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The Big Are Getting Bigger

Amidst an active discussion of change, robust transaction activity, and consolidation in our industry, it is worth considering just exactly why this is all coming about. To put it simply: the benefits of size are really starting to play out. And it’s not just a story of economies of scale, though that is certainly part of it. Increasingly, large groups are using their size to diversify, innovate and better position themselves for the future.

Platforms Getting Larger 

To start with the numbers, there is clearly a bias towards larger platforms. While consolidation has been discussed for two decades or more, the past five years has seen a record level of transaction activity. Kerrigan Advisors estimates 1/8th of the dealer body has changed hands since 2013. Multi-franchise transactions are up 43% through the first half of 2018 versus the first half of 2017 (see Chart 1), and now the average multi-franchise transaction represents 3 ½ franchises.

There are now 176 dealership platforms with more than 11 dealerships, which represents an increase of 63% since 2010 (see Chart 2).

The publics also continue to grow their platforms through dealership acquisitions. After a strong year of acquisitions in 2017, acquisition spend is up an additional 9% in 2018 and the publics are tracking towards one of the highest levels of acquisition spend in the last 10 years (see Chart 3).

Economies of Scale 

Upon reviewing the financials of the publicly traded auto retailers, their SG&A (sales, general & administrative) expense as a percentage of gross profit, even with all of the expenses associated being a publicly traded company, averages just under 73%. It is fair to assume that many large private players, without the expense of operating as a public company, are less than 73%. When we compare that to the smaller dealer operators, who have historically been the nimble players in our industry, we see average SG&A expense far exceeding the public’s rate of 73%, coming in just shy of 90% (see Chart 4).

And when viewing the statistics over time, this is an issue that is getting worse in recent years (see Chart 5).

While there are some basic things that larger players can do more efficiently, such as advertising, human resources, and in-house legal, we believe this story is fundamentally about technology.

The cost of adopting new technology, and signing up for new subscription sources, is really driving up the cost structures of many independent dealers and smaller groups. By contrast, larger groups are leveraging the same technologies, and more fundamentally, changing their operations to drive cost efficiencies.

Economies of Scope, Broadening Operations 

Perhaps even more impactfully than economies of scale, we are seeing larger players flexing their ability to broaden their business models at a time when new-car profits are shrinking (new car gross margins are down 49% versus 2011 – see Chart 6).

To quote David Hult, Asbury Automotive’s CEO on their first quarter earnings call this year, “Our plan for the remainder of 2018 is to focus on the aspects of he business that we can control, specifically, parts and service, used cars, F&I and overall expense management.”

Large groups are diversifying away from the new car business in multiple ways, including:

AutoNation has also made a very significant commitment to acquiring collision centers, and now operates 81 collision centers across the US.
Sonic Automotive, AutoNation, and Group 1 Automotive are investing in standalone used car dealership concepts, Echo Park and Val-U-Line respectively, to pursue the higher margin used car business. Interestingly, Val-U-Line is targeting used car segments that many dealerships choose to wholesale, representing a real expansion of the scope of Group 1 Automotive’s operations.

Holman Automotive continues to grow into fleet management, now operating the largest privately-held fleet management company in the world. (This will likely pay dividends as automotive retail continues to experiment with different kinds of fleet management and subscription models.)

And, some such as Penske Automotive Group are diversifying outside of the US market. Penske continues its international expansion with the completion of its acquisition of Car People, a used car retailer in the UK earlier this year.

Tapping Scale to Innovate

Large groups are also tapping their scale to innovate and try new ideas in an industry that we know to be changing. To cite a few examples:
AutoNation has been using its strong market presence in the Phoenix MSA to partner with WayMo, offering its customers a Waymo vehicle instead of a loaner. AutoNation also announced a partnership with WayMo to complete the service needs of WayMo’s autonomous fleet.

Lithia recently announced a strategic partnership and $60 million investment in online used car platform Shift. Shift aims to simplify and bring online the transaction process, and Lithia is able to put its very significant used car inventory on this platform by way of this partnership.
Penske made a strategic investment in Fair, an innovative platform that allows for flexible-length, all-in vehicle subscriptions to consumers. This overlaps nicely with Penske’s largely luxury platform, providing them direct experience in new types of flexible ownership and fleet management.
Other large regional groups are trialing Clutch to gauge new subscription concepts and fleet management as a business model.

The Warren Henry group out of Florida announced they are rolling out their own subscription model, FlexWheels, in which they will allow customers to shift between different makes and models – a subscription service that is dealer centric versus OEM centric, much like Clutch.
Publics, like AutoNation and Lithia Motors, and private dealership groups such as Del Grande Dealer Group (DGDG) in Northern California are announcing the addition of CTOs (Chief Technology Officers) to the executive leadership team. DGDG has multiple technology initiatives underway, including innovating real-time tracking of regional inventory and pricing of used cars, as well as highly efficient, real time evaluation of different online media campaigns.

Though there has always been some benefit to size in automotive retail, the benefits of scale are becoming increasingly clear. Starting with overhead expense, large groups are operating at a distinct cost advantage to smaller players. And, increasingly, large groups are using their size to expand the scope of their operations, diversifying away from the new car business, and using their cash flow and balance sheets to innovate. This is a phenomenon that has been seen many times in other industries and is starting to play out in automotive retail.

We regularly talk with dealer groups that have been considered “the big guy” in their local marketplace, but even these management teams are feeling the need to get bigger, and to accelerate their acquisition plans. While uncertainties remain about the future of auto retail, there is one peg you can hang your hat on: consolidation is here and will accelerate in the coming years.

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