Appraisal Matters

So we’ve explored unique aspects of appraising automobile dealerships and delved into the three approaches to value.  It’s time we went “outside the box” and discussed a topic that real estate appraisers are generally uncomfortable with:  alternative valuation techniques and business value.

Why Nontraditional Valuation Techniques?

A typical purchaser of an automobile dealership typically buys the real estate, the franchise agreement, the goodwill, and the business value that results; in many cases, assets of the business such as the used car inventory, furniture, office equipment and computers are also included.  Purchasers I have spoken with do not have a consistent formula for separating business from real estate, if they even choose to at all.  They pay the total price, which includes both aspects.  Tax considerations are also an important part of the sale equation, which is not modeled in traditional appraisal practice.  Given that the business value can exceed that of the real estate and it typically is a large percentage of the total sale price, it is prudent to consider nontraditional valuation techniques.

Business Valuation

There are entire books dedicated to business valuation techniques, so space warrants that I be brief.  There are nine basic business valuation models that can be applied in the appraisal of automobile dealerships:

1. Asset-based models
2. Basic Method
3. Capitalization of Earnings Method
4. Cost of Capital and Required Equity Method
5. Multiple of Discretionary Earning Method
6. Industry Specific Multipliers
7. Rules of Thumb
8. Excess Earnings Method
9. Discounted Future Earnings Method

The applicability of the above methods depends on the industry, the availability of industry-wide and regional/local comparable information, and the presence of a dealerships financial statements for one or more years.

Outside of the three traditional appraisal techniques, my preference is for the industry-specific multiplier.

• It has the most availability of data
• It does not require “adjustments” or mathematics that attempts to simulate market thinking and behavior.
• Business brokers, accountants and, consequently, owners and investors speak the fluent language of multipliers
• It is the simplest of all to apply.
• As discussed below, there are lots of ratios that we can use, so we have a wealth of possibilities.
• The automobile industry has it’s own term for a special rate used throughout the industry - “blue sky” multiples.  It is used to calculate franchise value and is typically a multiple of adjusted earnings.  It is difficult to ignore such a well-known, industry-specific term.
• As a corollary, multipliers are the inverse of the rates, so a net income multiplier is the inverse of the capitalization rate.  How’s that for mixing the traditional income approach with business value practice?

A Little Deeper on Ratios

Another way to view industry-specific multipliers is to classify them by source.  Think of it as subcategories of industry-specific multipliers.  There are two types of ratios:  balance sheet ratios and income ratios.

Balance Sheet Ratios

A further subdivision includes the following balance sheet ratios:

1. Price to Asset Ratio (Total Assets divided by Sale Price)
2. Price to Net Worth Ratio (Shareholder’s Equity divided by Sale Price)
3. Price to Revenue Ratio (Sale Price divided by Total Revenue)
4. Price to Adjusted Book Value (Sale Price divided by Adjusted Book Value)
5. Goodwill to Adjusted Earnings Ratio (Goodwill divided by Adjusted Earnings)

Income Statement Ratios

Not to be outdone, we have three useful income statement ratios:

1. Price to Earnings Ratio (Sale Price divided by Net Income)
2. Price to Earnings Before Interest, Taxes and Amortization)
3. Price to Cash Flow Ratio (Sale Price divided by Net Profit plus Non-cash Charges, specifically depreciation, depletion and amortization).

Show Me the Money

All this mumbo-jumbo sounds great, but how do we apply it?  And how do we reconcile differences among dealerships?  That’s where the business appraiser comes in.  By comparing a dealerships key financial data to other similar market tier dealership ratios, such as gross profit margin, selling/general/administrative expenses as a percentage of sales, operating margin, pre-tax margin, current assets divided by current liabilities, and net worth divided by total assets, we can determine if it is performing better or worse than dealerships in the same competitive category.  We would not want to compare dealerships in different market tiers from the subject, such as a Ford dealership to a Toyota dealership or a rural town dealership with low sale volumes to a high sale volume urban location.  So when we examine multipliers for similar market tier dealerships that sold and compare their ratios to the subject’s, we can conclude appropriate multipliers for the subject.

Reconciling Ratios

Lastly, we reconcile among different subject multiplier conclusions, selecting those that are the most applicable, relevant and reliable.  A range may also be acceptable.

As part of the reconciliation process, there is one final caveat that needs to be considered.  Many automobile dealership sale transactions can occur under atypical motivations or characteristics.  The greatest examples of this have been with publicly traded companies or large dealership groups.  What is atypical about these transactions?

• The desire for purchasing an established reputation - higher multiples are paid for dealerships that have a strong name recognition in the local market.
• The desire for obtaining a geographic presence in the top 50 markets.
• The pursuit of market share and dominance - public companies issue press releases that declare their plans and target markets, and there’s pressure for those plans to move forward.
• The pursuit of economies of scale - dealership clusters can achieve marketing savings and cross-dealership synergies.
• The desire to acquire the “hot” brands - examples include Toyota, Nissan and Honda
• Pressure to grow - this results in the acquisition of especially profitable dealers, but at multiples that reflect the top of the market.

John Simpson, MAI