Much like the overall car market, the dealership M&A market is once again heating up. In 2010, the public dealership groups spent an estimated $208 million on acquisitions, 7.5 times more than all of 2009, according to their public filings. This trend is continuing in 2011 with most of the publics announcing sizable acquisitions (including AutoNation’s recent acquisition of Fort Meyers Toyota, one of the largest transactions announced to date). In the first quarter of 2011, the six public dealership groups spent an estimated $166 million on 11 acquisitions, nearly as much as they did during all of 2010. At this every increasing run rate, the publics could easily spend $1 billion on dealership acquisitions in 2011 (see Chart 1).
Chart 1: Announced Public Dealership Acquisitions in Q1 2011
Source: Companies’ public filings
So, what is causing such a significant increase in M&A activity and why do I expect it to continue?
Improving new vehicle sales: Even with the considerable challenges associated with the devastating tsunami and a sharp increase in gas prices, 2011 will be a growth year for vehicle sales. IHS Global Insight estimates 2011 new vehicle sales will hit 12.8 million (revised slightly downward), a 10% increase over 2010 and 23% increase over 2009. 2012 is expected to be an even stronger year with J.D. Power and Associates estimating as much as 15 million new vehicle sales.
Increased dealership profitability: Average dealership profitability is at an all time high. This profitability is primarily driven by reduced costs, higher grosses and increased market share per dealership. This is primarily due to the dealership population contraction. As of February 2011, the average dealership made $684,000 in net profit before taxes on a trailing twelve-month basis, a record high according to NADA’s data center. Average dealership net profit margins have also improved significantly from 1.5% in 2009 to 2.1% in 2010, a 40% increase and the highest margin since 1986. The publics have also seen their operating cash flow rise sharply and are under pressure to put their capital to work.
Rebounding blue sky values: The combination of increased profits and enhanced blue sky multiples is resulting in very attractive blue sky valuations. Because buyers expect continued sales growth, they are willing to pay higher multiples on current earnings for blue sky. Some dealership blue sky values are rivaling those seen at the peak of the market. Based on the public companies current valuation multiples and the recent M&A activity, I estimate tier one franchises (BMW, Lexus, Mercedes, Toyota and Honda) are valued at 5 to 7 times pre-tax earnings plus net asset value, while tier two franchises (Ford, Chevy, Nissan and Hyundai) are valued at 2 to 4 times pre-tax earnings plus net asset value. Some of the variables that affect these multiples include dealership location, facility upgrade requirements and earnings upside potential.
Recovering real estate values: Many industry experts believe commercial real estate values have finally bottomed after their painful decline of 30% to 50%. The improved credit market (next bullet), particularly the reopening of the CMBS market, is expected to facilitate a recovery in commercial property values. Furthermore, improved dealership sales and profits will support higher rent factors, which will ultimately lead to higher real estate values.
Healing credit markets: The credit markets are slowly normalizing, thus providing the required capital for acquisitions, particularly of dealership real estate. In addition, interest rates are attractively low. Many buyers know rates will not stay at these levels for long, and many are interested in locking in low interest rate acquisition financing.
Larger and healthier buyer pool: The large public groups in particular are very well capitalized and have strong cash flow. Given that their stock prices are reaching near record highs (see Chart 2), stock buy backs are generally less attractive to the publics than private dealership acquisitions. Also, most dealership acquisitions are accretive to their earnings. Large private dealership groups may also be well positioned to buy dealerships, particularly given their improved balance sheets and increased access to acquisition financing.
Chart 2 – Auto Retail Index (AN, PAG, GPI, SAH, ABG, LAD) Vs. the S&P 500
Source: Yahoo Finance
Pent up seller demand: Between 2007 and 2009 very few dealerships sold. With the market improving, those dealers that would have sold during that period are now coming to market along with new sellers. Also, a large percentage of the dealer population is at or approaching retirement age, which may expand the market for buy/sells over the next five years.
The combined affect of all of these factors foretells a rare and lasting “win-win” period for dealership M&A, a “new normal” of sorts. Sellers are receiving attractive offers from buyers, while buyers are earning attractive returns on their acquisitions. On a personal note, I am such a believer in this new normal that I decided to make a career move, returning to my roots in investment banking. I am pleased to announce that I have joined The Presidio Group, LLC as a Managing Director in their investment banking practice, Presidio Merchant Partners LLC.
As you can probably tell, I am very excited about joining such an impressive firm. I look forward to strategizing with our dealer clients on how best to capitalize on the fruits of their labor. We have entered a rare period when the future is bright for both buyers and sellers. The dealership M&A market is finally back!