For many years, domestic franchises were a challenge to sell. Buyers were unwilling to pay up for blue sky and were rightly concerned about declining market share and potential OEM bankruptcies. As a result, the prices offered for these franchises were very low, sometimes as little as zero, particularly in 2009. Even highly profitable domestic franchises were unable to garner significant blue sky.
How times have changed! For the first time in almost a decade, the sale of domestic franchises is not only possible, it can be profitable. Domestic franchises are in greater demand and have increased in value for several reasons:
OEM balance sheets have been repaired and cost structures rationalized: General Motors and Ford recently received a credit rating upgrade from S&P and both are more profitable than they have been in years. With healing balance sheets and improved P&Ls, domestics are able to invest in product development and marketing, further strengthening their businesses and ultimately the value of their franchises.
Product quality is equivalent to imports: Product quality has improved significantly, with most domestics ranking at or above high-volume import manufacturers for the first time in decades.
Domestic market share is rising, often at the expense of high volume Asian imports. As Chart 1 clearly indicates, the current market share shifts are favoring the domestics at the expense of the high volume Asian imports – though much of this is currently driven by the effects of the Tsunami and the floods in Thailand. That said, this shift may be difficult to undo given the yen’s recent rise, which limits Japanese companies’ ability to profitably buy back market share with incentives.
Sales and profits at domestic stores are rising. In part due to the decline in the number of franchisees, sales and profits at domestic dealerships are rising sharply, in some cases to the highest level seen in years.
As a result of these trends, we have seen domestic franchises return to the top buyers’ shopping list. Chart 2 shows the breakdown of franchise acquisitions by the top 10 dealership groups in 2010 as compared to 2011 (YTD November). As you can see, the leading buyers are once again acquiring domestic franchises and spending less of their acquisition capital on non-luxury import franchises.
In a lot of ways, the shift in buyer interest is not surprising given the potential return on investment available to buyers of domestic franchises. If you compare the blue sky multiples as published in Presidio’s August M&A Report (available at www.presidioautomotive.com), to manufacturer sales growth, you can see why buyers are once again interested in domestic franchises, see Chart 3. Buyers feel they can buy a franchise with above average sales growth at a low blue sky multiple, which could result in a high return on investment.
Despite the domestics’ market share increases, there are a number of factors that may keep domestic’s blue sky multiples lower than those of the high volume imports:
Excess real estate. Most domestic stores sit on facilities that were originally sized for much higher volume. They have far more property than they need to meet current demand. These unproductive assets are still viewed as valuable by a current dealer, but may not add value to a buyer. Generally, the higher the property value, the lower the blue sky value.
Facility improvements are needed.Many domestic facilities are old and require significant investments in order to match the level of appearance and customer comfort offered by import competitors. A high investment requirement reduces blue sky value.
Supply and demand. There are still 10,288 domestic dealerships in the U.S. compared to approximately 4,600 midline Japanese and Korean dealerships. Dealership buyers have many domestic stores from which to choose, so they can look until they find a lower priced dealership. (Source: NADA)
Lower profits.In 2010, the average Ford store selling 588 new units per year was making a lot less than the average Toyota store selling 1,201 new units per year. Most buyers are looking for higher earnings to support their investment in real estate and working capital. (Source: NADA)
Weaker acquisition financing. The captive finance companies for Toyota/Lexus, Honda, BMW and Mercedes-Benz are very well capitalized and will offer attractive real estate and possibly blue sky financing to qualified buyers. These captives have access to a lower cost of capital than the financing arms of Ford, GM or Chrysler. Less attractive financing terms contribute to lower multiples for the domestics.
In the end, one of the factors that determine the blue sky multiple a buyer is willing to pay for a franchise is the franchise’s perceived investment risk. The greater the risk, the lower the multiple, while the lower the risk, the higher the multiple. As it relates to domestic franchises, we may be at a tipping point where the perceived risk is beginning to decline – particularly if market share gains stick. If the risk associated with domestic franchises declines, those who bought them at three to four times blue sky will certainly look like geniuses. Only time will tell. In the meantime, it is nice to see domestic blue sky value return and it will certainly be interesting to see where it heads in the future.