The dealership world has just come off two of the most profitable years in the industry’s history. The conditions that created that profitability are gone, however, and those looking to acquire a dealership are faced with the question of how to determine what the fair price for a franchise is.

Buyers in the market now are especially concerned about one element of a dealership’s operations, George Karolis, president of The Presidio Group, tells Getting to Go! -- what is the quality and sustainability of the cash flows going forward?

“We are seeing buyers focused on that more than ever,” he says.

As profitability begins to slip, the dealership world is entering what The Presidio Group calls “The Great Normalization,” a reversion back to more historical operating levels, including lower profits.

Into uncharted territory

In 2021 and 2022 dealerships were living large. Profit levels were two to three times historical levels, Karolis says

There was strong consumer demand, low inventory, and low interest rates, which meant low inventory carrying costs. That made buyers willing to pay a bit more.

“Generally, many buyers at that time expected a couple of years of heightened earnings, so if they acquired at higher prices, they would have the benefit of stronger cash flows for a period of time, helping their overall investment metrics and returns,” Karolis says.

That has changed. Inventory is close to historical norms, demand has slowed, consumer affordability is an issue, and high interest rates and higher overall costs are adding expense pressures “on the heels of reduced margins,” he says.

While dealerships are still more profitable than they were pre-pandemic, in 2023 profitability was off some 20% compared to 2022, The Presidio Group said in its fourth quarter Presidio Perspectives report, an auto retail and M&A outlook compiled with NCM Associates.

For the first quarter of 2024 the decline continued, with dealership profits off 32.4% compared to the same quarter in 2023, according to the Presidio Perspectives first quarter 2024 report. Pretax profits were still 1.8 times higher than 2018 levels, the report notes.

The average dealership is still doing “pretty well,” Karolis says. But it is hard to know when profitability will level off.

“This is uncharted territory,” Karolis says.

In such times, the standard elements of a dealership’s worth – brand and geography – become even more important.

Toyota still tops the list of most desirable brands in The Presidio Group’s survey for the report. Toyota has the most throughput per dealer, the dealers have inventory, and the manufacturer supports the dealer body, Karolis say.

That beats the “let’s throw out a bunch of stair step (incentives) and chase volume” approach of some other franchises, he says.

As for geography, “people buy cars and drive cars everywhere, but we are seeing a lot of demand in California, Texas, Florida and Tennessee,” Karolis says.

The operating environment influences what buyers are willing to pay in some states, according the Presidio report, which notes “higher premiums continue to be paid for stores in pro-business states such as Texas, Tennessee and Florida.”

Patience is a virtue if you are a buyer

The Presidio Group saw buyers in the market in the last few years that it hadn’t seen before because of the level of profitability, Karolis said. “Folks that were not acquisitive became acquisitive,” he says. “There were a lot of buyers that we have not seen before.”

So, for example, Canadian groups began looking to buy franchises in the U.S. Also, smaller groups were in the market.

“Because the dealer model was so strong and cash flow was good, dealers were feeling really good,” Karolis says. “Small buyers all over the place were constantly trying to grow and acquire.”

That is changing. Though it is still a seller’s market, that is beginning to wane, he says. Buyers are becoming less gung-ho.

And from a buyer's perspective, that is good. “You see so many deals as a buyer, you are not going to chase them all,” Karolis says. “On the buy side you are specifically targeting assets you are really interested in.”

Buyers are better off being patient and making targeted investments that fit their expansion strategy, even if that means paying a bit more than the buyer initially intended to pay.

Karolis compares it to a runner choosing to buy a $70 pair of running shoes instead of investing in the $200 pair. “You’re gonna be mad every time you put (the $70 pair) on,” he says.

“Time is the enemy of a successful deal”

Buyers should avoid being too difficult to deal with when it comes to negotiating price, Karolis says. He also recommends moving quickly.

“We’ve seen so many deals get awarded to buyers who are really easy to deal with and who move quickly and are fair and step up to the valuation that is expected from the seller,” he says.

But sellers can’t be unrealistic about the price their dealership can fetch, Karolis warned.

“What we are going to see this year is, we are going to see more deals not getting done because sellers are unrealistic,” he says. “They want last year’s money.”

Buyers want to pay based on future earnings potential, Karolis says. There will be some ask spread challenges, he predicts.

This year, “buyers are going to be in the main more refined and detailed and focused in ensuring they understand the cash flow they are requiring and that it fits into their return metrics” he says.

This article was written for Getting to Go, a buy/sell newsletter from Scali Rasmussen.