By Stuart McCallum and Jon Paul Davis, Henderson Hutchinson & McCullough PLLC
In a time of compressing gross profits on new and used vehicles, it is not uncommon for dealerships to experience financial difficulties. Sometimes those hardships come with an added layer of complexity when a dealership has debt with a bank or OEM on its balance sheet. It can be in the dealer’s best interest to take his or her business to market sooner rather than later when facing financial troubles.
In addition to the voice of other stakeholders, there could be additional oversight, auditors, and committee-determined management decisions with which to contend if a dealer waits too long. When there are multiple stakeholders in the troubled dealership, the individual interests of each stakeholder are not always aligned to maximize gains.
With the flurry of merger & acquisition activity in the dealership space the past several years, the Original Equipment Manufacturers (“OEM”) and their respective captives have made available to certain dealers financing to execute transactions. Most of the time it seems the availability of OEM financing is to execute the OEM’s broader retail strategy in certain markets. In addition, various financial institutions that may not have been involved in the industry previously are now looking for opportunities to finance acquisitions.
The combination of OEM lending, existing lenders to the industry, and lenders new to the industry has provided dealers with more financing options when structuring their acquisitions. The terms of the financing arrangements vary depending on the facts and circumstances.
We have seen many transactions where the OEM captive has more capital in the transaction than the buyer when Blue Sky and real estate are taken together. In these financings, the lender has a desire to generate a return on its capital like any other investor, however its ultimate goal could simply be getting its money back. This is an important distinction from you, as the dealer, who may rely upon the overall return for the next investment or maybe even your retirement, and therefore want to maximize your return.
In situations where the lender or OEM is concerned about a dealership’s ability to return the capital, they are likely to pursue a few options. From the OEM perspective, an option may be to bring in a team of experts to try to restore the dealership to normal levels of profitability. This is usually in the later stages of financial distress.
For the lender, there may the option to force the sale of the store, thereby liquidating assets to repay the debt. This final step could even be orchestrated by the lender without forewarning. When a dealership is liquidated by the lender, the lender’s goal is to minimize the loss of capital. The desire of the lender to generate the return of capital above its requirement may not be the primary focus. As such, the dealer’s equity may often be nothing in these situations.
When a dealership is liquidated, the OEM specifically may force the sale of the store to a local dealer in a noncompetitive sales process, or already have an individual or an automotive group in mind for the acquisition. Again, the intent is for the OEM is to find a buyer that will minimize the loss, not maximize the transaction value.
Dealerships with average performance generally trade within a range of multiples of historical pre-tax earnings, as published regularly by brokers in the space. The range is impacted by a host of facts and circumstances including brand, region, and facility, however historical profitability is the largest driver within each of the respective brands.
When a dealership is greatly underperforming, the method of valuing a dealership based upon historical earnings is no longer appropriate. Instead, buyers and sellers may negotiate a Blue Sky value based upon the potential upside of the dealership or even an agreed upon minimum franchise value for the respective market.
It is the job of an advisor, representing the seller, to illustrate that the true value of the store is in its untapped future performance. In a forced liquidation or sale, there may be little incentive for the lender or OEM to negotiate or sell the store based upon its potential, so the only voice at the table is that of the buyer who wants the lowest price possible. In this case, it is certainly not in the best interest of the dealer.
The old adage “good things come to those who wait” may be true in some circumstances. However, when it comes to dealers who are operating stores on the brink of failure, immediate action may be the best option.
When a dealer takes a distressed store to market, there is a possibility of getting close to a full market value for the dealership if he or she retains the right advisor. There is a likelihood of generating a greater market value from a competitive bidding process than what the Lender could get in an off-market backroom negotiation, or by liquidating the assets.
By taking control of the transaction, the dealer can potentially access the capital necessary to retire or to reinvest in their next venture. Either way, being proactive could generate a greater amount of return for the dealer than allowing other stakeholders to make the important decisions.
Stuart McCallum is a partner at Henderson Hutchinson & McCullough PLLC. He can be reached at 1-423-702-7698 or smccallum@hhmcpas.com. Jon Paul Davis is also a partner and can be reached at 1-423-70-.8388 or jpdavis@hhmcpas.coms
Henderson Hutchinson & McCullough PLLC, with offices in Chattanooga and Memphis, is a CPA firm serving multiple industries with accounting and financial services.
