Beyond pondering dealership value
Halbert B. Rasmussen
In today’s unique market, many dealers are considering their buy-sell options. Getting a sense of the value of the business is the typical starting point. Brokers and investment bankers who focus on dealership transactions are quick to point to rules of thumb, especially the earnings multiplied by a multiple, where the multiple is based entirely on the franchise represented by the dealer. But this approach alone does not account for the wide variety of variables that are involved, nor does it deal with dealership real estate. While the earnings-times-multiple approach provides a quick gauge of value, both sides of this mathematical equation deserve some further attention.
On the “earnings” side, buyers and sellers seek to normalize or adjust the reported income and expenses to the scenario where the dealership is operating under the buyer’s ownership. As such, many items of expense are believed to be inapplicable and should be removed. These often relate to generous compensation, benefits, or personal expense items attributable to the selling ownership group. Often, this includes costs associated with the owner’s personal fleet of vehicles, boat, club memberships, life insurance, executive assistants, etc. Also common are adjustments to the gross income side of the income statement, where attributes unique to the seller may have resulted in income being higher (or lower) than would be the case under the buyer’s ownership. This is often seen where the seller is perceived as less than nominally effective in its sales efforts, such that sales, and thus gross income, would be higher under the buyer’s ownership. While it would seem easy to correct for the latter circumstance, simply adding income that the buyer “would have made” is not necessarily a prudent route, as it ignores the deeper questions of whether the missing sales could really only be made up by an increase in fixed expense, or a higher variable expense structure.
Another example that impacts the earning side is the dealership real estate. If owned by the selling dealer, or an affiliate, the rent expense reflected on the financial statement may be significantly under market. Where the buyer intends to purchase the real estate (or the seller intends to adjust the rent when it leases the facility to the buyer), it is necessary to determine a reasonable or appraised rental value and use that amount as a substitute for the rent expense on the income statement. Moreover, with today’s space needs necessitating the rental and/or use of multiple storage spaces, determining the actual rental expense can be challenging. Valuation experts understand the nuances involved in normalizing financial statements, both in the examples discussed above, and for a variety of other elements, such as for inventory valuation and working capital determinations.
Once the “earnings” side is normalized, it is important to tackle the “multiple” side of the earnings-times-multiple equation. As a starting point, multiples published in industry newsletters, while helpful, are not definitive. Some dealerships, such as “destination” high line operations, defy the earnings-times-multiple approach entirely. For more typical dealerships, it is still essential to determine where the dealership should fall within the range of multiples reported for the applicable brand. Factors that should be considered include historic new vehicle sales volume; dealer compliance with factory requirements under the dealer agreement and all available margin programs; dealership location; up-to-the-minute economic and brand performance information (so as to update the reported multiples, which are trialing indicators); and the current and anticipated competitive environment, especially from nearby same-brand dealers.
After taking the above steps, both the earnings and the multiple will be more carefully calibrated. Using the earnings-times-multiple approach can now provide helpful information about the anticipated blue-sky component of dealership value. Blue-sky is often pivotal because the other assets are considered “hard” and relatively easy to value – with several significant exceptions, and one huge exception: fixed assets. Fixed assets often have a value less than reported on the balance sheet – in fact, there is very little reason to assume that all of the fixed assets reported on the books even exist. Buyers and sellers are certainly aware of this, resulting in fixed asset valuation being handled in variety of ways in a buy-sell. For example, a fixed price can be agreed upon; a value can be determined by appraisal; or the book value can in fact be used, but perhaps adjusted to include deferred depreciation and to remove “missing” items. In short, a dealer considering the value of his or her dealership should ask the controller or accountant for the fully depreciated value of the reported fixed assets, and to probably back out leasehold improvements or other assets that cannot be physically touched in a furniture, fixtures, and equipment inventory or hand-count.
Finally, where dealership real estate is also to be included in the contemplated buy-sell, there are relatively few alternatives to having a recent real estate appraisal. While various rules of thumb can be used to “update” an older appraisal, or publicly known comparable sales might provide some direction, dealers considering a possible foray into the buy-sell world with a dealership and real estate to sell can benefit from a current appraisal. The buyer and/or buyer’s lender are most likely going to require an appraisal, and being forearmed with how the property is viewed by appraisers can help set the stage for the seller to negotiate the best price possible.
While it may be entertaining to complete an earnings-times-multiple valuation on the back of a napkin at lunch, dealers who want to evaluate their prospects in today’s buy-sell market will have to dig deeper. The steps discussed above can yield a more realistic “first cut” on value, but an even deeper dive will be necessary, with the help of valuation experts, before moving ahead with establishing an asking price.