Dealers are exceptional at tracking their financials. They often recite from memory their monthly new car PVRs and net income, sometimes to the penny! They know their net to gross and net to sales ratios, as well as key balance sheet figures such as total inventory, floor plan and mortgage debt outstanding. They attend 20 group meetings to further track their metrics against their peers and pinpoint areas for improvement.
But dealers rarely bring the same kind of analytical rigor to their manufacturer’s financial statements. Few can tell you their manufacturer’s profit margin or, more importantly, how much debt their manufacture is carrying as compared to equity. This is surprising given that the financial health of a franchisor drives franchise value. A financially strong manufacturer usually means a financially valuable franchise.
Consumer creditworthiness and financial health is tracked through a credit score. Likewise, businesses creditworthiness and financial health is tracked through a credit rating. Recently, we all became very familiar with the importance of credit ratings when the U.S. government was downgraded by Standard & Poor’s. That downgrade was a stark reminder of the importance of good credit, whether you are an individual, business or the government.
A manufacturer’s credit rating is an indication of its ability to raise funds in the capital markets, as well as the cost of those funds. A high credit rating usually means a low cost of capital and strong access to capital, while a low credit rating means a high cost of capital and limited access to capital. So, why should dealers know and understand their franchisor’s credit rating?
Here are a few good reasons:
When a manufacturer has a low cost of capital as reflected by a high credit rating, its franchises are usually highly valuable. The inverse is also true. When a manufacturer has a high cost of capital as reflected by its low credit rating, its franchises are usually much less valuable. Table 1 demonstrates this conclusion. It compares Moody’s* current credit ratings (8/23/2011) and The Presidio Blue Sky Multiples**, which are our estimates based upon recently closed transactions, current conversations with leading buyers, and Presidio’s opinion of these franchises’ future performance (Presidio recently completed its M&A Update for the first half of 2011 which includes a detailed discussion of these multiples. Please contact me if you are interested in receiving a copy).
Clearly, there is a close correlation between a franchises’ blue sky multiple and its manufacturer’s credit rating. If you are a buyer of franchises, you may use this table as an indication of where you should invest your capital and the risk level of that investment. Alternatively, dealers can gage the value of their businesses today based on the financial fortitude of their manufacturer and determine if now is the right time to sell, hold or invest further in their businesses.
Just as Americans have a major stake in the creditworthiness of the country, dealers have a major stake in the credit rating of their manufacturer. Dealers should apply the same kind of analytical rigor to their manufacturer, as they do to their own business, especially if they are a buyer or seller. A financially successful dealership and a financially sound manufacturer are the two key ingredients for strong franchise value.