Published on November 27, 2017

Automotive News: Myth of 'Multiple of Earnings'

The net profit does not impact the goodwill value as much as you were led to believe.

What is your dealership worth? How do you know? Gut feeling? Accountant’s opinion? Articles in the Automotive News? Published articles from 'experts'? Most likely your opinion was formed based on recent articles and publications that speak about the concept of 'multiple of earnings'.

These publications refer to 'multiple of earnings' as a benchmark to 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 CPA’s relying on that data. Some even state that a specific brand will trade between 3-5 times earnings. Well, the difference between 3 times and 5 times is 66%...

Beware, such representations are incomplete at best, and could mislead dealers to false pricing expectations, flawed financial planning and costly decisions.

In June 1995, an article published by NADA referred to this rule of thumb as a "greater fool’s theory". In 2004, it further stated that it is "rarely based upon sound economics or valuation theory". We sold a Chrysler dealership showing a net profit for 2016 of $1.2M and the goodwill portion was sold at $9.5M. Does Chrysler dealership therefore trade at 7.9 times earnings?

No single valuation method, comparables, 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 twelve 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 dealerships for millions of dollars 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 is matchless with unique circumstances. By only utilizing the method of '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, PMA, demographics, single-point, competition
• Earnings sustainability and growth potential
• Management, reputation, customer loyalty
• Fixed operations gross, sales expectancy, UIO
• Real estate and facility size, price and condition
• Operational risks when the market softens and (inevitable) disruptions occur
• Reason for selling, CAP-X requirements, union, unfunded liabilities, etc.

A dealership’s value lies in its ability to produce income and cash flow, not based on comparables or 'multiple of earnings'. Therefore, a return on investment (ROI) 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 EBITDA? Perhaps just EBIT? Do you normalize earnings to reflect FMV occupancy? If so, at what cap-rate, 5.5% or 8.0%? Do you recast earnings to reflect discretionary expenses, excess salaries, one-time expenses, packs, reinsurance, management fees?

A multiple of past earnings does not dictate value, it is the multiple of buyer’s pro-forma!

Buyers use seller’s track record to build their own pro-forma, and rely mainly on expenses, patterns, trend 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 like: proximity, synergy, scalability, management structure, a tuck-in opportunity, etc.

Furthermore, if any facility remodeling is required as a condition to the approval and issuance 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 (ROI)

In general, as it pertains to ROI, buyers are seeking an opportunity to generate 17.5%-25% ROI for domestic and second-tier brands, 15%-20% ROI for tier-one import brands, and will settle for as low as 10%-15% ROI for the top luxury brands.

…and if the unique buyer is found, the unique buyer will pay more!

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Moshe Stopnitzky, President of Performance Brokerage Services, Inc.
Auto dealership brokerage firm. Over 25 years and 600 dealerships sold.

www.performancebrokerageservices.com