Is This a Good Time to Buy a Dealership? - Insight Vol. 33

By Phil Villegas

When’s the best time to buy a car? Ask any dealer and more than likely the response will be that undoubtedly right now is the best time to buy a car.

When’s the best time to buy a dealership? Ask a dealership broker and more than likely the response will be the same as above.

As mergers and acquisitions advisors, the last four years have posed significant challenges when determining if it was an opportune time to buy a dealership. Reflecting on the period from mid-2020 to mid-2021, we realized our predictions may have been incorrect; we failed to foresee the subsequent increase in dealership profitability driven by excess customer liquidity and vehicle supply shortages.

Dealership valuations are often reduced to a simple equation: annual earnings multiplied by an agreed-upon Blue Sky multiple. The opportunity to purchase a dealership in mid-to-late 2020 turned out to be quite advantageous. Consider that the valuation at the end of 2020 might have utilized either the normalized earnings from the end of 2019, an average of the previous three years' earnings including 2020 year-to-date, or even earnings from trailing twelve months. Regardless of the method, the outcome would have been a remarkable acquisition price.

Looking ahead to the present, we are in the third quarter of 2024. The past few years have yielded impressive profitability, leaving most dealers with substantial cash reserves. Is now then the best time to invest in a dealership?

Despite the risk of repeating the error made in 2020, I would advise that unless the opportunity is highly strategic or exceptionally valued, this is not the appropriate time. Factors such as increased interest rates, stabilized inventory levels, historically high dealership profitability (which forms the basis for expected Blue Sky values), and a decline in customer sentiment suggest delaying an acquisition unless specific conditions are met.

Entering into an acquisition today necessitates a reevaluation of the traditional methods used to value a dealership. Relying on the previous year's performance, trailing twelve month results, or the average of the past three years is not a strategy to adopt for the upcoming years.

While each potential dealership buyer will have unique motivations and target internal rates of return, no purchaser wishes to pay a significantly higher price today than they might tomorrow.

Valuation considerations for the next couple of years must be forward-thinking and take into account projections based on factual data rather than relying heavily on the performance of the past few years. While revenues from the previous year can provide a benchmark for growth in new vehicle sales, gross profit margins must be adjusted back to pre-2020 levels.

With low-interest rate loans no longer a viable commercial option, sellers aiming to maximize their sale price will likely need to retain a portion of their Blue Sky value—a decision that carries inherent risk.

Our recommendation is to proceed with caution. The forthcoming years will require dealers to concentrate their efforts and resources on minimizing the impact of any market slowdowns on their current operations.