Vol. 19, No. 4, April 2013 BUSINESS VALUATION UPDATE TIMELY NEWS, ANALYSIS, AND RESOURCES FOR DEFENSIBLE VALUATIONS The Current Auto Dealer Acquisition Environment and Its Impact on Blue Sky By Timothy W. York, CPA/ABV New automobile dealership acquisitions were lower in 2012 as compared to the steady deal flow in 2010 and 2011. Although this news comes as a surprise to industry insiders, their consensus is that acquisitions stalled in 2012 because buyers and sellers simply couldn t agree on selling prices. Dealers who are making more profit than they have in years may be waiting for a high offer before selling, but sophisticated buyers aren t willing to pay what they are asking. Among the other reasons for owners to hold back on selling their businesses: attractive compensation and benefits such as trips, the use of demonstrators, and the ability to give jobs to family members. Buyer motives. As we move into the second quarter of 2013, deal activity is expected to rise and appraisers should be prepared for an increased demand for auto dealership valuation. With the improving industry landscape, investors have a heavy and renewed interest in buying new auto dealerships. The following points outline where the auto industry was in the past and where it s heading. Increased sales per store. As Chrysler and General Motors dealerships failed and many others went bankrupt or consolidated with other dealerships, unit sales per dealership declined sharply from 2006 to 2009 (see Exhibit 1). However, in 2010, unit sales started to increase. In fact, in late 2012, NADA estimated sales of 785 million units per store annually. After seven years, dealerships are selling more per store than they were during good economic times back in 2006 and buyers are seeing a great investment opportunity. Improved seasonally adjusted annual rate (SAAR). The current rate of scrapping vehicles, used vehicle prices, vehicle age, and the number of vehicles per driver indicates a pent-up demand for new vehicles. From 2000 to 2005, the seasonally adjusted annual rate (SAAR) of sales was between 15 million and 17 million units (see Exhibit 2). However, SAAR dropped to 13 million in 2008, and to 10 million in 2009. In 2012, SAAR was back up to 15.3 million, and many analysts now forecast at least 15.5 million for 2013. Industry profits on the rise. Many dealerships went out of business as net profits and margins lowered to 1.5%, and then to 1%, at the onset of and during the recession. However, for 2012, net profit before taxes was 2.2%, and more 900 800 700 600 500 Source: NADA Exhibit 1. Sales per Store 2006 2007 2008 2009 2010 2011 2012 Sales per Store bvresources.com
BUSINESS VALUATION UPDATE Publisher: Legal Editor: Managing Editor: Desktop Editor: Customer Service: VP of Sales: President: CEO: Sarah Andersen Sylvia Golden, Esq. Janice Prescott Monique Nijhout Retta Dodge Lexie Gross Lucretia Lyons David Foster EDITORIAL ADVISORY BOARD CHRISTINE BAKER CPA/ABV/CFF MEYERS, HARRISON & PIA NEW YORK, NY NEIL J. BEATON CPA/ABV, CFA, ASA ALVAREZ & MARSAL VALUATION SERVICES SEATTLE, WA JOHN A. BOGDANSKI, ESQ. LEWIS & CLARK LAW SCHOOL PORTLAND, OR MICHAEL A. CRAIN CPA/ABV, ASA, CFA, CFE THE FINANCIAL VALUATION GROUP FORT LAUDERDALE, FL NANCY J. FANNON ASA, CPA/ABV, MCBA MEYERS, HARRISON & PIA PORTLAND, ME JAY E. FISHMAN FASA, CBA FINANCIAL RESEARCH ASSOCIATES BALA CYNWYD, PA LYNNE Z. GOLD-BIKIN, ESQ. WEBER GALLAGHER NORRISTOWN, PA LANCE S. HALL, ASA FMV OPINIONS IRVINE, CA THEODORE D. ISRAEL CPA/ABV/CFF, CVA ECKHOFF ACCOUNTANCY CORP. SAN RAFAEL, CA JARED KAPLAN, ESQ. MCDERMOTT, WILL & EMERY CHICAGO, IL GILBERT E. MATTHEWS CFA SUTTER SECURITIES INCORPORATED SAN FRANCISCO, CA Z. CHRISTOPHER MERCER ASA, CFA MERCER CAPITAL MEMPHIS, TN JOHN W. PORTER, ESQ. BAKER & BOTTS HOUSTON, TX RONALD L. SEIGNEUR MBA, ASA, CPA/ABV, CVA, CFF SEIGNEUR GUSTAFSON LAKEWOOD, CO BRUCE SILVERSTEIN, ESQ. YOUNG, CONAWAY, STARGATT & TAYLOR WILMINGTON, DE JEFFREY S. TARBELL ASA, CFA HOULIHAN LOKEY SAN FRANCISCO, CA GARY R. TRUGMAN ASA, CPA/ABV, MCBA, MVS TRUGMAN VALUATION ASSOCIATES PLANTATION, FL KEVIN R. YEANOPLOS CPA/ABV/CFF, ASA BRUEGGEMAN & JOHNSON YEANOPLOS, P.C. TUCSON, AZ Business Valuation Update (ISSN 1088-4882) is published monthly by Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR, 97205-3035. Periodicals Postage Paid at Portland, OR, and at additional mailing offices. Postmaster: Send address changes to Business Valuation Update, Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR, 97205-3035. The annual subscription price for the Business Valuation Update is $399. Low-cost site licenses are available for those wishing to distribute the BVU to their colleagues at the same address. Contact our sales department for details. Please feel free to contact us via email at customerservice@ BVResources.com, via phone at 503-291-7963, via fax at 503-291-7955 or visit our web site at BVResources.com. Editorial and subscription requests may be made via email, mail, fax or phone. Please note that by submitting material to BVU, you are granting permission for the newsletter to republish your material in electronic form. Although the information in this newsletter has been obtained from sources that BVR believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not intended as financial, investment, legal, or consulting advice. Copyright 2013, Business Valuation Resources, LLC (BVR). All rights reserved. No part of this newsletter may be reproduced without express written consent from BVR. dealers are profitable and producing substantial cash. See Exhibit 3. Additional motives. Buyers have capital. Publicly traded groups certainly have capital, and public money is generally cheaper than the private sources. Additionally, sophisticated buyers the large privately held and publicly traded groups know their businesses well enough to maintain their profitable expense structures. Many smaller, privately held auto dealerships were late to the game (in 2008 and 2009) in cutting costs and making sure their businesses 18 17 16 15 14 13 12 11 10 2000-2005 Exhibit 2. SAAR (in $ Millions) SAAR (in millions) Sources: NADA and Automotive News 2.5 2 1.5 1 0.5 2007 2008 2009 2010 2011 2012 2013 Exhibit 3. Net Profit Before Taxes (As a Percentage of Total Sales) 2005 2006 2007 2008 2009 2010 2011 2012 Source: NADA Net profit before taxes (as % of total sales) 2 Business Valuation Update April 2013
could withstand all of the challenges and drops in volumes. The large groups, however, were more expeditious with expense controls and performed better in the tough times, and as a result, they had more cash more quickly. These groups generally experienced exponentially higher profits levels for their size, which has allowed them to feel more secure in searching for additional stores. Due to very low rates of return for cash investments today, groups of all sizes are searching for better returns on those assets. As a result, they are looking for dealership-buying opportunities to find better returns on investments. Thus, attractive returns that can be gained by well-performing dealerships have driven blue sky multiples higher. Auto dealership valuation methods. There are many complexities in valuing auto dealerships and multiple approaches. When appraisers value an auto dealership for acquisition purposes, they often use the current market industry method. Some appraisers refer to this as the blue sky multiple method, or the profit method ; others say it s just a rule of thumb. My firm, Dixon Hughes Goodman, termed it the current industry market indicator (CIMI) several years ago because it uses current market multiples to help determine total value. Practically speaking, the CIMI is similar in nature to methods mentioned above, in that it combines two pieces of value: an intangible and a tangible. The intangible (blue sky) is derived by multiplying pretax income by a multiple of earnings applicable for that particular business (the multiple is described elsewhere in this article). The figure derived by this calculation is considered the bucket of intangible assets, and tangible assets (adjusted net assets) are added to the intangibles to derive the total value. Other methods to value auto dealerships are: 1. Discounted cash flow method. Larger, multistore dealer groups with financial analysis departments often use the discounted cash flow method. This method projects net cash flows, usually for a period of five years, and then using current costs of capital present, values those future cash flows. Interestingly, many of these groups derive values here, but use the CIMI as a sanity check and/or reference point. 2. Per-unit retailed. Occasionally, appraisers value dealerships based on the number of retail units sold, but there are several dangers to this method. Among other significant concerns, this approach creates a value indication that is driven on sales (not necessarily profits), and also does not consider back-end operations, such as parts, service, and collision center operations. 3. Return on investment. Many auto manufacturers require that each dealership put in a certain amount of working capital that relates to the store s selling potential, as well as its size of operations. Working capital is required to be an equity infusion, so no debt is allowed on these working capital requirements. Consequently, some appraisers value a dealership on a return an investor would require based on the required working capital or the amount of equity that has been placed into the dealership. By doing so, a value is imputed based on reasonable market expectations. As an aside, one word of caution when performing a dealership valuation: Often appraisers spend so much time considering intangible assets that they neglect or spend too little time on the tangible net assets. The levels of capital/ equity retained by dealerships seem to vary greatly, depending on the ability and desire of various dealership groups to fund those dealerships with adequate working capital or, in some cases, well above the requirements given from the manufacturers. Thus, similar dealerships could have similar intangible values, yet great differences in the tangible value. Equal time and effort should be spent on the tangible value area to determine the proper fair value of assets and liabilities, since they are one of two components of value (intangibles plus tangibles). April 2013 bvresources.com 3
Blue sky considerations. Even with all of the different approaches to auto dealership valuation, appraisers can t value a dealership without considering blue sky. Years ago, blue sky (considered the entire bucket of intangibles in a dealership) was labeled goodwill. In today s environment, where GAAP has demanded further delineation of those intangible assets, it is common to segregate the franchise rights from the goodwill. Thus, on purchases of stores, most appraisers are asked to segregate those assets. Those considerations are often based on the assets related to and the returns from the assets attached specifically to the franchise. As a result, the returns created by the new vehicle department are considered first to be from the franchise rights. A detailed assessment is required to determine these figures. Listed below are some other issues appraisers should look at when considering blue sky. What profits to use? The methods often apply multiples, but it is important to know which profits to use in that calculation. Generally, a pretax, pre-lifo of earnings is used. So, LIFO is a big issue in auto dealerships. If those multiples use a net of tax number or the LIFO adjustment is missed, the value will be misaligned. Also, pretax is not the same as EBIT or EBITDA. Whichever multiples are used, appraisers must ensure that the earnings utilized are consistent with industry data being utilized. Location. Manufacturers give each franchise a certain number of ZIP codes and/or geographic landmarks that provide an area of responsibility (often referred to as AOR ). For example, a Chevrolet store in a certain type of market is different than one situated in another market with completely different demographics. Certainly, one consideration is urban versus rural, but so is the location in the country as well as the area s income levels. Appraisers should consider the area in which the dealership operates. Facility status. In a recent informal poll, over half of dealerships indicated that they have recently completed, are contemplating, or are undergoing facility enhancements to comply with the auto manufacturers imaging requirements. Also, many franchisors provide financial incentives to do such enhancements; however, the costs of these improvements are extensive, often reaching into the millions of dollars. This is even more of an issue because many in the industry debate whether these image programs actually improve the performance of dealerships. Thus, the status of a dealership in this facility status area is a very large consideration of value. Franchises. The type of franchise(s) held by a dealership is a huge component of its value. Each franchise has a target market, its own reputation, standards, following, trends, and future expectations. Multiples are often dictated first by the type of franchise in consideration, and then additional factors impacting that multiple in an increasing or decreasing direction. The franchise agreement that each dealership holds is a very valuable commodity, further protected by strong automobile franchise laws in each state. Unprofitable dealers can often achieve healthy values for their dealerships when the franchise, facility, and location are attractive. Impact of high earnings. The more money a dealership makes often results in a higher multiple. While that seems unusual, higher earnings often indicate certain characteristics that make it worth paying more. Examples include reputation, solid employee base, excellent systems and procedures, and attractive customer lists. For instance, one would think that a Lexus dealer would achieve a six times earnings multiple for its blue sky. Thus, no matter how much it makes, it should just be six times earnings. However, again, often the higherearning Lexus dealer will get an even higher multiple than six, and a lower-performing Lexus dealer will get a lower multiple, all due to the other considerations mentioned above. Synergistic or hypothetical buyers. As in most industries, at times there are differences between synergistic and hypothetical buyers for a dealership. This shows up particularly often in dealership sales activity due to geographic considerations and state franchise laws. Also, manufacturers have the right of first refusal on 4 Business Valuation Update April 2013
sales of franchises, so these factors often create the type of environment where the buyers of stores often have extra incentives to purchase stores. Thus, a synergistic buyer who already has another dealership down the street might be willing to pay five times earnings, whereas a hypothetical buyer who doesn t already have a store in the area would pay four times. Therefore, when studying specific sales activity, appraisers should consider how potential synergies have changed valuation trends in the past as well as how they may impact future valuation considerations. Buyer motives and impact on blue sky. No matter how sophisticated the valuation model, most dealerships trade on multiples of earnings. Naturally, appraisers valuing auto dealerships need to consider the current industry environment on blue sky. Whereas very few dealerships traded hands in 2009, today buyers are actually searching for stores, which has caused multiples to rise. Willing buyers will pay a premium for this blue sky to have the chance to sell new vehicles and make a good return on their investment. The divide between franchises is growing again. When we think of franchises that would bring the highest multiples, Lexus, Mercedes, and BMW come to mind. Conversely, the franchises that might bring the lowest multiples may include Mitsubishi and Lincoln. Naturally, some franchises are more attractive and desirable than others, and the multiples paid are often aligned with that desirability. Which dealers are selling? The first group is the thrilled survivors dealers with loan covenant violations, those that infuse capital just to make payroll, or dealers that are just scraping by after enduring the Great Recession. The second group comprises dealers that do not have clear succession plans; are tax motivated; or are tired of the regulatory issues, impending finance-related regulations, legal issues, and pressures. These dealers are thinking, There s probably never a better time for me to go ahead and take the money off the table. They are selling the dealership, the offshore warranty company on extended service contracts, the real estate, etc. Some of these folks are cashing out at $15 million, $20 million, $50 million, and $80 million levels, especially considering related real estate. Conclusion. As illustrated throughout this article, there are many considerations to take into account when valuing a dealership, and an appraiser must consider them all each time to ensure that a proper conclusion is reached. First and foremost, gathering current industry trends and buyer motivations is crucial in understanding the motives of hypothetical and synergistic purchasers and sellers. Also, grasping how the market works in determining values of dealerships and then unique characteristics of the business that impact intangible value (blue sky) are two remaining crucial steps in getting the right answer. While not dissimilar to other industries, these steps must be done by appraisers in this area. Timothy W. York, CPA/ABV, is partner-incharge, dealer services group, at Dixon Hughes Goodman LLP. He can be reached at tim.york@ dhgllp.com or 205-212-5300. April 2013 bvresources.com 5