The automotive retail industry has been abuzz in recent weeks after the announcement of Warren Buffett’s acquisition of the Van Tuyl Group, and the creation of Berkshire Hathaway Automotive Group. This acquisition has the industry talking about private equity and other types of outside capital seeking dealership acquisitions.
Do these financial players represent the car dealers of the future? I believe they will likely play a larger role in the buy/sell market. For starters, let’s define private equity and family offices. Although there are different variations, the typical private equity firm raises capital from 10 to 20 large institutions, including pensions, endowments, and insurance companies. These institutional investors are called “limited partners” – in contrast to the private equity firm, which serves as the “general partner” of the fund.
When a private equity firm says it has a $500 million fund, what that means is this: its limited partners have committed to investing up to $500 million over a certain period of time. When a private equity firm decides to do a deal, they do a “capital call” from the limited partners, who forward the cash, allowing the private equity firm to close on the transaction.
Private equity firms often have a five-year period in which to invest the capital, and an additional 4 to 5 years to mature the investments and sell them. They are not buy-and-hold investors, but rather, “buy, improve and sell” investors. Generally speaking, private equity firms need to sell all of the investments in each fund within 10 years of the inception of the fund. (Note: This is not 10 years from when each investment is made. The clock starts ticking when the firm raises the funds from its limited partners.)
Not surprisingly, manufacturers’ primary concern with private equity is that they are not long-term investors by definition. That said, there have been some private equity firms that have made investments in auto dealerships, there are many firms currently doing serious research, and considering entering the space.
In contrast to private equity firms, there is another source of private capital that can play the role of long-term investor. Family offices are investment teams that are assembled to manage the assets of a single high-net worth family, or in some cases, the assets of multiple high-net worth families. Tycoons, Wall Street moguls, and “old money” families are among those that establish family offices to manage their assets.
Family offices are often staffed by investment professionals with private equity backgrounds, and will evaluate transactions in a similar manner as private equity firms, but with a notable difference – they have a long-term investment horizon and do not have the mandate to sell within a specific period of time. Family office capital is often referred to as “evergreen” because they are not confined to the time limitations of private equity funds. Given the long-term nature of their capital, family offices have been viewed on more favorable terms by manufacturers and been approved to acquire top franchises.
The constraint that private equity firms and family offices share is a lack of industry knowledge. Ours is an “operationally intensive” industry, which means that investors need to know what they are doing, or they can lose their shirt. As with any dealer who delegates responsibility for a dealership to a general manager, these outside investors must partner with very strong operators in order to be successful. Any experienced dealer knows that this is no easy task. Private equity firms and family offices are beginning to learn this lesson.
So, are these new sources of capital likely to come into the auto retail space in a significant way? It is certainly possible, for a couple of key reasons.
For these key reasons, we anticipate continued interest on the part of private equity firms and family offices in auto retail. What does this mean for dealers?
Warren Buffet may well kick off a major trend in the investment community – become a car dealer! We anticipate a number of acquisitions to occur in the near future. Even if many of these investors are tire kickers, there is enough kicking going on that more buying should occur.