By Fred O’Halloran, MD Johnson Inc.
What is my store worth? This question is asked regularly by many dealers to many professionals including CPAs, attorneys, business brokers, bankers, and factory reps. Unfortunately, the people being asked this question will quite often rattle off a multiple of earnings they’ve heard or read about.
MD Johnson’s answer to this question is almost always “I have no idea.” This answer definitely gives the questioner reason to pause — you see it in his or her face or hear it in his or her voice. “How does a business broker not know the value of my store?”
Someone who rattles off an answer to this question is not being fair with the questioner. There are so many variables in determining a multiple of earnings or market value that without additional information one can’t give an honest answer.
We often hear the terms blue sky and goodwill interchanged in conversation. The reality is that in an asset transaction, the seller is selling goodwill. It is the tangible and intangible value of the seller’s customer base, vehicle sales records, trade names, service records, intellectual property, franchise rights, domain names and the list goes on.
The term Blue Sky is highly regulated by individual states and the SEC. It started being used around a hundred years ago. The Merriam Webster dictionary defines Blue Sky “having little or no value” and “not grounded in the realities of the present”. The term first appeared in a supreme court decision by Justice Joseph McKenna in 1917 and he defined blue sky as “speculative schemes which have no more basis than so many feet of ‘blue sky'”; or, as stated by counsel in another case, “to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other like fraudulent exploitations.”
Goodwill in an automobile transaction is the money a buyer is willing to pay over and above the value of hard assets. It normally is derived on a multiple of profits. The first question is “What are the Profits?” Before our company will take an engagement, we will review at least three years of trailing earnings. We will look at the manufacturer’s financial statements and tax returns. We will look at the operating metrics in the various departments to see if there is an opportunity for growth in any of the departments.
The next item we look at are the addbacks or adjustment to profit. Many dealers run a number of various expenses through the dealerships and are able to so, as they own the business. Our job is to normalize the profit, that is try to find what an average operator with normal expenses’ profit would like.
Extraordinary expenses could be: management fees, packs, overrides on units or products, legal bills as well as non-reoccurring non-operational expenses such as the lake house, the boat, the airplane, etc. We also need to determine if rent is over-stated or under-stated. Most organizations look for a capitalization rate on the real estate rent of at least 7% and will adjust the profits accordingly.
Some owners might charge their actual loan costs to their companies as rent. These monthly rental expenses would probably be adjusted up to a market rate of 7% and profits down when building your pro forma. Some operators may charge themselves a rent factor of say 10% or maybe even 15% or higher. In this case you add back to profits the difference between the 10-15% and 7%. This overcharge will positively impact the profits.
This exercise is the first step to determining market value. At least now we have an understanding of profits!
The next area we review is market effectiveness — pump-in/pump-out, the local and regional market demographics. We need to know if the market is growing, static or contracting. We consider the age of the population, income levels, and other demographic factors. Is the manufacturer still viable in the market or is the public losing interest in the franchise? Remember, we are asking someone to pay the seller for future profits.
An interesting variable in determining value is to ask how effective or efficient is the seller? Is the operation a marginal or average performer, say achieving a net on sales of 2% versus 4-5%? Acquirers find it easier to pay a little more for an under performer, as opposed to the high performer. That is because most acquirers are not as confident of replicating high the performance business model as opposed to fixing the low performer. This issue will cause some sellers to not achieve their desired cash out. It is unfortunate to see a strong performer penalized for achieving.
There are folks within the industry that publish books purporting to know the “Goodwill” multiples. When asked about these reports, my only comment is “Where is the Goodwill or Blue Sky Clearing House?” That question again, gets you a funny look. However, the facts are no one really knows what the number is. While a contract says the buyer is willing to pay $XXX in goodwill, it very rarely says what the multiple is.
A manufacturer sees the contract, but may not know the company’s real profit. It knows what the financial statements present, however the manufacturer doesn’t know the amount of the addbacks. On top of this, deals are structured to maximize tax savings, usually for the seller. When a deal is written, some goodwill could end up in the real estate, fixed assets, parts, etc.
Even if a manufacturer does know the multiple, they can’t disclose this information. Bankers will come close to knowing what the goodwill multiple is on deals they work on, but no one has industry-wide knowledge as there are many banks involved in financing these businesses.
The only real source of the multiple is the buyer and seller. And if you find a seller willing to talk, chances are he or she will embellish the number or tell you a total transaction number including new vehicle inventory and real estate. So, guessing at multiples is just that, a guess.
Remember, value is specific to the seller. It is driven by regional location, market demographics, actual dealer performance, the manufacturer’s value, the condition of the store, and the facility’s compliance with manufacturer standards. Without a deep dive into a dealership, its actual value is a mystery.
Fred O’Halloran is a consultant with MD Johnson Inc., a dealership valuation firm based in Seattle, Wash. He can be reached at email@example.com or 816-225-1908.