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Blue Sky Financing Returns

If you are attending the NADA Convention in Orlando this month, I recommend you do two things during your visit. First, I hope you attend my workshop on “Key trends in buy/sells.” If you are a reader of my articles, I think you will find the workshop very informative (last year’s ranked number one by NADA attendees). This year’s workshop will discuss today’s buy/sell activity, the franchises in highest demand by buyers, current blue sky multiples and the effect of the aging dealer body on future buy/sell activity. I will also discuss the current financial markets and their impact on dealership values.

This leads me to my second recommendation for the convention: spend time with lenders. This recommendation is driven by the fact that business lending has finally returned and capital is once again flowing to our industry. These lending relationships are critical to your business, particularly if you are planning to acquire dealerships. Financing can make or break a buy/sell.

As most of us know, buy/sell activity (except for workouts) nearly came to a standstill during the depths of the recession. This was in large part due to severe weakness in the credit markets. The credit crisis not only truncated car sales, it halted dealership sales. Even well capitalized dealers faced never-before-seen roadblocks when trying to obtain floor plan for an acquisition. The financial markets determined that dealerships were too risky. At that time, most lending institutions focused on reducing auto retail exposure, not increasing it.

How the world has changed! The financial community has re-discovered what many dealers never forgot. Auto retail is a highly attractive, generally recession-proof industry, that provides dealers with a strong investment return and lenders with a profitable, low default loan source. Even during the recession, the average dealership remained profitable and has since come roaring back. According to NADA, the average dealership has seen its pre-tax profits rise 35% annually since 2008 (see Chart 1), a remarkable comeback and one that exceeds even pre-recession performance.

Average Dealership Profit
Source: NADA

As a result of this robust rebound, investor interest in our industry is high. As an example, the public auto retailers have raised $7 billion dollars in bond offerings and lines of credit since May 2010 (see Chart 2). Another example of the industry’s renewed capital availability is the securitization market for both auto loans and floorplan. These securitizations are approaching pre-recession levels and are being priced at record lows. In this low yield investment environment, even companies like Google have parked their cash in securitized pools of AAA rated auto loans. Banks and captives are taking advantage of this low cost capital source and are prepared to put their capital to work for dealers.


Public Auto Retailer Debt Offerings

Source: Company SEC Filings

This increased capital availability combined with a very low cost of capital and a very healthy dealership business are having a dual effect on our industry: more banks are entering the market and there is renewed competition for dealership business. This competition is greatly improving dealership lending terms, driving banks to increase their financing levels on real estate and blue sky, and putting increased pressure on rates. Dealers are reporting significant reductions in their floorplan rates. I have also spoken to several banks who indicated their willingness to lend 50% or more on blue sky at rates as low as 5%. Similarly, I recently heard of a captive who financed nearly 100% of blue sky for a buyer.

Dealers should understand that most industries do not have the luxury of such low-cost acquisition financing. The auto retail industry is unique in this regard. Why is this? It is largely due to the fact that most lenders link acquisition financing with floorplan and real estate. When pricing an acquisition loan, lenders consider their overall return from the dealership/dealer relationship, not just the blue sky financing. As such, to some degree, the blue sky financing is subsidized by the floorplan line, resulting in below market acquisition financing.

What does all of this mean for dealership buyers and sellers? For buyers, it means that you may be able to pay more for a dealership if you can finance a significant portion of the acquisition at currently low interest rates. With less equity in a transaction and low financing rates, your return on equity will likely be very high, even if you pay a strong blue sky multiple. Consider Chart 3, which shows the amplification of equity returns when leverage is deployed. For sellers, it means your timing is good. As we learned during the recession, the credit markets are a key player in buy/sells. Today they are more than cooperating.

Equity Investment Returns on a Dealership Acquisition at Differing Debt and Interest Rate Levels
Source: Presidio Automotive Analysis

So, when you are choosing which party to attend at NADA this year, I strongly suggest including the lenders on your list. These relationships are very important and can have a meaningful economic effect on your business today and your ability to grow your business in the future. In my experience, the more you have the better. I hope to see you in Orlando!

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