For auto dealers, a moment of contemplation

NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided. 

After the slow down of late summer, the tragic events of September 11, the roller-coaster ride of sales resulting from reduced new car interest rates, the moment is here for you, the American car dealer, to reexamine and reassess your goals and alternatives.

The decade of the 90s was an unprecedented period of prosperity for most dealers. At the same time, private entrepreneurially owned dealerships faced down challenge after challenge that threatened the status quo — public consolidation, shrinking margins, dot com mania and factory ownership, to name just a few. Through it all, the retail dealer adjusted, persisted and ultimately thrived. Even through the summer of 2001, car sales, particularly imports, remained strong, despite warnings that the economy was slipping. And many commentators are now saying the recession that was just formally identified in the late fall is now ending.

Some voices say that this constantly changing environment may not be even directly connected to car sales anyway. Most analysts project that car sales will remain relatively strong and fall to maybe 16 million vehicles in 2002. Chris Cedergren of NexTrend suggests that outside of a catastrophe, such as a deep depression, this is the new base number for the industry. His theory is that there is a new breed of consumers who will not change their buying habits even in the face of growing unemployment numbers and other evidence of a deteriorating economy.

Others including the public dealer chains argue that the diversity of revenue found at retail dealerships insulates them from the peaks and valleys of vehicle manufacturers. Higher margin service and parts business will protect profitability in a downturn. Lower interest rates and the overall affordability of vehicles should also help. Certainly the tremendous incentive programs instituted by manufacturers in the aftermath of September 11 generated new vehicle sales although at some risk to sales in future months. (Twin concerns, likewise, are the ramifications for the residual value of used cars and the marketability of used inventory).

The reality is that none of us knows how severely we will be tested. One thing is clear. It’s gut check time. Hard decisions will have to be made. Many dealers have already tightened their belts and have made tough choices about laying off employees. That, in many cases, may only be the precursor to more difficult and even more emotional choices. The question for many is whether to stay in the business altogether.

After years of hard work and perseverance many dealers have accumulated substantial assets. Are these dealers now prepared to give it back if need be? Are they willing to absorb losses to support the business while awaiting a return to good times? In many cases the dealership is the single largest component of their net worth. Are they willing to risk their hard won financial well-being on the uncertain prospects of the future? It comes down to whether they want to stay in the business and deal with the challenges of the future or declare victory and cash out their investment.

Conversely, others are staring at the same haze and are recalibrating their appetite for new acquisitions. Was it a Chinese philosopher who once said that uncertain times are the father of opportunity? Many have told us that they were waiting for a downturn so that they would be able to buy dealerships at better prices. They understand that, despite potentially troubled waters ahead, dealerships, in most cases, are a valuable and scarce commodity. The unvarnished reality is that a healthy car business is indispensable to our county’s return to normality. For those of us that believe this to be true, vehicle retailing will be a damn good investment for those with patience and deep pockets.

As you prepare for selling your store, or eyeing additional stores for purchase, here are some key pointers to help get the most out of a deal:

•Go beyond traditional, blue sky valuations.The formula of three to four times earnings plus net assets is useful, but it should be one of several methods you use to derive a value for a store.One reason: The traditional valuation method doesn’t account for the efficiency of a store’s operation. For example, a store with $640,000 in profits and $800,000 in net assets would get a value of $2.72 million ($640,000 x 3 (blue sky multiple) + $800,000). Meanwhile, a different store with $640,000 in profits and $1.6 million in assets would get a value of $3.52 million ($640,000 x 3 (blue sky multiple) + $1.6 million). The calculation gives a larger value to the less efficient store-a glitch that other valuation methods that focus on return on investment can quantify.

•ID the store’s true earnings power.It’s not uncommon for a store to pay out expenses for country club memberships, excess compensation, non recurring expenses, etc. The approach can have tax benefits, but it also masks the earnings power a store may deliver to a new buyer. In most valuations, buyers and sellers should add back these monies to determine profit potential. Note to sellers: Some brokers recommend you start making such adjustments – and take the tax hit in the months prior to a sale so your store’s earnings statements will accurately reflect its potential. By saving some money in taxes now, you might be giving up considerable money in good will latger.

•Charge a fair market value for rent.Dealers who own their store’s property often charge their stores rent rates that are below market value. The approach helps a store’s profitability, but it can also harm its valuation. Here’s why: In valuations, rental income is worth more to prospective buyers-sometimes as much as three times more-than if the same income goes to other operations.

• Address under-performing departments.It’s no secret to buyers that a store’s true profit picture comes from successful service and used vehicle operations, says Diane Anderson, a manager at Moss-Adams Advisory Services, a Seattle-based firm that handles valuations. Prospective sellers should take steps to address under-performing departments in the months prior to a sale to demonstrate their potential profit strength. Buyers are more likely to pay for proven performance than potential, she adds.

• Get appraisals of fixed operations and real estate.Buyers should insist on these to get a sense of a store’s asset value, and sellers should have them completed within a year of the time they plan to sell. Prospective sellers should also spring for a full-blown audit of their financials -or at least a review–prior to a sale to give buyers confidence in their numbers, Anderson says.

• Qualify would-be buyers.You don’t want to waste time with a tire-kicker buyer. Key questions to consider: Does the buyerhavethe money? Do they have the strategic interest? Will they get factory approval?

• Know a store’s potential.Buyers will be looking at a store in terms of what they cans produce at a location-and most think they can do better than theexistingowner. For sellers, this dynamic is key in negotiations to get the “seller to pay for some of that potential,” Schmidt says. At the same time, buyerscan use a store’slack of prior performance to keep the price low.

It’s my bet that there are many dealers who delayed taking the inevitable steps into retirement because they were making a lot of money and were just having too much fun in the process. If nothing else the events of September have reawakened them to the vulnerability of their business. Just as in boxing, it’s often the punch you don’t see that knocks you out.

Our advice. It’s a requirement to be optimistic — but foolish not to be realistic about your own situation. Take stock of your individual needs and goals. A starting point might be to get an educated appraisal of the value of your dealership. It’s the critical first step in your reassessment.

This article was written in 2002.