The auto dealership buy/sell market shattered records in 2021 with 383 transactions, representing 830 franchises, completed—a figure 32.5% higher than 2020’s prior record, according to the Blue Sky Report by Kerrigan Advisors.
Erin Kerrigan, founder and managing director of Kerrigan Advisors, reports the buy/sell market stands poised to do it again, even with record high vehicle prices, supply chain shortages, tightened inventories, and inflationary and geopolitical pressures pressing the market.
The number of dealership acquisitions in the first quarter buoyed her expectations for 2022. An Automotive News report recently estimated that 52 transactions happened in the first quarter, involving around 78 dealerships.
Kerrigan notes she had a less positive outlook in December. In fact, she expected the buy/sell market to remain flat, and possibly even decrease, but today she predicts it may best 2021 levels.
The reason? Key market conditions that made the market rich for Mergers & Acquisition (M&A) activities in 2021 remain in place—at least for now—in 2022. These include unprecedented dealership earnings and elevated blue sky valuations.
“We saw another record quarter of earnings for the industry, so the same dynamics exist as in 2021,” she says. “There is more capital in the industry than there was at the end of 2021.Buyers are eager to put their capital to work by acquiring dealerships and more sellers are coming to market in 2022 because of the financial risks on the horizon. This is a recipe for a lot of buy/sell activity.”
And, even if supply constraints ease, she expects demand for vehicles to remain higher than supply for some time, which “will enable more activity,” she adds.
Automotive News’ 2022 Dealership Outlook Survey supports her findings. Their research revealed that one out of every five of the 196 dealers and dealership managers who responded noted they plan to buy dealerships in 2022. Nearly 5% of respondents reported plans to both buy and sell stores in 2022.
Valuations: A Moving Target
Still, an uncertain market with volatile conditions threatening to make an impact affects valuations, making them a moving target.
“The hardest part in today’s buy/sell market is the valuation equation,” Kerrigan says. How do you value a dealership when its profits have tripled or quadrupled? We still need to figure out a fair price.”
With record earnings under their belts, sellers often hit the market with unrealistic expectations; expecting to get top dollar based on their best earnings ever. That’s because historically the market based dealership valuations on prior earnings. Today, buyers must do their homework, figure out what they believe normalized earnings for an acquisition might be, then value the business on that basis. Valuations have become more forward looking versus historical, she explains.
“Interest rates are rising, and higher interest rates always have an inverse relationship with valuation,” she says. “I expect them to affect valuation because buyer’s cost to capital will increase. Because transaction sizes continue to rise, the average auto dealership transaction is more sensitive than in the past to financial markets.”
These factors make Kerrigan less bullish about valuations. “We don’t expect valuations to rise considerably in 2022, though earnings will likely continue to increase,” she says.
However, she maintains it is unlikely for valuations to decline. She uses the housing market as an analogy. Interest rates are rising but house prices are not declining because demand remains higher than housing supply. “In fact, you are seeing valuations rise because more product is coming to the market and is therefore being sold,” she says. “This is not dissimilar to what we are seeing in the auto retail industry buy/sell market. There is much demand but so little supply. So, when really attractive assets come to market, they get picked up immediately.”
However, she tempers her enthusiasm with concerns over OEM changes to dealership business models as part of their pivot toward electrification and digital retailing. Some OEMS now eye a shift to flat fees for vehicles removing the negotiation process, for example.
“Uncertainty creates greater volatility in a business’ valuation and the more uncertain buyers are regarding a franchise’s future earnings, the lower the blue sky multiple they expect to pay,” she says. “With this in mind, we downgraded our outlooks on Chevrolet, Ford and Buick GMC franchises to ‘negative’ from ‘steady.’ The domestics are flirting with new business models for their vast dealer networks and the unknowns associated with these changes is adding a level of risk to their Performa earnings, which may reduce their multiples in the future.”
This is already reflected in the buy/sell market. Domestic dealerships’ share of the buy/sell market fell to 46% as import franchises saw their buy/sell market share soar to 54%. The big winner here was Toyota, which hit a new high of 7.75%. Kerrigan Advisors attributes this to the Toyota OEM partnership business model with dealers, relative to the sometimes strained relationships between domestic OEMs and their dealers.
“We are seeing more buyer skepticism about Ford’s and GM’s plans to go direct-to-consumer, which may lead to a decline in buyer demand for these franchises in the future,” she says. “The demand for Toyota franchises, in contrast, is the highest we’ve ever seen. Buyers believe an investing in a Toyota franchise will stand the test of time because Toyota partners with its dealer network.”
Driving Toward Digital
“Auto retail experienced a ‘black swan’ moment in 2020, the results of which continued to transform the industry throughout 2021,” Kerrigan states. “The pandemic was a catalyst as shrinking new vehicle inventories and rising consumer demand resulted in one of the most extreme supply/demand imbalances in auto retail history. Dealers leveraged their new pricing power while also reducing expenses and enhancing employee’s productivity, which resulted in record dealership profits and increased operational efficiency. All of which led to the high velocity of dealership transaction activity in 2021.”
Digitization began to transform auto retail and accelerated consolidation, as the “once impossible online vehicle sale became the possible because of the pandemic,” she says. In turn, auto retail accelerated its transition from local to a national marketplace, the consequences of which, she says, “will be long lasting, particularly for private, family-run dealerships.”
For this reason, Kerrigan Advisors expects digital retailing, along with OEM’s attempts to go direct-to-consumer, to stimulate industry consolidation throughout 2022.
“Digital retailing will render the concept of primary market area or PMA somewhat moot. It removes the geographic boundaries of a dealer’s franchise and enables them to sell to a much larger market area,” she says. “With this change, dealers will need to reconsider the way they sell vehicles. They will have competition from others beyond the local area. They will have regional and even national competitors.”
What Dealers Can Do
The pandemic clarified that scale, and a national platform, will separate the wheat from the chaff. According to Kerrigan, the first step for dealers looking to buy or sell in 2022 is developing a strategic plan for their business.
“Whether that’s a growth plan or an eventual exit plan, having a strategy as this industry evolves is vital,” she says. “The historic inertia strategy of staying the course and not focusing on reengineering the business for a digital and electric future will be more risky.”
Dealers also must develop plans for growth. “I believe scale is going to be a key determiner of success in the next decade,” she says. “They need to think through their plans. What acquisitions are accretive to their business? How do they want to grow? Do they want to grow into new markets or in franchise numbers? Do they have the staff to grow? These things are crucial to consider.”
If a dealer considers these things and finds they are not interested in growth and investment, Kerrigan stresses, “the best plan may be an eventual exit.”
Focus on the Future
When asked to get out her crystal ball and predict the buy/sell environment for 2023, Kerrigan states her ball is “very cloudy.”
“I expect 2023 will still have a strong supply-demand imbalance with new vehicles and earnings remaining strong. I say that with the caveat that any unforeseen geopolitical event could change this. But if earnings remain strong, I expect 2023 to be another busy year for buy/sells sales, but perhaps not as strong as 2021 and 2022.”
See all comments