As a lifelong, avid sports fan, the lack of live sports over the past few months has created a huge void. In their absence, I have enjoyed watching the replays of several classic, iconic games from my childhood and teenage years: the 1986 World Series Game 6 aka the “Bill Buckner game,” the 1992 Elite 8 matchup between Kentucky and Duke aka the “Laettner Shot,” and the 1992 NLCS Game 7 between my beloved Atlanta Braves and the Pittsburgh Pirates aka the “Sid Bream Slide game” among others. The replays have been fascinating for the memories and emotions that they evoke, but it’s also interesting to see the finer details that had been lost or blurred from my memory over time. And yes, Buckner still missed the ball, Laettner still hit that miraculous shot (unfortunately), and Sid Bream was still safe! But what made these games iconic and have the classic value over time that they still do today?
The appreciation and ultimate value of an auto dealership is impacted by several key value drivers.
All of them had certain ingredients that were “controllable.” An Elite 8 or playoff game will always have greater stakes than a regular season game, and playoffs tend to have greater talent at a higher level of competition. It also just means more when it’s your team. And rivalries will always up the ante. These situations increase the likelihood of a game becoming a classic, but I also realized the games I rewatched had other uncontrollable components that contributed to their value – pressure moments, unlikely heroes like role players stepping up, and the never-ending spirit to keep competing until the final out or buzzer.
Just like these classic sporting events, the appreciation and ultimate value of an auto dealership is impacted by several key value drivers. Some of these value drivers are controllable or able to be affected by the owner, and some are outside of their control.
Auto dealers, like most business owners, are likely always curious about what their dealership might be worth. While there are many times they may want to know, there are various life events that make them need to know the value such as a transaction (including buy-sell), litigation, divorce, wealth-transfer, etc. While valuations tend to be performed infrequently around these events, dealers can evaluate their business and improve its value by understanding and focusing on the value drivers of their auto dealership and addressing them on a consistent basis. So, what are some of the value drivers of an auto dealership?
An auto dealership’s franchise affiliation has a major impact on value. Each franchise has a different reputation, selling strategy, target consumer demographic, etc. Public value perception of franchises tends to be unique and are most easily illustrated through Blue Sky multiples. As the Haig Report and Kerrigan’s Blue Sky Report indicate, Blue Sky multiples vary over time even if they are frequently stagnant from period to period. Often auto dealerships and franchises are grouped into broader categories, such as: luxury franchises, mid-line franchises, domestic franchises, import franchises and/or ultra high-line franchises. Dealers may not have significant influence over the value perception of their franchise, making this value driver appear “uncontrollable.” However, dealers do have the opportunity to make bolt-on acquisitions and expand their operations to more rooftops. This will likely improve foot traffic to the various franchises in general and ultimately may improve the value of the business, particularly if they are able to appropriately decide which franchise to add.
Real Estate/Quality of Facilities
Typically, most dealership operations are held in one entity, and the underlying real estate is held by a separate, often related entity. Several issues with real estate can affect an auto dealership valuation. First, an analysis of the rental rate and terms should be performed to establish a fair market value rental rate. Since the real estate is often owned by a related entity, the rent may be set higher or lower than market for tax or other motivations that would not reflect fair market value. Second, the quality and condition of the facilities are crucial to evaluate. Most manufacturers require facility and signage upgrades on a regular basis, often offering incentives to help mitigate these costs. It’s important to assess whether the auto dealership has regularly complied with these enhancements and is current with the condition of their facilities. Owners seeking to drive value can do their part in making sure their facilities are up to date and appealing to customers.
Due to the coronavirus pandemic, facility upgrades may become less of a value driver. Stay-at-home orders have forced consumers to buy automobiles through more automated means. While dealers have long touted their omnichannel offerings, the pandemic has put them to the test. The shift to digital platforms is expected to decrease foot traffic to the actual dealership. With the focus moved away from the dealer’s real estate and physical showroom, the importance of the latest and greatest signage is likely to be diminished. It’s possible that the quality of a dealer’s facilities may become less of a value driver if consumers are less dependent on those facilities.
The quality and depth of management can have a positive impact on an auto dealership valuation. Auto dealerships with greater management depth and less dependence on a few key individuals will generally be viewed as less risky by an outside buyer. Also, an auto dealership’s CSI (Customer Service Index) and SSI (Service Satisfaction Index) rating can influence incentives from the franchise and the overall perception of the consumer. A strong CSI and SSI are reflections of a strong service department and a commitment to quality customer service. While franchise customer service figures are not controllable, owners can make sure their employees provide consistent, exemplary customer service which will boost reputation and drive value.
Recent Economic Performance
Like most industries, the auto industry is dependent on the national economy. The auto industry measures and tracks sales of lightweight automobiles and trucks in a Seasonally Adjusted Annual Rate (SAAR), which is an indicator of historical economic performance in the auto industry. In addition to monitoring and understanding the current month’s SAAR, the longer-term history of the SAAR and its trends also provide insight into the auto industry and an auto dealership valuation. Below is a long-term graph of the SAAR over the past 20 calendar years:
While dealerships tend to ebb and flow with the general economy, the industry can also be cyclical based upon the average age of cars owned. Consider a period with significant volumes over a number of years. Because cars are typically owned for several years, these customers are not repeat customers except to the extent they visit the parts and service departments. All else equal, periods with high volume sales tend to be followed by lower volume periods. As you might expect, dealers have minimal influence over these cycles. Like the bottom of the 9th in Game 7 of the World Series, it’s just going to mean more.
Buyer demand in the transaction market can illustrate the value climate for auto dealer valuations. Typically, buyer demand is measured by the deal activity in the M&A market. The Haig Report indicated that 2019 was another strong year for the buy-sell market after a sluggish beginning. They estimated 78 stores were acquired by public and private buyers in Q42019 alone. Similarly, Kerrigan’s figures also illustrate a strong buy-sell market for 2019 after a slow start. Kerrigan notes 2019 was the strongest year for transactions since 2014. Increased buyer demand leads to higher multiples and ultimately valuations for dealers. While this is not something that dealers can directly influence themselves, adhering to the other aspects noted in this piece can increase the likelihood dealers receive a favorable multiple.
Buyer demand and M&A activity will be severely affected in 2020 as the buy-sell market has largely been placed on pause due to the economic conditions and stay-at-home mandates related to COVID-19. Again, this is largely out of the dealer’s control, though they can take steps to make their dealership more attractive.
The value of an auto dealership can be more complex than urban vs. rural or major metropolitan city vs. minor metropolitan city. Each store location is assigned a certain area or group of zip codes referred to as an area of responsibility (AoR). Particularly, how does a location’s demographic characteristics line up with a certain franchise? For example, a high-line auto dealership would perform better and seemingly be more valuable in a major metropolitan area with a high median income level, such as Beverly Hills, California, or South Beach in Miami than in a mid-western city. Conversely, a mid-line Store would probably fare better in areas with more moderate median income levels.
We’ve discussed how the national economy can affect an auto dealership’s value, but in some instances, performance can also be greatly influenced by its local economy. Certain local markets are dominated by a particular trade or industry. Examples can be auto dealership locations near oil & gas refining areas, mining areas, or military bases. For example, there may be an influx in car sales as members of a particular base are deployed or return home. In such instances, a dealership is probably more dependent on local economic conditions than national economic conditions. This is where it is key for owners to recognize the environment in which they operate and tailor their operations to maximize these opportunities. Like Steve Kerr said when Michael Jordan was double-teamed in Game 6 of the NBA Finals, “I’ll be ready.”
Single-Point vs. Over-Franchised Market
The amount of competition in an auto dealership’s AoR, as well as the nearest location of a similar franchised auto dealership, can also have an impact. It’s important to make the distinction that we are talking about a single-point market and not a single-point dealership. A single-point market refers to a market where there is only one auto dealership of a particular franchise. An over-franchised market would be a larger market that may contain several auto dealerships of a particular franchise within a certain radius. Often, an auto dealership in a single-point market would be viewed as more valuable than one in an over-franchised market that would be competing with its own franchise for the same consumers. Additionally, the auto dealerships of the same franchise in the same market could be drastically different in size. One may be part of a larger auto group of dealerships, while the other may be a single-point dealership location, meaning that owner only owns that one location. A dealer with one of many Ford dealerships in a city, for example, is likely to be worth less because customers going to buy a new Ford have many convenient options. Additionally, a dealer with a single-point franchise is likely to lose out on customers that aren’t sure what make or model they want. If they only offer vehicles from one franchise at their location, they may draw less foot traffic due to less variety. We’ve already discussed how certain brands tend to receive higher Blue Sky Multiples and how that should factor into acquiring a new franchise. Owners looking to enhance the value of their dealership operations should also consider the saturation of franchises in their market. While a Lexus dealership may have a higher Blue Sky multiple than a Kia, if there are no other Kia dealerships in the market, they may be able to earn more in profits. Improving earnings are an easier way for owners to improve the valuation of a dealership as multiples tend to represent other uncontrollable market influences.
Conclusions and Observations
As we’ve discussed, the value of an auto dealership is influenced by a variety of factors. Some of the factors are controllable, and some are external. Just like a classic sporting event, auto dealers have to focus on what they can control, hoping to create value and maintain or grow it over time.
To find out the value of your auto dealership today, contact one of the automotive industry professionals at Mercer Capital. Whether or not you may have an upcoming life event that may necessitate a valuation, we can help you understand your progress and further understand our process. That way, when it comes time, you’ll be ready.