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WHERE THE RUBBER MEETS THE ROAD
2017 Annual Market Profile of the Automotive Dealership Landscape
“She’ll do a hundred and forty
In the top end floored
She’s my little deuce coupe
You don’t know what I got”
-Little Deuce Coupe,
The Beach Boys
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CONTENTS
Letter from the Presidio Team 3
Driving with Brodie Cobb 4
About The Presidio Group 4
Northeast and Midwest Consolidation 5
Presidio’s Brand Listing 5
Transaction Structures: Partnerships and Recapitalizations 6-7
Threats to Franchise Law 8
Presidio’s Team Members 9
Contact Us 10
Annual Market Profile | 2017 3
LETTER FROM THE PRESIDIO TEAM
We are pleased to present The Presidio Group’s 2017 Annual Market Profile of the automotive dealership landscape which we have entitled, Where the Rubber Meets the Road.
We chose that title because our goal through this communication is to provide you with real, actionable, and value-added information, rather than inundate you with pages of charts and statistics.
The summary takeaways are:
These are historic times:
Borrowing costs are still near record lows, allowing investors to pay higher prices and receive acceptable returns on their dealership investments
The current bull market is eight years old with the S&P 500 increasing over 160% since the beginning of 2009
Values may be peaking:
Further increases in Federal Reserve rates will discount today’s values
The cost of capital is increasing and overall market performance is declining
This issue once again opens with a casual, yet informative, Q&A with Brodie Cobb, who is not only the founder and CEO of The Presidio Group but also has decades of experience to understand the ins and outs of the dealership marketplace. His thoughtful comments address some of the questions around the future of car ownership and the Millennial generation.
As always, we stand ready to answer any questions you may have and look forward to keeping in touch. So reach out, and let us know how we can help you.
Brodie Cobb
Founder and CEO
James “JT” Taylor
Managing Director
Lawrence Pier
Vice President
Doug Stewart
Principal
Lucy Sinacola
Analyst
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DRIVING WITH BRODIE COBB Brodie Cobb founded The Presidio Group in 1997 and was one of the first investment bankers to focus on transactions in the automotive retail sector. To date, The Presidio Group has closed 58 separate dealership transactions worth more than $3.7 billion and remains a leader in the automotive retail sector.
Q: Is car ownership becoming an outdated idea for Millennials?
There seems to be a common misconception that Millennials dislike driving and the idea of owning a car. The Millennial generation is defined as those born between approximately 1980 and the early 2000s. The existence of Uber and Lyft have certainly made traveling easier, and services like GetAround allow young people to access a vehicle for short-term rental with relative ease. Millennials have delayed large purchases, including cars, for longer than previous generations have. This has been due to a host of reasons, including the costs associated with car ownership and the reduced need for a car in urban areas. However, this does not mean they are not interested in car ownership ever. A Kelley Blue Book study reported that 75% of those using a ride-sharing platform still plan to buy a car. Presidio believes that the majority of this generation are still interested in owning their own vehicles. In 2016, nearly 30% of new vehicle sales were made to Millennials, a figure that is estimated to increase to 40% by 2020.
As Millennials have accumulated more wealth, they have been able to afford life’s larger purchases such as homes, and yes, cars! Q: How will Millennials affect the dealership model?
We would caution dealers not to forget about the Millennial car buyer since it will not be long before the majority of new vehicles will be purchased by this demographic. For these younger people, buying a car is more of a practical decision. They have limited loyalty to specific brands. Millennials approach dealers armed with vast quantities of data about comparable pricing, product information, and reviews. Having all of that information at their fingertips, Millennials also want convenience and speed moving through the sales process and will not spend an entire afternoon filling out paperwork at the dealership. This growing customer group will want the ability to fill out credit applications and various lease documents online to save the trip to the dealership where they will inevitably end up waiting. Not surprisingly, Millennials demand the latest technology in the dealership’s product offerings. A Cox Automotive report found that 64% of people in the 18-24 age range expect their vehicles’ technology to perform all the same functions as their smartphones. Manufacturers must not only provide these capabilities in their vehicles, but also dealers will have to understand and sell these features. All dealers will need to adapt their sales and marketing strategies to attract this growing group of buyers or risk missing out on a generation with enormous purchasing power. Research shows that the desire to own a vehicle has not changed, but dealerships will have to adapt to the unique traits of the Millennial generation.
The Presidio Group LLC is an independent merchant banking firm focused on investment banking and principal investing. The firm was founded in 1997 with the simple mission to relentlessly put the interests of our clients first. By steadfastly adhering to this philosophy, the firm has earned the trust of clients throughout the United States. The firm’s seasoned and intellectually honest professionals create client relationships based on mutual respect and a commitment to long-term results.
ABOUT THE PRESIDIO GROUP Merchant Banking
Strategies designed to achieve our clients’ financial objectives and personal aspirations
Advisement and/or investment in entrepreneurially led companies, family businesses, private equity firms, and public corporations in the auto dealer sector
Specialization to deliver authentic industry knowledge, experience, and relationships Investment Banking
Corporate advisory with emphasis on M&A and private capital raising
Focus on the auto dealer sector
Deep relationships with broader corporate and financial community Principal Investing
Capabilities to invest typically $5 million to $20 million of long-term equity in auto dealerships
Culturally-sensitive approach from professionals who are dealer operators and entrepreneuri-ally-minded founders themselves
Align with dealers on all assets owned (i.e. real property)
Securities are offered through Presidio Merchant Partners LLC, member FINRA, SIPC.
Annual Market Profile | 2017 5
available for reasonable blue sky. Unlike paying up for dealerships in the “Smile States,” dealer groups can realize attractive returns in the New England, Pennsylvania, Ohio, and Indiana markets. Presidio also believes both the availability and modest cost of real property in these markets help generate a higher Return on Invested Capital (ROIC) for buyers. Moreover, these large, well-capitalized, private dealer groups had previously encountered limited competition for Northeast and Midwest stores. The supply of dealerships was high and prices were low. Groups like Napleton and Suburban took advantage of these market conditions to expand to their current footprints. As consolidation occurs, stores have become more expensive, which has slowed down these groups’ expansion plans. Presidio sees this trend continuing in the short-term, an opinion which Banks echoes. “Some of the recent activity will drive more consolidation,” says Banks. Additionally, the markets Presidio has identified are home to many large dealer groups with aging ownership who may have yet to develop exit strategies. We will wait and see, but for now, buyers appear to be moving into the
Northeast and Midwest.
Presidio understands and sees trends in automotive retail M&A as we average over 60 in-person meetings annually with buyers. The automotive retail industry has seen recent market consolidation in the Northeast and Midwest United States. Whereas large auto groups once preferred sunnier skies to these snowy markets, recent acquisitions suggest a trend shift. Cliff Banks, author of The Banks Report, which contains automotive buy-sell data and industry news, agrees. “The last time public groups actively consolidated in the Northeast was in 2004-2005, when AutoNation, Group 1, and Penske bought stores in the area,” said Banks. Group 1, Asbury Automotive, and AutoNation divested stores — mainly in the Long Island and New Jersey areas — in recent years. It appears, though, that interest in the Northeast is heating back up with AutoNation’s acquisition of four New York City area luxury franchises last summer along with Penske’s acquisition of several Jaguar Land Rover stores. Among the public auto retailers, however, Lithia Motors seems to be leading the charge with the recent acquisitions of Baierl Auto Group in Pittsburgh and of Carbone Auto Group in upstate New York and Vermont. GPB Capital Holdings, a New York-based asset management firm, is expanding its portfolio as well with its recent transaction with Kenny Ross Automotive Group in Pittsburgh, in which Presidio advised the seller. While the public consolidators were focusing on other geographies, some private, regional dealer groups were quietly working in these markets to amass large dealership collections. For example, Napleton Automotive Group now has 40+ franchises with over 25 situated from Pennsylvania to Wisconsin. Suburban Collection, headquartered in Troy, Michigan, has become a mammoth group with over $2.3 billion in sales and 49 dealerships in 2016 according to Automotive News. Zeigler Automotive Group has also embarked on an aggressive acquisition strategy in the Midwest with 25 stores located in Wisconsin, Illinois, Michigan, and New York. The Northeast and Midwest are particularly ripe for consolidation now. As we discussed in last year’s Annual Market Profile, these markets have geographies that result in a large number of smaller stores. These smaller stores may have unrealized profit potential making them excellent acquisition targets. Bryan DeBoer, CEO of Lithia Motors, said in discussing their acquisition of Baierl Auto Group with Automotive News that acquisitions of underperforming stores give Lithia “greenfield rates of return.” Consolidators are looking at these markets as they transform and are seeing ample opportunities to move in. What is ultimately driving both publics and privates to seek acquisitions in the Northeast and Midwest? “One reason is pricing,” says Banks. Stores in solid markets are becoming
Based on the current buyer demand that Presidio has observed, we have classified certain franchises into three categories listed below. The accompanying percentages represent the Return on Invested Capital (ROIC) demanded by a buyer or an investor. ROIC is the total annual return for each dollar invested in a dealership. Category A represents brands that currently have the greatest demand, and thus the highest value and the lowest required return, while Category C represents brands which are currently less desirable and require the highest return. Be aware, this list is not set in stone and the desirability of each brand can fluctuate based on other value drivers.
Presidio’s Brand Listing
NORTHEAST AND MIDWEST CONSOLIDATION
B Brands ROIC Requirement 20%-25%
A Brands ROIC Requirement 15%-20%
C Brands ROIC Requirement 25%+
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For dealers, a partnership offers numerous advantages. The dealer can “test drive” the partner (and vice versa) to ensure cultural fit with the dealership employees and customers while not exiting entirely. Employees may be more receptive to the idea of the owner staying on for some period of time while introducing the new partner, lessening the risk of business transition issues. The dealer can focus on improving operations while having a solid financial backing. For example, the new investor may want to complete those image upgrades that have been put off, which can increase incentive money and the dealership’s overall profitability while also boosting real property value. Additionally, a capital partner may bring the energy and financial resources to acquire new franchises. As Scott Earthy, Managing Partner at Fremont, said in their press release announcing the Morrie’s transaction, “We are excited about the opportunity we have to enhance our operations and expand in the Upper Midwest region over time.” Since Fremont’s investment, Morrie’s has announced the acquisition of two dealerships in La Crosse, Wisconsin.
For investors without the advantage of years of automotive experience, a partnership allows them to gain an understanding of the industry while putting up less capital initially. Yet, investors are still reassured by the fact that the original owner has some skin in the game. Partnering can give investors time to find management to eventually replace the owners who will retire and begin to transition the business to that new management. Fremont had already found that talent with Morrie’s existing CEO. What Does It Mean to Get a Second Bite of the Apple? Taking on a capital partner gives a dealer the potential to get a “second bite of the apple.” To illustrate this strategy, on the next page is an example showing how enterprise value can increase after taking on a capital partner. We discuss above some of the reasons that profitability might increase from image upgrades, new acquisitions, or better concentration on existing operations. In this example, the current operating business enterprise value is assumed to be $100 million today including (Continued on page 7)
The automotive retail M&A market remains strong with owners interested in monetizing their businesses. However, the way in which dealers are monetizing their businesses is evolving. Many dealers have been evaluating new sources of capital available in the marketplace and the potential to retain some ownership through a recapitalized partnership. Who is Pursuing Partnerships and Recapitalizations? Private equity groups and family offices are relatively new entrants into the automotive retail space who are looking to partner with successful dealership owners. For example, Fremont Private Holdings, a San Francisco-based family office, purchased a majority stake in Morrie’s Automotive Group in the Minneapolis area in early 2016. Other examples include The Jordan Company partnering with RFJ Auto Partners and Robert Johnson, billionaire founder of Black Entertainment Television (BET), investing in RML Automotive. As part of the Fremont/Morrie’s transaction, Fremont partnered with the dealership group’s CEO, who had worked at the dealerships for nearly 20 years. Besides private equity and family offices, dealer groups are also interested in this structure. Earlier this year, Presidio served as financial advisor to Serra Automotive (#20 on the Automotive News 2016 Top 150 Dealership Groups) and helped two iconic dealers, Joe Serra and Mike Maroone (former President and COO of AutoNation, Inc. from 1997 to 2015), come together to form a recapitalized partnership to operate four dealerships in Colorado Springs. Why are Dealers and Investors Interested in These Structures? Serra made the decision to conduct targeted portfolio management and market its Colorado Springs platform, which included two Chevrolet, one Honda, and one Volkswagen dealerships. Serra’s goal was to focus on its other existing markets as well as on future acquisitions. Maroone wanted to get back into retail automotive depending on the market, brands, and people involved. A recapitalized partnership ultimately helped both dealers achieve their goals. Maroone and his team will be able to leverage Serra’s experience and knowledge of the Colorado Springs market. Serra can focus on new opportunities in its existing markets as Joe Serra has told Automotive News that this transaction “gives me some capital to keep growing.”
TRANSACTION STRUCTURES: PARTNERSHIPS AND RECAPITALIZATIONS
A recapitalized partnership ultimately helped both dealers achieve their goals.
.
Annual Market Profile | 2017 7
Seeking a capital partner prior to full retirement instead of a 100% buyer at retirement can also be less emotionally draining. By taking this long view, dealers can give themselves time to exit the business in stages and enhance the total economics for themselves along the way. Dealers should consider manufacturer approvability of their potential capital partner. This includes an analysis of the partner’s other dealerships (if any), whether those dealerships are of the same brand, and the performance of any existing franchises. This partnership could also be the investor’s first foray into retail automotive, thus it is critical to answer the questions posed here to reduce the chance of a manufacturer rejecting the partner by exercising its right of first refusal. Dealers should decide what they are unwilling to compromise on and find the partner that best suits those criteria. What Should I Take into Account? Alignment on partnership issues is a critical aspect to this kind of transaction. Dealers need to consider operating agreements, minority and majority shareholder rights, governance, and how to exit the investment through clear and simple buyout provisions. The selling owner should also consider how much equity he or she would like to retain in the business, whether that be a majority ownership position (over 50%) or minority (under 50%). Serra will retain a minority interest in the Colorado Springs stores but will have a limited operating role, as Joe has said “Mike’s the captain of the ship.” Partnership discussions will require time and patience, but starting a partnership on the right foot is crucial. Pursuing a partnership structure requires careful
examination of the advantages and disadvantages inherent
in the opportunity. The right timing, right partner, and right
terms are all key ingredients to a successful partnership.
TRANSACTION STRUCTURES (CONT.)
$90 million in blue sky and $10 million in net assets. Selling 100% ownership today would result in $100 million of gross proceeds plus any real property value. Alternatively, the dealer could recapitalize 80% of his or her ownership to a capital partner for $80 million in proceeds and retain a 20% minority position. We then compare the enterprise value in five years when the owner wishes to retire. With no capital partner, the enterprise value would have grown to just $111 million with modest earnings growth under normal operations. However, by bringing on an 80% capital partner, the enterprise value instead increases to $180 million. We assume that the capital partner has been able to increase earnings by $2 million each year through accretive acquisitions. We also assume that buyers require a lower ROIC on the operations due to better brand mix, increased size of the platform, and the cash flow improvement. There are clear economic advantages to the original owner, who can now sell his or her 20% retained ownership at an 80% higher valuation of $36 million as well as collect dividends along the way. When Should I Look for a Capital Partner? Careful timing is key in seeking a capital partner. The best approach is to look for a capital partner a few years before retirement. An owner can take some chips off the table while not exiting his or her life’s work completely. Investors are hesitant to partner with owners who are looking to retire immediately after the close because this often leads to business transition issues. One example is the dealership’s employees who might be unfamiliar with the new partner, causing potential turnover issues.
$ 90
$ 10
CURRENT ESTIMATED ENTERPRISE VALUE= $ 100 MILLION
$ 165
$ 15
ESTIMATED ENTERPRISE VALUE IN FIVE YEARS 80% CAPITAL PARTNER
= $ 180 MILLION
$ 101
$ 10
ESTIMATED ENTERPRISE VALUE IN FIVE YEARS NO CAPITAL PARTNER
= $ 111 MILLION
Blue Sky Net Assets
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lawsuit against the State of Michigan. The governor, a state senator, and a state representative were among those subpoenaed to turn over their communications related to the bill’s passage. Tesla is hoping to prove through this investigation that it was unlawfully, directly targeted by the bill. If that proves true, it could pose changes to Michigan law, setting a powerful precedent.
Tesla is not the only company facing trouble from longstanding franchise laws. Berkshire Hathaway Automotive has run into difficulty with Texas franchise law that states that the owner of a vehicle manufacturer cannot also own vehicle dealerships. Berkshire Hathaway Automotive’s parent company, Berkshire Hathaway Inc., is a conglomerate that also owns Forest River Inc., an Indiana-based recreational vehicle manufacturer. An investigation by the Texas Department of Motor Vehicles enforcement division found Berkshire Hathaway Inc. to be out of compliance with Texas law because it owns both dealerships and a vehicle manufacturer. The Texas DMV further recommended that Berkshire Hathaway Automotive have its dealership licenses revoked, although that has not yet happened. Berkshire Hathaway Automotive, Texas lawmakers, and the Texas DMV will be contemplating this situation and seeking a resolution to what appears to be a sticky regulatory issue for Texas dealers. We expect more high profile cases challenging franchise law in the near future with state auto dealer associations and NADA leading the charge to protect franchised dealers. We will stay tuned as to whether Tesla will continue to fight state laws in order to sell their products nationally or if they might begin franchising dealerships as CEO Elon Musk has hinted. We will also see whether Berkshire Hathaway Automotive decides to maintain a presence in Texas if it cannot successfully reach an agreement there. What is clear, however, is that franchise law in its current form is being threatened, and a legal shift appears possible.
Franchise law is a central tenet upon which the auto industry operates. Many auto franchise laws were enacted from the 1930s to the 1950s, and the laws have remained largely unchanged since then. These laws came about in order to protect dealers from the much more powerful manufacturers, who often exerted their control over dealers forcefully. Franchise laws became crucial to level the playing field between the manufacturers and the dealers. Additionally, the laws prevent an area from becoming over-dealered. This also keeps intra-brand competition at a reasonable level, benefiting both dealers and consumers. Today, however, we see growing threats to franchise laws from both a relatively new market entrant and an established dealership group. Clearly, one of the biggest threats to franchise law today is Tesla, the Palo Alto, California-based electric vehicle manufacturer. Tesla operates manufacturer-owned showrooms but not franchised dealerships. Their direct to consumer model has put the company at odds with lawmakers and automobile dealers associations across the United States, including the National Automobile Dealers Association (NADA), who embrace the franchise model. Tesla is not permitted to operate in a number of states, and the company continues to fight legal battles in many more states by challenging laws that prohibit direct to consumer vehicle sales. Tesla’s main arguments for their business model is that a dealership would not be able to explain electric vehicle technology and its benefits adequately and that a direct distribution model saves customers money. NADA in particular has disputed the latter claim and is fighting back fiercely against Tesla, who is the outsider in the franchised dealer world. In October 2014, the Michigan House of Representatives passed a bill that on its surface had to do with dealership documentation fees. However, a last minute change to the bill’s language enacted a rule that bans new vehicle manufacturers from selling directly to customers “other than through franchised dealers.” The circumstances under which the bill’s language was changed prompted Tesla to bring a
THREATS TO FRANCHISE LAW
We expect more high profile cases challenging franchise law in the near future
.
Annual Market Profile | 2017 9
Doug Stewart, Principal
Doug joined Presidio in 2014. Prior to Presidio, he was the West Region Chief Financial Officer for Group 1 Automotive for 11 years responsible for 12 import, luxury, and domestic auto dealerships all located in California. Prior to Group 1, Doug was the CFO for 13 years for a private dealer group with six Japanese franchises in Southern California. In his 25-year tenure as an automotive group CFO, he was involved in 26 acquisition, disposal, and termination transactions valued at $240 million. Doug is a CPA and worked for one of the “Big Eight” accounting firms for nine years. Doug earned his B.S. in accounting from the University of Southern California. Doug is involved in amateur sports car road racing and races a Spec Racer Ford. He also enjoys golfing and cycling and is an avid hockey fan.
PRESIDIO’S TEAM MEMBERS
James “JT” Taylor, Managing Director
JT joined The Presidio Group as the primary relationship manager for our clients. During his more than 30-year career in the automotive industry, he has worked on both the retail and manufacturer sides, developing deep relationships throughout the U.S. and Canada. Prior to Presidio, JT led product planning for Toyota in North America and was also part of the Lexus launch team. JT was an operating partner in a number of successful dealerships and worked with Joe Gibbs Racing, Southeast Toyota distributors, and the Wolfington Companies in a variety of automotive opportunities. JT earned his B.A. in economics from the University of Cincinnati. JT and his wife enjoy their six adult children and serving at their church. He follows motorsports with a passion and will go to a race of anything with four wheels and a motor.
Brodie L. Cobb, Founder and CEO
Brodie founded Presidio in late 1997 with the simple goal of bringing transparent advice to entrepreneurs and the lifecycle of their wealth building process. To that end, he formed three different business groups within Presidio that address each part of that lifecycle: private equity, investment banking, and wealth advisory. Brodie is The Presidio Group’s CEO and chairs the firm’s Board of Directors. Brodie heads Presidio’s Investment Banking Group. Prior to Presidio, Brodie was with Montgomery Securities, First Boston Corporation, and Security Pacific Bank. He earned an M.B.A. from the University of Texas and B.A. degree from Tulane University. He competed for a spot on the U.S. Olympic Team in 1988 and still races sailboats and bicycles. He is married with three daughters.
Lawrence Pier, Vice President
Lawrence joined The Presidio Group in 2015. Prior to Presidio, Lawrence was an investment banker at Stifel for two years where he served on dozens of transactions for over $1 billion in value. Before his finance career, he worked as an entrepreneur and as a consultant. Lawrence previously founded a limousine service, which he sold in a strategic disposition. He also designed a performance scorecard solution for ADP Dealer Services (now CDK Global) to provide real-time Dealer Management System feedback. Lawrence earned his M.B.A. from the University of California, Berkeley and his B.B.A. from the University of Michigan. Lawrence has refurbished a 1980 Ferrari 308 GTSi and enjoys keeping up with vintage autos. He is also an avid baseball fan.
The Presidio Group brings its unmatched experience in auto dealership M&A, sophisticated financial knowledge, and relationship-driven approach to every client we serve. During our careers, we have closed more than $3.7 billion in auto dealership transactions and are well-versed in the often emotional process involved in selling and buying a dealership. Ultimately, with The Presidio Group by your side, you can focus on the business, while we work to optimize the transaction structure and terms on behalf of our clients.
Because we are an investment bank, not a dealership brokerage firm, our clients receive thoughtful and insightful advice tailored to help them attain their individual strategic goals. Our services include: market assessment, financial analysis and valuation, offering materials, transaction structure and negotiation, and even advising on OEM and employee communications.
Lucy Sinacola, Analyst
Lucy joined The Presidio Group auto team in 2016 as an analyst. Previously, Lucy held internships at Stifel in investment banking, Spinnaker Capital in private equity operations, and Hercules Technology Growth Capital in accounting. She graduated with a B.S. in business administration from Northeastern University. Lucy enjoys running, rock climbing, hiking, and following hockey.
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Managing Director
(415) 449-2520
CONTACT US
We hope you have enjoyed our 2017 Automotive Market Profile. As the leading
investment bank in the auto dealer sector, we would be pleased to discuss any of
the subjects in our report or other questions you may have. Just call us, and we
will give you our view points on Where the Rubber Meets the Road!
JAMES “JT” TAYLOR BRODIE COBB
Vice President
(415) 449-2542
LAWRENCE PIER DOUG STEWART
Founder and CEO
(415) 449-2525
Principal
(415) 449-2522
(415) 449-2500
© 2017 The Presidio Group, LLC. All rights reserved.
LUCY SINACOLA Analyst
(415) 449-2533
