For this week’s blog post, we sat down with Kevin Nill of Haig Partners to discuss trends in the auto dealer industry and the recent release of their First Quarter 2020 Haig Report. Haig Partners is a leading investment banking firm that focuses on buy/sell transactions in the auto dealer industry, along with other transportation segments. As readers in this space are familiar, Haig Partners also publishes Blue Sky multiples for each of the auto manufacturers based on their observations and data from participating in transactions in this industry.
It’s still early on, but how does the economic disruption due to COVID-19 compare to the Great Recession in 2008/2009 on the auto dealer industry?
KN: 2008 provided a great recipe for how to manage dealerships in a time of financial stress. But COVID-19 hit so quickly and with unprecedented shutdowns and associated reductions in sales volume and service revenue. The financial disruption was far more harsh in 2020 but there were some tailwinds that dealers didn’t have during the Great Recession. For example, almost 100% of lenders offered interest, principal and curtailment deferments immediately. PPP funds were available to most dealers and provided some necessary working capital. Interest rates were lowered to almost 0% immediately. And most OEMs got aggressive quickly with 0% deals for 72 and 84 months.
SW: As Kevin alludes to, the biggest difference between 2008 and 2020 in navigating these troubling times is the assistance from OEMs. Industry bailouts were widely debated, and these manufacturers have been conscientious about being part of the solution this time around.
What impact has the COVID-19 pandemic had on a) Blue Sky multiples, b) deal flow, and c) overall dealership value?
KN: The pandemic has clearly impacted dealership operating performance and instilled some uncertainty around future earnings for the remainder of 2020 and even into 2021. In general, valuations have tended to recede approximately 10% but there are some dealerships that continue to attract pre-COVID 19 value due to franchise attractiveness and/or geographic demand. Buyers appear to be taking 2 different approaches – 1) they are utilizing 2019 and pre-COVID 19 2020 YTD results (i.e. historic performance) and then applying a slightly lower historic multiple to arrive at a moderately discounted value; or 2) they are utilizing unadjusted pre-COVID 19 multiples but against a forecasted 2020 and 21 earnings base that reflects a slightly lower expectation for income. Either way, it typically works out to about a 10% lower valuation. But again, some stores remain as or more valuable than before the pandemic.
New transaction deal flow has been impacted in the short term simply because potential sellers have been fully engaged and focused internally on operating their dealerships during an unprecedented period of stress. They’ve been working on getting their PPP money, furloughing and rehiring associates, building a process to sell and deliver vehicles remotely, managing inventory, etc. We expect when the proverbial dust settles, there will be some motivated sellers who have experienced the Great Recession of 2008 and now the pandemic and will raise their hands and say enough’s enough. Additionally, the pandemic has further set in motion the need to have scale to compete in the new digital age of automotive retailing and some owners are recognizing it’s time to get big or get out.
SW: Our valuation approach considers a broader analysis of historical earnings to estimate ongoing earnings. We are cautious not to overvalue a dealership in its best year or undervalue a dealership in its worst year if neither are sustainable. Typically, forecasted earnings approaches were only utilized on start-up locations or early-stage dealerships where historical financials could not be produced. The economic impacts of the pandemic to the current year’s earnings will present a challenge to all valuation professionals. As to the impact of the pandemic on dealership valuations, we think it is relative to each individual dealership and their unique set of factors.
Has any segment/classification of franchise (luxury, domestic, import, high-line) type been hit harder with regards to the impact of their implied Blue Sky multiples than others?
KN: Higher value dealerships – luxury, very large dealerships or very high performing dealerships might experience moderately lower interest in the near term. This is strictly a function of capital availability as we wonder how many lenders are prepared to extend large amounts of credit on an expensive dealership. These types of stores generally have less risk and yield attractive valuations and will still be in demand but it may take several months of normalcy before buyers and lenders are ready to step up for an expensive BMW or Mercedes-Benz dealership as an example.
Have you seen different effects on value in different areas of the country? If so, what are those differences?
KN: The quantity and severity of COVID-19 cases and the related state shutdowns is partially correlated to valuations and demand for dealerships. Businesses in the northeast and California, where the pandemic hit hard and governors reacted with severe operating restrictions, have suffered far more than dealerships in the southeast and TX. The latter areas were able to operate, albeit with some restrictions, and sell and service vehicles more effectively. As a result, we’ve spoken with a number of dealers who’ve enjoyed record performance in May as states reopened and consumers took advantage of good weather, stimulus checks, and big OEM incentives.
SW: In our discussions with clients, the severity of the impact on operations/earnings is also widespread. In addition to the pockets of the country mentioned by Kevin, we have noted dealers in Arkansas and Utah seem to have suffered less than other areas.
Are there buying opportunities for larger auto groups, public companies, and those poised to be in the auto dealer market for the long-term?
KN: Auto retail remains a highly attractive investment despite the inherent cyclicality of the industry. Dealerships can be very profitable and generate significant cash, further supplemented by the offshore and captive insurance companies many owners operate. Public companies, outside investment groups including PEFOs (private equity and family office investors), and well-capitalized private dealers have access to low-cost capital and are able to enjoy significant operational synergies. As the industry continues to consolidate and as the need for technical proficiency to master and innovate within the digital retailing sphere accelerates, buyers are going to continue to find opportunities to invest with strong returns.
What is the profile of buyers and sellers that you’re seeing on current M&A deals?
KN: For sure, a majority of buyers, particularly for the more attractive and valuable dealership assets are the consolidators, both private and public. They are pursuing opportunities to broaden their geographic footprint and franchise representation. Growth becomes a way to leverage both their cost structure over more stores but also to take market share through their improved processes, customer acquisition and retention strategies, and digital strength.
Of course, smaller stores remain attractive to local buyers who want to expand their portfolio in their “backyard” or extend into nearby markets.
Lastly, outside investor capital or PEFOs are again evaluating opportunities in this sector as they believe stores have some newfound upside with the recent reductions in performance.
SW: Family office investors tend to have longer-term investment horizons than public/private consolidators. Additionally, family office investors present additional challenges as they often require more education, due diligence, and they also must bring a dealer principal/operator to the transaction or retain an existing person from the acquired company to assume this role. Once such a person is in the fold, bolt-on acquisitions become smoother and a platform can be created.
What are your predictions for the auto M&A market for the remainder of 2020 and 2021?
KN: We think 2Q 20 will again be slow as deals that were “inked” before or right at the beginning of the pandemic have been slow-walked to allow time for stability to return to operations. However, judging by the strong progress within our pipeline and conversations with other dealers and professional service providers, the back half of 2020 and 2021 should see some pretty strong transaction volume. Further, we anticipate some dealers will re-evaluate their future once they’ve had the chance to catch their breath from the shutdown and restart of business. This could include a full exit or a partial disposition of certain stores either to raise capital or eliminate some problem stores.
What impact has the pandemic had on digital retailing vs. facilities/image requirements?
KN: The concept of executing the purchase of a vehicle remotely had begun to gain some smaller degrees of traction before the start of the pandemic. However, a fully digital solution has received far more interest since consumers were forced or chose to transact as much of the vehicle purchase over their phone, tablet, or computer during the shutdown. Even home delivery has ramped up for both sales and service. Various surveys seem to indicate a digital end to end solution is becoming more desirable but a vast majority of consumers still want to come to the dealership for a test drive and thus complete the sale on site.
We see those dealerships and groups who have the capital and sufficient intellectual horsepower to invest in digital solutions to be the winners over time. This is one more reason consolidation will continue.
We are also hearing that OEMs are recognizing this trend and may soften their stance around upgrades of facilities, larger buildings, more acreage, etc. It’s a tough balance for dealers to have the best online solution and also invest millions of dollars to have the most extravagant and new building when fewer customers want to come to the store for both sales and service.
SW: We tend to agree that these improvements appear to be declining as a value driver. We expect there to be more pressing needs for capital than facility upgrades, both from acquirors and dealer principals. These funds will go to consolidation efforts and shoring up finances coming out of the pandemic.
What impact will the bankrupt rental car companies have on mitigating the sluggish used vehicle supply market?
KN: It appears the bankruptcies of a couple of the large rental companies will restructure debt and equity, not necessarily eliminate operations. It allows the weaker operators time to weather the storm until rental activity ramps up. However, if the recovery goes slowly and business and vacation travel doesn’t pick up, you could see some permanent reductions in rental volume. That could impact nearly new used vehicles from supply in the coming years which are good sources of inventory for dealers and generally produce strong gross margins.
What effect will the slowing down of new vehicle production supply from factory shutdowns have on auto dealer valuations and M&A activity?
We believe tight inventories will be a short-term disruption that gets resolved over the next few months as production returns to normal. If you couple a big ramp up in production with lower new volume sales, dealer lots should get back to a steady state inventory level well before most current and any new transactions close.
SW: Near-term supply will continue to remain a question as manufacturers cope with COVID outbreaks and the need to shut plants down for a day to sanitize. The stop-start nature may play a significant role in how quickly supply can ramp up.
Do you anticipate that we will see a V, U, W-shaped recovery, or something else?
KN: We are by no means economists and read the same data you and your clients see around the recovery expectations. It seems the consensus lies in the U or W recovery as it’s highly unlikely we immediately return to the low levels of unemployment pre COVID-19. Regrettably, too many businesses won’t reopen and certain industries that are large employers will be slow to recover. Think hospitality, transportation, entertainment, energy, etc. The near term improvement will occur far more quickly than the Great Recession comeback but it’s probably wishful thinking to believe we bounce back to past levels in just a couple of months. The good news is we have low rates, stimulus, OEM incentives and a strong banking sector to accelerate growth this time around.
We thank Kevin Nill and Haig Partners for their interesting perspectives on the auto dealer industry. Industry participants are cautiously optimistic that retail sales, earnings performance and deal flow are trending in the right direction, but not without additional challenges. To discuss how recent industry trends may affect your dealership’s valuation, feel free to reach out to one of the professionals at Mercer Capital.