By Richard H. Kotzen, CPA, Crowe Horwath LLP
Several forces are working together to drive today’s robust merger and acquisition (M&A) market in the automotive industry. The first article in this series examined some of the contributing factors, which include a stabilized auto industry, the general resilience of the dealership business model, a growing number of willing sellers, and an active pool of interested buyers.
This article and the one that follows will look more closely at the last of those crucial factors – the buyers who are driving the sales. While traditional dealer-to-dealer sales continue to make up the largest share of today’s mergers and acquisitions, at least some of the momentum can be traced to other types of buyers, including many who are relatively new to the automobile industry.
This injection of fresh capital and fresh faces helps accelerate the overall pace of M&A activity and helps drive higher dealership valuations. For the dealer who is considering selling, however, dealing with buyers who are new to the industry can present some significant challenges.
We’ve Been Here Before
This is not the first time the auto dealership industry has seen an injection of new blood. When publicly traded companies first began aggressively buying up dealerships in the 1990s traditional privately-owned dealers – and the manufacturers themselves – weren’t sure how to respond.
These new types of buyers evaluated potential acquisitions and approached transactions using metrics and processes that were different from those that dealers had been used to. At times it seemed that buyers, sellers, and manufacturers were speaking different languages.
In time, though, the public companies adapted to the unique nature of the industry, and the various stakeholders came to understand each other. Large publicly-traded dealership groups now are an established force in the industry, and the process of buying or selling a dealership is roughly similar regardless of whether you are dealing with a large public dealership group or another private dealer.
Today’s Nontraditional Buyers
The same cannot be said when selling a dealership to one of today’s new nontraditional buyers. This new group of buyers includes several categories:
- Private equity groups that focus their investment strategies on privately-held entrepreneurial companies
- Family funds that professionally manage the business affairs, investments, and philanthropy of high-net-worth individuals and families
- Foundations that manage investments for universities, pension funds, and other long-term endowments
- Entrepreneurs from other industries who are attracted by the quality return on investment opportunities they perceive in an automobile dealership franchise
Pros and cons of dealing with nontraditional buyers
Although the various categories of today’s nontraditional buyers all present their own particular benefits and risks, they also share some basic characteristics. For example, when evaluating a potential acquisition this new generation of buyers tends to regard the earnings multiples that dealerships typically trade at as being quite reasonable in comparison to competing investment opportunities.
They also are attracted by the protective competitive barriers in their primary market area (PMA), which are inherent in the manufacturer-dealer distribution model. Eager to get into the auto industry, and knowing that they will be protected from direct, same-brand competition within their PMA, they sometimes are willing to pay slightly more than market value for the opportunity.
Typically, such buyers are interested in acquiring the entire dealership package – the operating company along with facilities such as land and buildings – rather than taking a piecemeal approach. Above all, they have either the necessary capital or access to sufficient credit to consummate the deal.
On the downside, however, buyers who do not have a history in the auto industry often do not fully understand the complexity of the business, particularly the nuances of the manufacturer-dealer relationship. Because of the learning curve they face as well as manufacturer approval process issues, they often ask the seller to retain some interim management role to help ensure a more orderly transition. For a seller who is eager to move on to other ventures, such a phased transition might not be appealing.
Perhaps the biggest risk in dealing with nontraditional buyers comes from manufacturers’ lack of familiarity with the buyers’ ownership structures and financing arrangements. Since these buyers cannot offer the personal guarantees that a traditional dealer will offer, manufacturers dig deeper to try to peel back the layers of capital in order to fully understand the sources of funding.
As a result the approval process can be quite lengthy. As the due diligence and documentation requirements grow, so does the risk that the deal will not be approved by the manufacturer. Typically, such a failure occurs only after the manufacturer, employees, and other interested parties have already been alerted to the impending sale, which can make managing the various relationships difficult if the deal cannot be consummated.
Because of these uncertainties and the risks, any dealer who is contemplating an M&A transaction with a nontraditional buyer is strongly encouraged to build a team of automotive legal and financial consultants who have experience working with such transactions.
The next article in this series will examine these general risks in more detail, pinpointing the differences among the various categories of nontraditional buyers.
Rick Kotzen, a partner with Crowe Horwath LLP in the retail dealership services group, is based in the Fort Lauderdale, Fla., office. He can be reached at 954.489.7430 or richard.kotzen@crowehorwath.com.
