Bridget: Erin, thanks for joining us today.
Erin: Thanks so much for having me, Bridget.
Bridget: How has the buy-sell market performed in 2019?
Erin: Well, buy-sell the market was very strong in the first half of 2019. We had over 103 transactions completed year to date, and that’s down 10% from last year, but keep in mind it’s still tracking to over 200 transactions for the year. That would be the sixth consecutive year of over 200 transactions in our industry. To give you a sense, what that means is about 12% of the dealer bodies traded hands since 2015. I’d say that’s a pretty active market.
Bridget: What about valuations? How has Blue Sky fared?
Erin: The Blue Sky in the industry has generally been tracking downwards since 2015, but what we saw in the first half of 2019 is that it stabilized. In fact, it eked up a bit, and that’s largely due to the fact that we did see earnings rise in the first half. We had predicted that this would happen in the last two Blue Sky Reports, and the reason we thought that is that we are very aware that the dealership business model is a diversified one in which the dealers are able to refocus their energies on the higher margin parts of their business when new car sales decline. Now, new car sales, as we all know, is a low margin business. However, fixed operations and used cars are a very high margin part of our business model, and those two segments have been on the rise, resulting in a stabilization of dealership earnings and in fact a slight increase in the first half
Bridget: Given rising earnings and valuation increases, is the buyer pool also increasing?
Erin: Interestingly, the buyer pool for dealerships is also increasing, and this is counterintuitive. Again, the whole industry seems to be focused on the fact that new car sales are declining, and the news headlines certainly love to discuss this, but what we find is that our model keeps proving itself out. That it is a well balanced model that actually is somewhat counter cyclical. When the economy gets more challenging and new car sales do decline, the other parts of our business tend to rise. Consumers tend to service their cars more, or instead of buying new cars, they buy used cars, which, again, have higher margins for dealers. This is highly attractive to investors who are looking for a hedge if there is a recession, and so we do see more high net worth investors, more family offices, and private equity firms continue to contact our firm, interested in ways that they can invest in auto retail. We do think this is a trend that we will continue to see in 2019 and into 2020
Bridget: How about the public auto retailers? How has their valuation fair?
Erin: The publics are doing very well. I think Wall Street also is recognizing, gosh, this is a really interesting place to put your money if there is a recession. We’ve seen the public’s rise in terms of their market capitalization over 30% year to date. That compares the S&P, which was up only about 16% year to date. Again, the public’s had record earnings as a group in the first half of 2019, and I think that really speaks volumes about the business model and the attractiveness of the auto retail business model, especially in times where there is concern about a recession coming.
Bridget: With public valuation increases, do you think there’ll be more transactions with the publics?
Erin: We do expect with the rise in the public stock price that you will see them divest fewer franchises and in fact make more acquisitions. We estimate that their Blue Sky is now 5.9 times on average. That’s 1.4 times higher than the average dealership in the industry. That means more acquisitions are creative to earnings, and therefore more attractive in terms of a place to allocate capital. We do think you’re going to see a shift to towards the publics allocating more capital to US acquisitions, and this is a trend we’re obviously watching.
Erin: One thing to keep in mind though, there is a lag when they decide to do this, because our transactions take six to nine months to complete, mostly because the OEM has a 30 to 90 day approval process, so you might not see their acquisition activities show up until perhaps the beginning of 2020. But we do think they’re going to start allocating more capital and they’ve said so in their earnings report in the second quarter.
Bridget: It seems like we’re gearing up for a lot more buy-sell activity. Now, which franchises are seeing the most bicycle activity?
Erin: Well, the first half was pretty interesting. We saw the buy-sell market share shift pretty dramatically to the domestics. 70% of the buy-sells in the first half were of domestic franchises, almost evenly split between Chrysler, Ford, and GM franchises. Now interestingly, that market share was taken away from the imports. Import luxury represented just 9% of the buy-sell market in the first half, and important non-luxury represented 11%. we really think this is a testament to the fact that the domestics have a pretty interesting and attractive return on investment. Their Blue Sky multiples are about three to four times and they are in a growing market. Trucks continue to grow. That is a segment that is on the growth mode. Even though the overall SAAR is declining, truck sales continue to rise, and these companies certainly benefit from that. Also, the fact of the matter is their return on investment is attractive because their multiples tend to be lower than the import franchise multiples. You can see that investors today are very sensitive to their ROI, and I think that’s why we’re seeing an increase in domestic market share in the buy-sell market.
Bridget: Your Q2 2019 Blue Sky Report just released. Have there been any changes in franchise market share?
Erin: Yeah, the market share changed quite dramatically in the first half of 2019. In fact, the domestics now represents 70% of the buy-sell market. That’s a real shift. It was 50% around that range for the last few years, and now 70%. We believe that is really driven by the return on investment profile of domestic franchises. Because they trade at lower multiples than most import franchises, they’re very attractive in terms of ROI from a buyer standpoint. Now, domestic took share obviously from the imports. Import luxury represented just 9% of the buy-sell market, and import non-luxury represented 22% in the first half of 2019. We expect this to be a continuing trend where we do see domestics take share. Again, they’re also very much benefiting from the growth in the truck market, so their sales in some cases are in fact growing even though the SAAR has been declining.
Bridget: Did you have any changes to multiples?
Erin: In the most recent quarterly report, the Blue Sky Report, we did downgrade two multiples. Unfortunately Nissan and Infiniti did see their Blue Sky multiple reduced to 3.5 times on the high end for both franchises. This was driven by the fact that there really is less buyer demand for those franchises today, unless they’re in very attractive markets like Florida or Texas. What we find is that buyers are concerned about the business model of Nissan and Infiniti and the fact that the incentives shift so dramatically from month to month, so dealers can make a ton of money one year and then not make very much money the next year. That’s just not an attractive business model today. I will also say that certainly all the negative headlines on the franchise also do not help buyer demand, so we have seen the multiple come down slightly for both Nissan and Infiniti.
Bridget: What other trends are you expecting for the remainder of 2019?
Erin: Well, the final trend that we discuss in our most recent Blue Sky Report is the fact that we have seen, of course, interest rates decline. The federal funds rate was reduced this quarter. We think that’s going to be a real positive for the buy-sell market. Because if you think about it, our transactions are heavily financed. A big chunk of the transaction tends to be real estate, and that’s financed 80%, and then Blue Sky is often financing as well as much as 50%. our firm estimates that the average transaction has about $12 million of debt, so you can imagine if interest rates decline and the terms on acquisition financing improve, that will be very beneficial to the buy-sell market. We are keeping a close eye on interest rates and we are actually pleased to see that they are declining. We also think that the decline will help the SAAR, and that of course is good for the entire industry.
Bridget: Well, Erin, it’s always great to get the market update report from you.
Erin: Thanks so much, Bridget, and I hope you have a great fall.
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