in the P/E multiples of these stocks. The publics’ average P/E multiple has declined from a high of 22.2 in January 2010 to 16.1 in January 2014 to 15.1 in March 2014. At a lower multiple of earnings, the publics’ stock becomes an increasingly attractive investment, particularly if there are few dealerships available for purchase that meet their framework agreement requirements or that are accretive to their earnings.
Private Dealership Acquisition Activity Q1 2014
As compared to the publics, private dealership groups continue to be the most acquisitive. According to The Banks Report and our research, there were 48 dealership acquisitions in the first quarter of 2014. Private dealership groups made 40 acquisitions, representing 83% of the buyers, up from 78% in 2013.
The dominance of the private acquirers is reflected in the increasing number of private dealership groups with greater than $1 billion in sales, rising from just 11 in 2009 to 36 in 2013, a 227% increase (see Chart 7). The majority of these companies’ revenue growth has come from acquisitions, not same store sales.
I expect private buyers to be the driving force of future dealership consolidation for three main reasons, listed below.
- Private Dealership Groups Have Tremendous Access to Capital: The dramatic recovery in the dealer credit profile has put private buyers on a much more even playing field with their public counterparts in terms of access to capital at competitive rates. Lenders have decided that our industry’s financial performance warrants more credit and banks are eager to grow their dealer loan portfolio. As such, banks are willing to lend to private dealers on acquisitions, including blue sky and real estate, with the expectation that these buyers will increase their floor plan credit and retail paper volume – a big bonus for most banks.
- Private Dealership Groups Have Fewer Investment Options: Many private buyers have maxed out on their CMA accounts and are sitting on a great deal of cash, generated from their highly profitable dealerships. Few are interested in handing that capital over to a professional money manager to invest in a diversified pool of investments. Rather most private dealers subscribe to Warren Buffet’s investment philosophy, “Diversification is for those who don’t know what they are doing.” Successful private dealers know exactly what they are doing. They know how to achieve a great return on a dealership investment and therefore are most focused on allocating their excess capital to acquiring more stores. Also, unlike public companies, private groups do not need to buy back their own stock (they already own 100% of it in most cases) and few are seeking international acquisitions – buying a dealership out of state can be challenging enough.
- Public Companies Have Growth Limitations: Public companies have a fiduciary responsibility to allocate their free cash flow toward investments that are earnings accretive and produce a high return on investment. If they cannot identify such investment opportunities, the companies may feel pressure to increase their dividend and provide their shareholders with the cash. As blue sky multiples continue to rise, some publics may find themselves having a difficult time justifying acquisition valuations. As Chart 8 demonstrates, it is estimated that the average public company blue sky multiple has declined to 8.3 times (similar declines were mentioned above in the P/E multiple). This decline is due to the fact that earnings have grown faster than their market capitalizations, which is likely an indication that investors believe earnings growth will slow. While 8.3 times may seem like a high blue sky multiple, this multiple limits the publics’ ability to make accretive acquisitions, particularly when factoring in transaction expenses and transition costs. The public’ boards ask themselves, should we make this acquisition or just buy back our own stock at an 8.3 times blue sky multiple with no transition expense or risk. Clearly, some of them have chosen the latter option. Another limitation for public companies is their manufacturer framework agreements which limit their ability to grow, particularly with certain franchises and in certain markets.
In closing, I am always surprised how focused many private dealers are on the publics. Dealers often assume a public is the most likely acquirer of their stores. And yet, the public companies own just 5% of the 17,875 dealerships in the US. 95% of dealerships are still owned by private companies. While the publics’ generally have greater access to capital, they also have more options for that capital and more manufacturer limitations on their acquisition strategy. As such, they are less active in the buy/sell market and less likely to be the buyer of your dealerships. Of course, if a new public emerges, that would be a different story. To be clear, that is a big “if”. Until then, I expect we will continue to see private groups lead dealership consolidation.