Date published: March 23, 2016
Will this year keep pace with 2015 buy/sell records & maintain blue sky multiples for sellers?
In the recent Blue Sky Report, authors Ryan and Erin Kerrigan of Kerrigan Advisors addressed the high volume of activity in the dealership buy/sell market in 2015. According to the report, transaction activity increased by 17 percent over 2014, from 206 transactions to 242 transactions.
The husband-wife team noted marginal fluctuations in the blue sky multiple “guide posts” they publish quarterly. But, the report also identified significant trends and unprecedented happenings in buy/sell activity history. DrivingSales News interviewed Ryan Kerrigan following the report’s release.
Summary of Buy/Sell Activity: Interview with Ryan Kerrigan
The Blue Sky Report gives readers a low-to-high gauge from which to analyze their dealership assets. The Kerrigan approach to developing the range is based on four factors: earnings growth expectations, buyer demand, real estate and market preference.
2015 Trends: New Entrants, ROFRs, and Increasing Importance of Real Estate
It was a year of unprecedented deals. The entrance of family offices, private equity firms, and public conglomerates (e.g. Warren Buffet) was probably the most unique element of last year’s buy/sell scene. New players captured 29 percent (165 franchises) of the total franchises sold according to analysis by The Banks Report and Kerrigan Advisors.
Kerrigan also noted in the report that the right of first refusal (“ROFR”) was commonplace in 2015, but more often exercised in single store transactions than multi-dealership transactions.
Finally, real estate became increasingly important. Kerrigan says buyers are more diligently incorporating real estate value into their analysis of operations and therefore valuations. This approach is driven by both the rise in cost of commercial real estate and OEM facility requirements.
Economics Sustaining the Swell
Kerrigan observed a cluster of factors that have sustained the past year as a sellers’ market: high unit volume, low interest rates making dealerships more profitable and vehicles more accessible, and manufacturer incentives supporting growth.
“Profits for dealerships have been strong and the willingness to pay full multiples on the earnings has been very strong,” Kerrigan said. “We’re certainly not one to call the market or predict it’s going to end on a given date, but we advise people to not take this bull market for granted. Times are good, and this period will not last forever.”
Synergies and Risk Mitigation Build Value
“Private businesses, and the smaller they are, tend to sell at a discount,” he said, citing that the rule isn’t specific to automotive retail. “Smaller businesses are perceived to be riskier and more susceptible to something happening: losing a key manager, a change in the town in which they’re located, and a host of other issues.” Kerrigan said large groups and publicly traded groups benefit from factors like brand diversification, strategic regional scale, and other synergies – assuming their operators are strong.
Brand and Location Drive Buyer Demand
Kerrigan says a specific trend within automotive retail has been a push toward metro and a push toward luxury. Kerrigan said, “The general dynamics of the United States have rural areas losing population or at least lagging population growth relative to urban areas.” He added that the broadening of the product lines by traditional luxury brands such as BMW, Mercedes, and Lexus has “redefined” what it means to buy luxury. “These trends put downward pressure on the salability of smaller franchises and those located in non-metro areas,” he concluded.
New Entrants and Holistic Approach to ROI
In the report, Kerrigan Advisors perceptively cites the pragmatic approach new entrants and buyers are bringing to valuation. The process of determining free cash flow as a percentage of total investment incorporates everything from full enterprise value, working capital, fixed assets, real estate and borrowing costs.
“We know private equity, and generally the people that populate family offices tend to have backgrounds from private equity,” he said. “They simply won’t write the check until those types of calculations are understood.”
Understanding and Building Value from the Dealers’ Perspective
Over the course of his career as an entrepreneur and dealer, Jon Lancaster has made what some might consider bold business moves. He sold his stores in Madison, Wisconsin to Penske Automotive Group in 2012. His insight on tax law, interest rates, and general market threats led him to prepare for sale. Today he applies a broad technical understanding of the industry to advise dealers around the globe.
“When you’re talking about macro market potential and you only look at industry SAAR, you’re missing the whole point,” he said. “I bought and sold deals locally and switched brands throughout my career, but it took me at least five years to get a real handle on valuations and who would best represent my transaction.”
Lancaster says if he had a store today, he’d be asking a lot of questions.
What is the trend between retail and fleet? Is the market at risk for the commoditization of used vehicles? What is our governmental risk, e.g. the CFPB? What is the general consumer sentiment? “If we look at the average American family, what we’re really learning is that the average household’s purchasing power is decreasing,” he said. “OEMs respond with bigger incentive budgets and extended finance terms but that behavior has an expiration date, I’ve seen it before.”
Long before he sold, Lancaster says he asked his executive team similar questions and as a result, dialed in his operations. The stores became exemplars of operational excellence; they got in the “real” (non-commodity) used car business, focused on service and parts sales, evaluated their brand/OEM partnerships, and became relentlessly cognizant of customer behaviors and trends, responding with innovations like 15-minute Quick Lubes.
Lancaster says a lot of dealers are behind the curve, and before a downturn they need to thoughtfully analyze expenses and evaluate their businesses for long-term resilience. Kerrigan Advisors paralleled the sentiment in their analysis of market trends shaping 2016; specifically 1) return on investment drives valuations, particularly for larger transactions and 2) blue sky multiples are firmer, less dependent on profit potential.
While Lancaster isn’t financially invested in stores today, he says he’s discussed strategic investment in dealer groups. He is known for urging his dealer-operator peers to manage their businesses with financial discipline. He said, “We need to re-establish to the public that despite disruption, dealers have a pivotal role in the responsible sale and service of vehicles.” He offered a few starting points:
The coming months will undoubtedly be heavily examined and analyzed against the unprecedented factors that spiked the level of transactional activity in 2015. Dealers who gain understanding of their true asset value will be better equipped to critically evaluate their unique place in the macroeconomics of the industry.
Kerrigan and Lancaster will be co-presenting with respect to many of the topics discussed in this story at the DrivingSales Presidents Club in Miami, May 4-6.