By Carl Woodward, CPA, Woodward & Associates
There are many existing dealers including public groups, large and smaller dealer groups, and individual dealers looking to buy additional new vehicle dealerships this year. There are several reasons for this buying effort, but some dealerships are not desirable or saleable. I will discuss the less desirable new vehicle dealerships first and then the more desirable dealerships.
The less desirable dealerships include the smaller dealerships and those in smaller rural markets. With the national average new vehicle dealer having annual sales approximating $40 million, the dealerships with less than $15 million in annual sales, which are many of those dealerships in rural areas, have limited desirability to most buyers.
The buyers with stores selling more than $30 million in annual sales have little demand for these smaller stores. Why? The returns on equity will most likely be less. Also, it isn’t a good use of quality managers. They can be better utilized in larger stores with a potential to make 2-3 times the profits of a store with $15 million in annual sales.
If you have a smaller store making 2.2% (average dealership 2013) pre-tax profits on annual sales of $15 million, the profits will be $330,000. If you invest in a store with $40 million of sales, this dealership will make $880,000 with a 2.2% pre-tax profit margin. Since there are a limited amount of qualified managers, the bigger dealer would rather have the limited supply of qualified manager’s work at a larger store.
Also, the rural stores’ facilities are usually older and not as good looking as the larger stores. Buyers with larger nicer stores will be turned off by the smaller less modern rural stores. In most cases, the best choice for a seller of the smaller rural store is another dealer in the area that is used to operating these smaller stores successfully.
The more desirable stores are those above $40 million in annual sales, and they are in limited supply. These stores can make $1 million a year or more pre-tax. These higher profits are more desirable to most buyers that have money to purchase larger stores.
Since most sellers are those dealers that are close to retirement or are losing money – which few dealers are this year — the number of willing sellers is limited. If you are a seller making, say, $800,000 per year plus a salary and other benefits, you need a large amount of after-tax cash to make it worthwhile to sell.
Since the amount you can safely earn today might only be 5%, you would need $16,000,000 of cash earning @ 5% to yield your dealership pre-tax profits of $800,000. It would require an unrealistically high amount for blue sky to have $16 million in after-tax cash. If you sell your store for blue sky of five times pre-tax earnings of $800,000, $4,000,000 in blue sky, plus the remaining cash from the dealership of approximately $2,000,000, you might end up with $5.0 million in after-tax cash. If you could find a deal where you could earn 5% on your cash—which is doubtful — you will earn pre-tax of maybe $250,000 a year versus the profits from the dealership of $800,000.
For this reason, some sellers are requiring blue sky much above what is normally paid or have realized it is not worth it to them to sell because the earnings on cash is so low. From the buyer’s perspective, they earn very little on their excess cash so I believe many buyers will lower their expectations of the return on investment they usually require.
This means they will now pay more for blue sky. If previously the buyer would pay 4 times earnings for blue sky, they might now pay 5 or 6 times earnings since they are willing to receive a lower return and / or they need to invest their available cash at a rate higher than the low rate they earn today.
Historically dealers have earned approximately 25% pre-tax on their investment. Our experience has shown that large dealer groups and public companies in the past might only require an expected 20% pre-tax return on their investment. With interest rates so low I believe some of these buyers will lower their expected pre-tax return on investment requirements to possibly 15% pre-tax.
If this is the case, then where these buyers might have paid $4.0 million blue sky in the past, they might now pay $5.3 million blue sky today. As a summary, the smaller rural stores are harder to sell than in the past for lower prices while the more desirable larger stores are bringing more for blue sky than in the past.
Woodward & Associates of Bloomington, IL provides specialized accounting services to automotive dealerships. www.cpaauto.com