By Richard H. Kotzen, CPA, partner, Crowe Horwath LLP
Virtually everyone in the retail automotive industry seems to agree that merger and acquisition (M&A) activity these days is hot – and getting hotter. What’s less clear is how individual dealers or potential buyers should respond to the trend.
Whether you’re a buyer, a seller, or an interested observer trying to plan ahead for the next few years, the first step in developing a successful strategy is to understand the factors that are driving today’s M&A market in retail auto dealerships.
Today’s hot market reflects a rare convergence of positive factors, all of which are contributing to the robust pace of M&A transactions. Three broad issues are behind the numbers.
Driver 1: A Healthy Industry
There’s no doubt that the primary factor boosting buyer interest in retail dealerships is simply the general health of the automotive industry overall. Manufacturers have recovered from the recession and are once again introducing interesting new product offerings at a healthy pace.
Significantly, though, while sales are up sharply from recession levels, there is still room for further growth – an important factor from a buyer’s perspective.
The numbers tell the story: U.S. light vehicle sales continue to improve each year post-recession, and many economists do not see this falling off until the end of the 2018 or 2019 model year.
Meanwhile, other indicators suggest sales growth could continue for the foreseeable future. For instance, new housing starts, which historically mirror new vehicle sales, remain solid and have been improving since the recession. They should be a catalyst for future new vehicle sales as we move into the later part of 2015 and into 2016.
Digging deeper into the numbers, the signs are even more encouraging. While the average vehicle age in the United States stands at a relatively high 11.4 years,[1] the portion of the U.S. fleet that consists of vehicles less than five years old is once again trending upward. This is significant because it is newer vehicles that typically drive service and parts sales, the most profitable part of the dealer’s revenue stream.
The National Automobile Dealers Association (NADA) reports total sales for service, parts, and body shop work, was up more than 5 percent from 2012 to 2013, reversing the downward trend in service and parts revenues. This trend has continued forward in 2014 and 2015.
NADA reports the average number of new vehicle sales per location reached a record high of 879 vehicles in 2013, up sharply from the recession-era low of 563 vehicles in 2009. This trend has also continued in 2014 and 2015.
Driver 2: A Resilient Business Model
In weathering one of the most severe recessions in many decades, the automobile industry’s dealership model has proved to be extremely resilient. As the recession demonstrated, the retail dealership business model allows expense structures to be scaled relatively quickly depending on the state of the market.
Although the total number of dealerships is down considerably from prerecession levels, the decrease has had a positive effect overall – today’s growing sales volumes are being spread among a smaller pool of dealerships. NADA reports the average number of new vehicle sales per location reached a record high of 879 vehicles in 2013, up sharply from the recession-era low of 563 vehicles in 2009.
Another reason the dealer model is attracting investor interest is the growing diversification of dealers’ income streams. New finance and insurance products and the introduction of dealer-based reinsurance or extended warranty programs are contributing further to dealer revenues, as are the traditional mainstays of parts and service.
Factory-dealer relationships are also improving, especially among large dealership groups that are better able to afford and comply with manufacturer-mandated facility image programs designed to project a consistent brand image.
From an investor’s perspective, an automotive dealership represents a moderate-growth, moderate-risk opportunity with a very good return on investment. According to NADA, the average return on invested capital for automotive dealerships was approximately 29 percent – a highly attractive alternative to other investments in the global marketplace.
Moreover, in addition to current profits, most dealerships also offer the opportunity for real estate appreciation and appreciation in the value of the operating company itself.
Driver 3: A Robust Market of Buyers and Sellers
Traditional dealer-to-dealer sales continue to represent the largest portion of today’s dealer transactions, as growth-oriented dealers look to expand and diversify their portfolios of franchises. As a result, higher valuations are no longer confined to the so-called Fab Five (Mercedes, BMW, Lexus, Toyota, Honda). Higher valuations, in turn, help build further M&A momentum, as a growing number of aging dealers begin to consider the idea of exiting the business while valuations are high.
Meanwhile, the buyer side also is growing more diverse. In addition to traditional dealers and large, publicly traded companies, today’s buyers include a growing number of private equity groups, family funds, foundations, and entrepreneurs from other industries. In addition, the Berkshire Hathaway acquisition of the Van Tuyl group, which settled in 2015, validated the upside of investing in retail dealerships.
Lenders also are adding to the momentum by making transaction funding available with excellent financing terms, so as long as there are more buyers than sellers, further upward pressure on valuations is likely.
Looking Forward
This convergence of forces – a stabilized auto industry, a resilient business model, and an active pool of both buyers and sellers – suggests continued brisk deal making in the months ahead.
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.
[1] Mark Rechtin, “Average Age of U.S. Car, Light Truck on Road Hits Record 11.4 Years, Polk Says” Automotive News,Aug. 6, 2013,http://www.autonews.com/article/20130806/RETAIL/130809922/average-age-of-u.s.-car-light-truck-on-road-hits-record-11.4-years
