Dealership valuations are expected to either remain steady or soften a bit in 2023. But merger-and-acquisition (M&A) activity is expected to remain robust, even as a variety of factors – the emergence of electric vehicles (EVs), high interest rates, inventory shortages and inflation, for example – continue to roil the auto industry. That’s the assessment of three experts: Farid Ahmad from DSMA, Peter Heasty from Baker Tilly Dealer Acquisitions Inc. and Landon Robertson from Templeton Marsh. Read on for more detailed insights and perspectives.
EXPERT INSIGHTS: Buy/Sell Trends
SOLID OUTLOOK FOR M&A ACTIVITY IN 2023
Q: Where are dealership valuations headed in 2023? Did expectations for valuations this year actually come to pass?
Farid Ahmad: Dealer valuations will head down next year, based on what we’re witnessing with the impact of higher inflation and interest rates on the economy. That being said, dealers will be sitting on large amounts of cash and have a lot on their balance sheet that they will be looking to deploy. As for expectations, the market was much stronger than we anticipated. Our valuation volume grew significantly this year, which prompted us to increase our internal M&A resources to meet the growing needs of our clients.
Peter Heasty: I think dealership valuations will remain steady in 2023. The ongoing consolidation of the last several years will continue. There is only so much inventory of new car dealers in the market. So, despite higher interest rates and uncertainty, the feeding frenzy will continue, especially since most groups are still flush with cash and desperate to deploy that cash.
Landon Robertson: Dealership multiples have started to soften due to record dealership profits during the past couple years. Now that 2018 has fallen off dealerships’ three-year analysis, average normalized income is comparably high, despite the pandemic. For this reason, multiples have naturally trended downward, but remain strong for the high-demand brands.
Q: We’re entering 2023 with an uncertain economic outlook, particularly with the specter of high-interest rates and inflation. How is this likely to affect dealership buy-sell activity?
Heasty: As stated above, the short-term turmoil will not deter buyers looking to gain market share. In fact, the uncertain economic outlook will likely push more sellers to the surface. For many sellers who have been pondering selling, the uncertainty of 2023 may be the final factor that gets them to pull the trigger.
Robertson: Access to capital and the cost of capital is, of course, the main factors impacted by the high interest rates and inflation. Financing partners have shown more risk aversion, especially with both smaller groups and dealers that do not have a proven track record of improving operational results. Additionally, when financing sources see dealerships being purchased at record profitability, the uncertainty about whether this is sustainable weighs on their willingness to lend. We still expect less impact on larger groups in Canada, as many have large acquisition facilities or revolving loans in place and can absorb the perceived risk across their platforms.
Ahmad: Recent buy/sell trends over the past few years – such as consolidation and dealers selling in order to retire – will continue, if not accelerate. If anything, the impact of the economy in 2023 will push dealers to make decisions sooner than later.
Q: Will vehicle inventory levels have any impact on M&A activity in 2023?
Robertson: The low inventory levels have been managed by dealers for almost three years, so it has become part of the normal course of business in the M&A space. We believe inventory shortages will remain across the industry for some time before production ramps up to pre-pandemic levels – that is, if OEMs ever manage excess inventory that way again. The order pipeline is still an important talking point throughout the acquisition process as many dealerships have hundreds of pre-orders that they will not get credit for unless it is negotiated in the transaction.
Ahmad: M&A activity will slow down until inventories become more consistent and return to normal, but it won’t stop transactions from taking place.
Heasty: Inventory levels will not affect M&A activity in 2023. The expectation is that inventory levels will be better than in 2022 and will stabilize in 2024. So, the general climate is that inventory levels are improving, and a continued short-term shortage will not impact buy/sell activity.
Q: As EVs continue to become more popular, how does this affect dealership buy-sell activity?
Ahmad: At this point, not much. It all will depend on the future volume of EV sales. The demand from car-buyers definitely is there. And dealers will support the market. But more EV production and dealer inventory are needed to meet consumer demand.
Heasty: The introduction of EVs on a large scale a few years ago caused concern and uncertainty among dealers. But as EVs enter the market on a mainstream level and most manufacturers support the dealer model, the introduction of and transition to them is starting to become commonplace. So rather than fueling further uncertainty, we’re entering a stage of normalcy. And in many ways, as another year or two goes by, dealers will just plug into (no pun intended) the business model and it will be business as usual.
Still, there are dealers who would rather sell today than venture into the uncertainty of a growing EV business model. So those dealers may sell now, rather than wait to see how EV business affects profitability.
Robertson: The EV discussion is still in the infancy stage and the true impact has yet to be seen. The most important thing at this point is knowing which OEMs are prepared. Some have publicly discussed their future EV lineups, financial investments, and partnerships to position themselves once the EVs fully roll out. Those OEMs that are prepared and well-positioned are attractive to many buyers, but this is not considered a stand-alone advantage in the buy-sell space.
Q: Another trend is the so-called agency model, where the automaker retains ownership of the vehicle while the dealer is the in-person touchpoint with the customer. Does this make dealerships more attractive to M&A activity?
Heasty: The introduction of the agency model in various forms continues to fuel uncertainty; it is unclear what this would do to dealer profitability. Therefore, from an M&A perspective, the uncertainty continues to promote activities from the sell side. This is just another variable in the decision-making process for those dealers who are contemplating monetizing their assets. Robertson: It is a very uncertain time regarding the agency model. For years, OEMs have required specific acreage and square footage for their dealerships. If agency models gain traction, how will OEMs manage their dealer partners that have, say, five or six acres of land and a 60,000-square-foot facility when they now will require only a half-acre and 12,000 square feet? It will be a very interesting dynamic and we will be watching intently to see who makes the move first out of the major OEMs.
Ahmad: I think it makes them less attractive. Although we’ve seen some recent announcements from manufacturers that want to go forward with a direct-to-customer sales approach, strong dealer-rights legislation in the United States will likely prevent this from happening in a widespread fashion.
Q: Will the consolidation trend continue into 2023? Has the business case for consolidation changed over the past year?
Robertson: We believe the consolidation trend will continue into 2023. It has become more important than ever to have scale and take advantage of synergies across dealer groups. Additionally, dealer groups don’t want to miss out on the good opportunities and be left behind in the growth race. So, it will remain a very competitive buy-sell space in the high-demand markets.
Ahmad: It definitely will continue for a car brand that organizations absolutely want in their network. For example, if a Ford dealership became available at a great price, somebody would make the acquisition this year. Conversely, if a Toyota dealership became available – and it was still at a “normal” asking price – some organization desperate to have Toyota in their network or dealer group also would buy it. If somebody owns a pretty average brand and asks for top dollar, I think they’d be disappointed in the sale result.
As for the business case changing, not really. Buyers ask if a dealership will be a fit for them regionally, brand-wise, or profit-wise. You may see many more sales in 2023 because the brand doesn’t support a dealer group’s future strategy. For example, some may want to go with luxury brands only and dispose of their domestic dealerships.
Heasty: Yes, the consolidation trend will continue and no, the business case has not changed. With a lot of cash waiting to be deployed, the inventory of small dealer groups is shrinking, which puts pressure on the consolidators to continue buying to ensure they still get the “meat-and-potatoes” deals as opposed to table scraps.
Q: Should we expect more U.S. dealership groups to try to acquire Canadian dealerships in 2023? Conversely, will more large retail groups in Canada pursue acquisitions in the United States?
Ahmad: That’s been a huge question. I say you will not see a big flurry of American groups buying in Canada because we don’t offer large population centers and our dealer agreements do not favor the dealer in Canada, like they do in the U.S. Contrarily, Canadian dealers are a bit of a bargain because of the strength of the U.S. dollar.
If the price of dealer valuations drops in 2023, I expect Canadian dealer acquisitions in the U.S. will continue.
Heasty: No, I think U.S. groups will not be actively looking to acquire Canadian dealerships. It’s the same historical principle that our market is too small and there is already enough competition between Canadian dealership groups. There is no real reason for Americans to pay over the money in an effort to outbid Canadians. In my opinion, the Lithia purchase of Pfaff was a one-off occurrence and had everything to do with the fact that Pfaff is heavily weighted with a number of ultra-premium brands. That type of opportunity is few and far between in Canada. I do expect large retail groups in Canada to continue looking south of the border. It’s just pure mathematics; the market south of us is ten times as big as ours and the opportunities in Canada for multi-rooftop transactions of an adequate critical mass is decreasing as the consolidation continues. Also, multiples are less in the U.S.
Robertson: We do not feel there will be any additional increases in U.S groups acquiring in Canada. Many are still looking but have been very disciplined in their strategy north of the border. But I believe there remains substantial interest for Canadian groups to pursue acquisitions in the US. Vacation homes, tax structure, competition, market saturation and lower multiples all impact dealers’ desires to acquire south of the border.
Q: What’s one key M&A trend you’re watching in 2023? And did the M&A environment for the past year play out as anticipated?
Heasty: I’m really not expecting any significant changes. But I would advise buyers who are pondering whether the uncertainty of the coming year opens the door to a more palatable price point may instead find the door is shut. Why? Because there’s likely another buyer that will pay the price without consideration of a turbulent single year. And that buyer will have another trophy for his or her mantelpiece that produces a more than acceptable rate of return and will not miss a beat in gaining market share.
Robertson: One M&A trend we will be watching in 2023 is the amount of small to mid-sized groups that sell. We believe the appetite has increased for larger groups to grow faster, rather than one-off transactions. The M&A environment provided some surprises in 2022, but very much followed the trend that many M&A experts anticipated.
Ahmad: During the last five years, we’ve completed more than 1,500 dealership valuations, most of which stemmed from dealers retiring. We feel dealers will continue to contemplate if it’s time to get out. The volume of transactions was much higher than we expected in 2022 and the economic changes also encouraged people to make decisions more quickly.
ABOUT THE PANELISTS
Founder and Chief Executive Officer of DSMA
With more than 35 years of global auto-industry experience, Farid is considered a genuine industry expert by dealers & OEMs alike, with his finger on the pulse of the automotive marketplace across North America. DSMA is an automotive intelligence and M&A advisory service with 1,000-plus years of combined industry experience and more than 1,500 valuations and 360 transactions completed.
PETER HEASTY, CPA, CA
President of Baker Tilly Dealer Acquisitions Inc.
Peter Heasty’s career spans more than 30 years in the automobile-dealership industry. He has operated as chief financial officer of a large dealer group, as well as dealer principal of his own operations. Heasty is an expert in dealership transactions, providing clients with a unique combination of skills in negotiation, asset valuation and goodwill, providing clients with a full-service, one-stop shop.
LANDON ROBERTSON, CPA, CMA
Director of Operations and Corporate Strategy, Templeton Marsh
Robertson facilitates and manages the buy/sell process and strategic direction of Templeton Marsh. He began his career at AutoCanada, where he spent more than six years holding various roles, including manager of acquisitions and director of corporate development. With more than 50 dealership and real estate buy/sells completed in his career, Robertson has been responsible for all aspects of strategic acquisitions, from inception through due diligence, valuation, financing, negotiation, closing and post-acquisition integration.