2015 marked an epic year in this multi-year boom of auto retail merger and acquisition activity. The year opened with the closing of Berkshire Hathaway’s acquisition of the Van Tuyl organization, the single largest acquisition in auto retail history. And, four additional new entrants made acquisitions, marking the formal arrival of private equity and family offices to auto retail. Overall, transaction activity set new records with 242 dealership buy/sell transactions in 2015, a 17% increase over 2014. These transactions were accompanied by booming real estate prices, attractive financing and continued strong SAAR. But, the story can never be that simple. All of this activity occurred as the stock market trended down, and the public auto retail stocks fell 29% from their 2015 recent highs. In this annual recap of the buy-sell market, we’ll review each of these dynamics in the following paragraphs.
Total Acquisition Activity
Transaction activity increased by 17% in 2015 according to The Banks Report, representing a record year for auto retail buy/sells. There were 242 dealership buy/sell transactions in 2015, compared to 206 during the same period in 2014. (Note: A transaction is defined as a sale between one buyer and one seller. By way of example, Berkshire Hathaway Automotive’s acquisition of Van Tuyl is considered a single transaction, although it included 78 dealerships and 116 franchises.)
Among the franchises being acquired, import franchises saw their market share increase by nearly 10%, while the domestics lost similar market share as compared to 2014. Kerrigan Advisors attributes this shift to an increase in supply of top import sellers, luxury and non-luxury. Though domestic franchises represent 67% of all US franchises, they accounted for only 36% of the franchises sold in 2015. This discrepancy is a result of the large number of domestic franchises that are smaller, and located outside of the major metro and suburban markets where buy-sell activity is concentrated.
The public retailers’ acquisition spending has decreased an estimated 43% in 2015 (final numbers not released, as this is being written) compared to 2014. Last year, the publics surpassed their annual pre-recession acquisition spending and reached their highest US acquisition spending in auto retail history at $1.45 billion. For the year, public acquisitions spending was almost entirely focused in the US, a notable shift from a few years prior when nearly 30% of acquisition spending was outside of the United States. That said, the strength of the US dollar may have prompted the recently announced acquisition by Group 1 of Spire Automotive, a 12 dealership platform that will expand their presence in the United Kingdom.
Though the public companies increased their acquisition spend, the private buyers, including new market entrants, continued to dominate the buy/sell market in 2015. Private buyers represented 91% of franchise transactions, and are generally less constrained than public companies, many of whom are subject to framework agreements which limit their ability to purchase certain franchises or make large multi-dealership acquisitions.
Family Offices and Private Equity
After two years of discussion, 2015 marked the entry of significant outside capital into the auto retail industry. As noted earlier, the Van Tuyl transaction by Berkshire Hathaway was finalized in the first half of the year, and was soon followed by the announcement of additional large, private acquisitions. For example, Mark McLarty purchased (backed by George Soros’ family office) Joe Machens Dealerships, a 14 store platform in Missouri, and Fremont acquired Morrie’s Automotive Group in Minnesota. New dealership buyers comprised of family offices, private equity firms, and public conglomerates acquired 30% of the franchises sold in 2015, a remarkable new development. Kerrigan Advisors believes these and other new entrants will increasingly shape dealership consolidation and meaningfully impact the future of auto retail.
Importance of Real Estate
In recent transactions, we have seen the new, outsized importance of real estate in automotive retail transactions. Appraisals are consistently coming in well above expectations, which has the benefit of increasing transaction sizes and allowing for additional buyer financing. When real estate appraisals are higher than anticipated, we generally increase the rent factor for the dealership, and reduce the store’s profitability.
Because real estate trades for a higher multiple than dealerships, this has the net effect of increasing total transaction proceeds for the seller. And, given low interest rates and aggressive financing options for real estate, buyers are generally willing to accept the higher real estate costs in order to get the deal done.
In some cases, buyers are basing their pricing on a multiple of EBITDAR (earnings before interest, taxes, depreciation, amortization and rent), offering a single price for an entire transaction including real estate. This approach recognizes the importance of real estate to dealership operations. As commercial real estate prices continue to rise and image requirements expand, Kerrigan Advisors believes transaction pricing will be increasingly affected by real estate values.
Publics’ Capital Acquisitions are Driven by Stock Price
The publics’ stock prices plummeted an incredible 29% since 2015 (see chart below). This decline has resulted in a significant decline in their valuation metrics. Generally, the publics only make acquisitions which are accretive to earnings. In order for an acquisition to be accretive to earnings, the buyer’s P/E multiple (stock price/earnings per share) must by higher than the seller’s P/E multiple (asking price of a transaction including blue sky, fixed assets and working capital divided by the dealership’s earnings).
The collective P/E multiple for all of the publics reached a peak in 2014. Given this, it is not surprising that public acquisition activity recently reached historic levels – public companies’ strong valuations increased their ability to pay up and still do transactions very accretive to earnings. However, at the end of 2015, the publics’ P/E multiple is expected to decline, reflecting the industry’s slowing growth rate. Similarly, in the private market, as the growth rate of dealership earnings declines, valuation multiples will begin to come down. Kerrigan Advisors has noted that both buyers and sellers are becoming increasingly aware of the interplay of earnings growth and valuation multiples, prompting more sellers to come to market and more buyers to sharpen their pencils.
In this light, the valuation metrics of the public companies are an important indicator for future private dealership valuation trends. The six public dealership groups are marked to market every business day by thousands of investors who buy and sell their stock. The efficiency of the public stock exchanges, relative to the private dealership buy/sell market, informs franchise valuation trends and should be closely watched.
In summary, 2015 was a momentous year in the buy-sell market for auto retail. Large transactions, a large number of transactions, and the entry of significant new players will impact our industry for years to come. We believe that the buy-sell market will remain strong in 2016, and – in particular – foresee the announcement of multiple large transactions that have been in process for many months, if not quarters. But, we anticipate the public companies will be less active acquirers in 2016, and may portend slowing buy-sell activity in the years ahead.
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