Don’t Buy in to ‘Multiple of Earnings’ Myth
December 15, 2017
What is your dealership worth? How do you know? Gut feeling? Accountant’s opinion? Articles in Automotive News— Published articles from “experts”?
Most likely your opinion was formed based on recent articles that speak about the concept of “multiple of earnings.”
Publications refer to “multiple of earnings” as a benchmark of valuations and offer monthly or quarterly fluctuations by brand. It is concerning that such publications have made their way into formal valuations prepared by automotive CPAs relying on that data. Some even state that a specific brand will trade 3-5 times earnings. Well, the difference between 3 times and 5 times is 66 percent …
Beware: Such representations are incomplete at best, and they could mislead dealers to false pricing expectations, flawed financial planning and costly decisions.
In June 1995, an article published by the National Automobile Dealers Association referred to this rule of thumb as a “greater fool’s theory.”
We sold a Chrysler dealership showing a net profit for 2016 of $1.2 million — the goodwill portion was sold at $9.5 million.
Does that mean Chrysler dealerships trade at 7.9 times earnings?”
No comparable or any rule of thumb can determine the value of a dealership. Establishing value using only a multiple of earnings is an irresponsible approach. Which earnings? The most recent 12 months? Three-year average? Five-year average? Weighted averages? And if so, what weight is given to each year? And if the dealership loses money, what multiple is used? We have sold for millions of dollars dealerships that lost millions of dollars.
A new-car dealership is a franchised business with territorial protection and commands intangible value, even if it loses money.
Unlike residential homes, there are no comparables. Multiple-listing services do not exist for car dealerships, nor is there a centralized data center. Each dealership has unique circumstances. By utilizing only multiple of earnings or comparables, you are ignoring a host of other intangible variables that influence value:
- The history and background of the dealership
- Brand desirability and market share
- Location, primary market area, demographics, single-point, competition
- Earnings sustainability and growth potential
- Management, reputation and customer loyalty
- Fixed operations gross, sales expectancy, units in operation
- Real estate and facility size, price and condition
- Operational risks when the market softens and inevitable disruptions occur
- Reason for selling, capex requirements, union, unfunded liabilities, etc.
A dealership’s value lies in its ability to produce income and cash flow. Therefore, a return on investment is the only method that should be used.
In the narrow view of using net earnings to establish value, how do you define “earnings”? Is it earnings before interest, taxes, depreciation and amortization? Perhaps just earnings before interest and taxes? Do you normalize earnings to reflect fair market value occupancy? If so, at what cap rate — 5.5 percent or 8 percent? Do you recast earnings to reflect discretionary expenses, excess salaries, one-time expenses, reinsurance, management fees?
A multiple of past earnings does not dictate value; it is the multiple of buyer’s “pro forma” earnings (anticipated higher earnings).
Buyers use the seller’s track record to build their own pro forma, and rely mainly on expenses, patterns, trends and gross profit, which speaks to the strengths and weaknesses of each department and the opportunity to maintain and improve performance.
Additionally, each buyer will value and analyze the same dealership differently based on items such as proximity, synergy, scalability, management structure, a tuck-in opportunity, etc.
Furthermore, if any facility remodeling is required as a condition to the approval of a new sales and service agreement, buyers are looking for sellers to participate in the expense and to discount the goodwill — sometimes as much as dollar-for-dollar.
Lastly, the auto industry is cyclical, and its performance magnifies the boom and bust of the overall economy. Buyers are now taking into consideration the uncertainties looming in our industry.
So, what is the value of your dealership? Ultimately, a dealership’s value is determined by the buyer.
The buyer’s decision as to how much to offer is reduced to two key points:
- The likelihood of maintaining or increasing future revenue and profits
- The buyer’s threshold of a desired return on investment.
In general, buyers are seeking an opportunity to generate 17.5 percent to 25 percent ROI for domestic and second-tier brands, 15 percent to 20 percent ROI for Tier 1 import brands, and will settle for as low as 10 to 15 percent ROI for the top luxury brands.
And if the unique buyer is found, the unique buyer will pay more!