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Factors Affecting Blue Sky Multiples

Today’s buy/sell market is robust and dealership values are very strong. This chart is based on the Kerrigan Advisors franchise values in the current buy/sell market. Each franchise in the chart is designated with a high, average and low multiple. I am often asked what causes franchise multiple variability? Most dealers understand the average performance multiple, which is associated with an average performing franchise. But they often ask what would cause a dealership to be valued in the high range, versus the low range.

Chart I - Kerrigan Advisors Blue Sky Chart - Luxury
Source: Kerrigan Advisors Analysis
Chart I - Kerrigan Advisors Blue Sky Chart - Luxury
Source: Kerrigan Advisors Analysis

There are four key factors that drive the variability of blue sky multiples. In this article, I am going to cover two of the four: (i) earnings growth expectations and (ii) buyer demand. In next month’s article, I will cover the remaining two: (iii) real estate and (iv) market vehicle preference. The combination of these four factors plays a major role in the blue sky multiple a buyer is ultimately willing to pay. Together, they determine whether a dealership will trade for a high or low multiple. Below is a review of the first two factors, including some examples.

FACTOR ONE: EARNINGS GROWTH EXPECTATIONS

1. Higher Growth = Higher Multiple:

  • Underperforming dealerships provide an opportunity for higher earnings growth. A dealership that is underperforming, meaning its profitability and/or sales are below market expectations, often commands a higher blue sky multiple. Why? Because buyers believe they can grow profits at an above average rate by reducing expenses, increasing gross profit or growing sales. Simply by “fixing” the underperformance, buyers should experience a higher level of earnings growth than they normally would with that particular franchise. For example, I recently represented two underperforming dealerships that commanded very high multiples (even higher than the multiples in our chart). The profitability of both of these stores was far below market. The buyers felt that they could achieve outsized earnings growth within a year and accordingly priced the blue sky at a multiple far above average.
  • Dealerships in high growth markets have higher earnings growth expectations.Dealerships that are located in high growth markets, meaning markets that are growing their economy and population faster than the national average, often command a higher blue sky multiple. Buyers are willing to pay a higher multiple because they know that their sales and thus their earnings will grow at a faster pace than what they would achieve in an average market. By way of example, Texas, Arizona and Florida are high growth markets where dealerships often command premium multiples.

2. Lower Growth = Lower Multiple:

  • Over-performing dealerships can experience below average earnings growth post sale. Ironically, a dealership that is over-performing, meaning its profitability and/or sales are above market expectations, often commands a lower blue sky multiple. This usually surprises sellers, as they believe their over-performing store should command a higher blue sky multiple. The reason over-performing stores receive lower multiples is because the buyer does not expect earnings to grow at an above average pace post transaction; in fact, they often believe earnings could decline after the sale. As a result, buyers are often unwilling to pay a high or average multiple for an over-performing franchise.
  • Dealerships in slow growth markets can expect slower earnings growth. Dealerships located in low growth markets, meaning markets that are growing their economy or population slower than the national average, often command a low blue sky multiple.

FACTOR TWO: BUYER DEMAND

1. Higher Demand = Higher Multiple

  • Dealerships located in major metro markets are in high demand. Today, there is more demand than supply of dealerships for sale in major metro markets. Large, well-funded buyers are seeking dealerships in these markets where they often already have a presence. As a result, there is a great deal of competition for major metro stores. High buyer demand, with limited seller supply, drives up price (Economics 101). Thus, dealerships in higher demand markets command higher blue sky multiples.
  • Dealerships in the Sunbelt are in high demand. Most of the largest, well-funded private and public dealership consolidators are focused on the Sunbelt states. Dealerships in these states can expect a higher multiple.

2. Lower Demand = Lower Multiples

  • Dealerships located in rural markets have fewer buyers. There are fewer buyers seeking dealerships in smaller/rural markets. Less demand means less competition and lower blue sky multiples. In addition, buyers seeking dealerships in smaller markets often have less capital, which can result in lower blue sky multiples.
  • Dealerships located outside the Sunbelt are in lower demand. As stated above, the largest dealership consolidators are expanding primarily in the Sunbelt states. Because there is less demand for dealerships located in areas outside the Sunbelt, dealerships located in these markets can receive lower blue sky multiples.

Sometimes all of these valuation factors can counter-balance one another. For instance, you may have an underperforming dealership located in a low-demand market or an over-performing dealership located in a high-demand market. In both cases, those stores could command an average franchise multiple. Next month, I will discuss the other two factors (real estate and market vehicle preference), which further affect the multiples a buyer is willing to pay.

Remember, valuing dealerships is much more of an art than a science. Ultimately, a dealership is only worth what a buyer can and will pay, and what a seller can and will accept, in other words the market-clearing price.

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