Multiples, multiples, multiples. Dealers talk about blue sky multiples, a shorthand for valuation, all the time. And, Kerrigan Advisors publishes The Blue Report™, where we discuss the recent multiples associated with each franchise.
But, we all might be accused of overly fixating on this topic, or at least overly simplifying our conversation about multiples.
As the industry cycle is evolving, it is worth revisiting the blue sky multiple and discussing the many nuances associated with this seemingly simple concept.
Contrary to common perception, the discussion of multiples going up, or going down, does not accurately capture the value of your business.
For starters, multiples are very hard to compare in a fragmented industry dominated by private companies. The manner in which private companies manage their financial statements, affiliated businesses, management companies and family expenses vary greatly from business to business. While there is a general industry understanding of applying multiples to “normalized” earnings, there remains great disparity in practice.
Working within the framework of “normalized” earnings, there are still many variables that impact the stated multiple. In The Blue Sky Report™, we identify four key factors that materially impact the multiple at which a dealership will trade: earnings growth expectations, buyer demand, real estate and market suitability.
First and foremost, buyers assess what they believe they can make in a dealership. Whether it is market timing or operational improvements, buyers’ perceptions of future earnings meaningfully impact their willingness to “pay up.” Conversely, market timing or over-performance can have the opposite effect.
“The next time you engage in conversation, or hear about a fantastic transaction that got done at “10 times,” bear in mind that this shorthand valuation metric leaves out many relevant variables. Ask the question, 10 times what?”
Recently, we spoke with a dealer making 40% net to gross, according to his financial statements, and achieving 120% sales efficiency. To his surprise, we advised him that his store would likely trade at a below average multiple. Given his incredible over-performance, buyers would be concerned that earnings would decline under their ownership, thus reducing their willingness to pay a full multiple. (That said, even at a discounted multiple, his store would sell for a great deal of blue sky and significantly more than any similar store in the region because of his high level of profitability.)
Likewise, demand for certain regions is much higher than in others. In recent years, the southern and western regions have attracted many more strategic buyers. And, the metro and affluent suburban locations have been in high demand given the strong performance of many of the luxury brands in the recent economic cycle. Conversely, we have witnessed noticeable discounts on deals in slower growth deals in the northern states, and in non-metro areas.
Real estate can also materially impact a store’s multiple. Real estate expense is generally fixed. As such, the higher the real estate value (and associated rent), the higher the dealership’s breakeven point, putting more pressure on the business model. High real estate costs can put downward pressure on multiples. Conversely, image compliant and relatively inexpensive real estate decreases business model risk, and can increase a buyer’s willingness to pay up. Again, two very similar dealerships can command different prices depending upon the real estate component.
Lastly, makes that are particularly well suited to a market tend to command higher multiples (i.e. trucks in Texas, four-wheel drive vehicles in the mountains, and luxury makes in Miami and Los Angeles). The strong suitability of certain products in certain markets reduces the perceived risk, and often gets buyers more comfortable with a franchise premium.
In terms of the industry cycle, we find that the industry’s definition of multiple varies as well. In the up cycle, sellers want to emphasize real-time or projected full-year earnings in the sales process. By contrast, in uncertain times, buyers emphasize historical results, possibly even basing valuation on a trailing three-year analysis or considering a projected decline in future earnings.
Obviously, by changing the time periods used, one can greatly manipulate the effective multiple paid, particularly when trying to analyze multiples on an apples-to-apples basis. Five times last year’s earnings could be eight times this year earnings, and vice versa.
Additionally, dealers need to add the real estate proceeds to get a full picture of the transaction value. As profits can flow from the dealership financial statement to the real estate company, and vice versa, there is interplay between the value of the dealership, and the value of the real estate.
The broader point is that multiples do not fully relay transaction value.
In the bigger picture, for a given franchise in a given location, we care more about the total transaction value, versus the multiple. Some dealers today are experiencing record profits, and in some cases, profits that are two or three times higher than historical performance. Selling the dealership at a non-exciting five times multiple may not sound like a phenomenal deal, but five times current earnings may result in a remarkably high transaction price, a transaction price that far exceeds the amount that could’ve been generated historically.
The next time you engage in conversation, or hear about a fantastic transaction that got done at “10 times,” bear in mind that this shorthand valuation metric leaves out many relevant variables. Ask the question, 10 times what?
At the end of the day, dealers considering selling their businesses want to get the best value possible. Overly focusing on “multiples,” may lead to poor decision- making.