The tech-driven changes in auto retail, particularly those around digital retailing, a generational torch-passing, are leading many family-owned auto dealerships to consider exiting the car business and selling their stores, says Erin Kerrigan, an expert in valuation, real estate and the buy-sell space of auto dealerships.
“The good news is, it’s also the same reason that the investors and buyers want to get into the game,” said Kerrigan, managing director of Kerrigan Advisors, in an interview for an upcoming episode of the AuSM Podcast at NADA Show 2019.
“It’s that adage from Warren Buffett at play here, where he says, ‘Be fearful when others are greedy and greedy when others are fearful,’” she said.
“And we’re finding that the buyer community is extremely excited about the opportunities that disruption and change are going to create in retailing. We like to say,‘Fortunes will be made in our trillion-dollar industry for those who innovate in this industry.’ So, with that, we just see a lot of capital interested in coming into auto retail and backing great operators to grow.”
Kerrigan, whose firm specializes in the buy-sell space of new-car franchised dealers, said there were more than 200 dealership transactions last year, the fifth straight time the buy-sell market has eclipsed that mark.
That sum over the last five years translates to roughly an eighth of franchised dealers changing ownership, Kerrigan said. With increases in both the number of buyers and the number of sellers, Kerrigan said this year could be even busier than 2018.
The last few years has shown the number of dealer groups with more than nine stores has increased at a 50-percent higher clip than groups with four to eight stores, she said.
Numbers for the one- to three-store groups are falling.
“So, you’re definitely seeing a shift to larger groups, and that’s quite natural, given some of the changes that we’re expecting in auto retail, specifically with digital retailing and really a changing of the way we retail,” Kerrigan said.
Many dealers might not want to shift how they’ve modeled their businesses (successfully, by the way) so selling often becomes a more attractive option, she said.
Estimates from Kerrigan Advisors indicate that about half of the franchised new-car dealer body is family-owned, many of which are second-generation or beyond.
“And there is just a natural challenge of shifting from generation to generation for every family business,” Kerrigan said. “And our industry is now bumping up against some of those challenges. Only about 30 percent of businesses make it to the second generation, about 12 to the third and about 3 percent to the fourth. Now, auto retail has defied those odds. We have actually done a much better job at that transition.
“However, now we’re finding that as these families are looking at the generational shifts — because I like to say that dealers think in generations, not decades — they’re looking at the future and saying, ‘Goodness, do I want to transition my business to my son or daughter?’ who may be in their 20s or 30s, and really those individuals would be stepping into the next 40 years of an industry that could change quite dramatically.
“I think the combination of sort of the fear factor that’s created by the discussion of disruption, combined with the generational shifts is creating an environment where more sellers are deciding the time is right to exit,” she said.
But, again, the buyer appetite is strong, too — including from those you might not expect to be investing in auto retail.
New investors come aboard
The first example that might come to mind is that of Berkshire Hathaway and its billionaire leader Warren Buffett. In 2014, Berkshire Hathaway agreed to purchase the Van Tuyl Group, the largest privately owned dealership group in the U.S. The purchase closed in 2015, with Van Tuyl becoming Berkshire Hathaway Automotive.
Asked if she was seeing more investment in auto retail from non-traditional parties, Kerrigan said: “We are — so much so that we’ve created a segment of our business at Kerrigan Advisors where we just raise capital for dealers that have a plan to grow and have the executive team to grow and consolidate the industry.”
The Blue Sky Report published by Kerrigan Advisors is distributed to 9,000 people in 35 countries, she said, and with that reach, the firm gets ed once a week by new capital sources — including private-equity firms, family offices and billionaires — who want to move into auto retail.
“And so, we really believe that actually the capital-raising function and service that we provide to dealers could eclipse our sale side advisory business at some point, because we do think that is the future,” Kerrigan said.
“That is the way that retail is going to consolidate. It’s not probably going to be the publics, the existing publics that we know and love,” she said. “We think the driving force of consolidation is actually going to be the entrepreneurs that always made auto retail so special, and those entrepreneurs no longer limiting themselves to their own balance sheets but rather tapping into other people’s money to really ignite their growth and reach even further than they would be able to reach with the limitations of their capital.”
So, what makes auto retail so attractive to new investors? For one, the consistent return on equity, Kerrigan said.
“I can think of very few industries in the entire country that have shown the level of return on equity that our industry has shown so consistently for some many decades,” Kerrigan said. “Even at the depths of the recession, when we all felt like the world might come to an end, auto retail on average remained profitable.
“And in fact, the return on equity at again 2008-09, the worst time in the industry, was still in the teens. That’s incredible. Right now, the average dealer is looking at ROE between 25 and 30 percent,” she said. "Very high returns. And so, I think the cash-on-cash return that you can achieve in our industry is unparalleled, and that’s why so many investors, smart money; they’re trying to figure out how to get in.”
Typically, the “barrier to entry” has been the fact that franchised dealer ownership has to be approved by the automaker, Kerrigan said. This has led to a “fragmented” and a “mom-and-pop” body of dealership owners.
“However, you’re starting to see some chinks in the armor there; you are seeing structures that are getting through the OEMs for approval,” Kerrigan said.
“And I think Berkshire Hathaway’s endorsement — the smartest investor in the world buying the largest private dealership group in the U.S. — really just spoke volumes about the opportunity,” she said. “And also, the fact that they frankly were able to get the structure done open opened people’s eyes to the fact that this is an industry that we actually can figure out how to invest in.
“And I think it’s just the beginning.”