By Don Ray, Portfolio
Several years ago, my son competed for his high school, Westminster Academy, in our hometown of Memphis, TN, in a city-wide competition of smart high school students (he gets his smarts from his Mom) by answering various questions in several different categories.
The judges used Wikipedia to settle any challenge to determine if an answer was correct. Unfortunately, Wikipedia does not have an answer as to the appropriate valuation for a car dealership. That being the case, I feel compelled to step in here.
You have negotiated a purchase price on a franchised auto dealership. We can debate over the net income base. Is it trailing 12 months, last calendar year, average of multiple years, weighted average of multiple years, forecasted earnings? You get it. The options go on and on. Whatever method you use to get there we will assume the net income base is $1,150,000 and the sales price of the Furniture, Fixtures and Equipment (FF&E) is $870,000.
The facts are something like this:
| net income (pre-tax) | $1,150,000 | |||
| add backs (take-aways) | ||||
| F&I packs | 100,000 | |||
| Country club costs | 40,000 | |||
| Absentee dealer compensation and benefits | 210,000 | |||
| interest (not including floorplan) | 35,000 | |||
| Rent normalization | (200,000) | 185,000 | ||
| adjusted net income | 1,335,000 | |||
| Blue sky multiple | 6 | |||
| Blue sky | 8,010,000 | |||
| FF&E | 870,000 | |||
| Working capital requirement | 1,600,000 | |||
| Total cost of acquisition | 10,480,000 | 10,480,000 | ||
| ARC (defined below) formation | 5,000 | |||
| Adjusted cost of acquisition | 10,485,000 | |||
| adjusted net income | 1,335,000 | 1,335,000 | ||
| ARC profits | 609,486 | |||
| Enterprise profits | 1,944,486 | |||
| multiple | 7.85 | 5.39 | ||
| return on investment | 12.74% | 18.55% | ||
When someone asked you what the multiple was, you probably said 6. But when you consider the entire purchase cost of the dealership (no real estate) including Furniture, Fixtures and Equipment along with the factory required working capital the actual multiple seems to be higher, coming in at 7.85. With these additional funds invested is the true enterprise multiple 7.85? Most likely the answer here is no.
Consider these additional facts: During the period the dealership reported to the manufacturer pre-tax net income of $1,150,000, the dealership also had monthly Finance and Insurance (F&I) product sales of 85 new and used vehicle service contracts, 80 powertrain warranties, 102 vehicle ID systems, 25 appearance protection packages and 48 GAP policies.
The sale of these F&I products not only produced income to the dealership but also produced underwriting income (i.e. premium paid by the dealership to the F&I product provider, less claims paid on the products, less operating costs such as bookkeeping, tax preparation, annual registration costs, etc.)
Utilizing a separate-from-the-dealership Allied Risk Company (ARC) creates $609,486 in average annual net income from a tax favored ARC reinsurance structure. For more information about ARCs please refer to my previous ABSR article at https://www.automotivebuysellreport.com/the-tax-cuts-and-jobs-act-impact-on-underwriting-earnings-participation/.
After considering this additional profit and the nominal cost of formation of the ARC the multiple is 5.39. I propose to you that this is the true enterprise multiple. Likewise, the unlevered return on investment is 18.55%; meaning as a buyer, you get your money back in a little more than 5 years even without an increase in profitability.
Are you considering all this information when you buy or sell a dealership? If not, you are not considering all the facts and cannot make a thoughtful and informed business decision.
As highlighted here determining a multiple is an art not a science. However, determining a return on total investment is much more of a science. Wikipedia defines science as … a systematic enterprise that builds and organizes knowledge in the form of testable explanations and predictions. So maybe I was wrong, and Wikipedia does in fact have information on dealership valuations.
Don E. Ray works at Portfolio…THE Reinsurance Company for Auto Dealers. He can be reached at 917-359-5128 or dray.portfolioco@gmail.com
