Supporting Franchise Value in Auto Dealership Valuations
It is common that franchise value is arrived at by applying a multiple to the Company’s normalized net income. Determining this multiple is somewhat subjective. There are industry publications that examine factors that determine what multiples should be for various franchises. These publications, such as The Blue Sky Report published by Kerrigan Advisors and the Haig Report can be used as a starting point in determining a multiple. The reports indicate that luxury franchises generally demand a higher multiple than non-luxury franchises. For instance, Porsche, Mercedes, Lexus, and BMW multiples range from 7 to 9 times normalized net income, while Toyota, Honda, and Subaru multiples range from 5 to 6.75 times normalized net income.
Once the valuation analyst selects the range of multiples for the franchises being valued, factors that are unique to the Company must also be considered to arrive at an appropriate multiple. Five key Company factors to consider when determining where a franchise multiple will fall within the range, as indicated in the Kerrigan Advisors Report, are:
Earnings Growth Expectations:
Higher Growth = Higher Multiple; Lower Growth = Lower Multiple
Buyer Demand:
Higher Demand = Higher Multiple; Lower Demand = Lower Multiple
Real Estate:
Image Compliant Facilities & Low Rent = Higher Multiple; Real Estate Investment Required and/or High Rent = Lower Multiple
Market Preference:
Highly Suitable Franchise for Market = Higher Multiple; Unsuitable Franchise for Market = Lower Multiple
Franchise Market Representation:
Single Point Market = Higher Multiple; Over-Dealered Market = Lower Multiple
In addition to the above, there are a number of additional factors that may become apparent when analyzing the Company, which should also be considered. Some of these may include the location of the dealership, the stability of employees, competition and depth of management, among others.
The fact that an auto dealership does not show any normalized net earnings to apply a multiple to does not mean there is no franchise value. There is always some value that a franchise generates. In these situations, the valuation analyst may want to look at a discounted cash flow of future anticipated earnings or a percentage of net sales based on industry statistics to arrive at an earnings amount to which a multiple would be applied. It is important that the valuation analyst use sound judgment in applying these methods.
Many dealers have an unrealistic expectation of their Company’s franchise value. Public companies, such as Penske and Lithia, have been paying very high multiples of earnings for dealerships around the country. But is this an indication of the true value of the dealership or a reflection of the premium the public companies are willing to pay to enhance their entire organization for such items as increased overall revenues or the addition of a particular franchise?
The standard of value in an auto dealership valuation is usually fair market value, which is defined in the IRS Revenue Ruling 59-60 as “the price at which property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
A dealer should want his Company’s valuation to adhere to this concept. Using multiples outside the range developed by the industry (taking into account the unique characteristics of the Company), which are based on transactions of public companies, would in most cases overvalue the franchise. For most dealership valuations this would be inappropriate.
In addition to industry accepted multiples, using as many factors as possible that are unique to the Company being valued will lend valuable support for the resulting franchise value. The dealer must be certain that the valuation analyst is going to adhere to professional valuation standards and that reasonable judgments will be used so that the valuation work product will stand up to tough scrutiny. Once the overall Company value is established a sanity check should be applied to verify that the rate of return on the investment is reasonable.
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