As an investor which business model would you find more appealing?
1) A retail distribution system that has existed and evolved since the invention of the product it sells, has been consistently profitable (even during industry downturns), and receives protection from both
manufacturers and lawmakers against an influx of outside competition;
2) A selling process that is in its infancy, is generating substantial losses, and faces a myriad of competitors, not the least of which are the manufacturer of the product it is trying to help sell and the dealers who are its customers.
Apparently, Wall Street prefers the latter. The initial public offering of Autobytel.com
and Autoweb.com, two firms specializing in generating automotive sale leads were greeted enthusiastically by the market in late-March 1999. The firms, which had combined revenues of $37 million in 1998 (and a combined net loss of $31 million) raised $173.5 million from the offering, their initial valuation was put at some $735 million, their market capitalization was quickly driven to over $1.2 billion, and four original founders were awarded $22.6 million in cash while retaining over 33 percent interest in the companies. To be sure, the stock price of each has fallen sharply after the initial rush to get in, but even so their market capitalizations, price-to-book, and price-to-sales ratios remain generous. Hefty market capitalizations also have been granted to many of the other Internet firms that specialize
in generating sales leads. Since when did the “bird dog” become more valuable than the dealer?
Indeed, four of the seven public companies¹ with a major interest in retail auto dealerships are down from their initial offering
price, five of the seven under-performed relative to the S&P 500 last year, and five of the seven under-performed the broader market indices during the first nine months of 1999. If, at the beginning of 1999, $10,000 had been invested in each of the seven PTARs,
that $70,000 investment would have deteriorated to $56,600 by late October.
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The publicly traded automotive retailers have received this shrug-of-the-shoulder from Wall Street despite an aggregate performance that shows substantial revenue growth and improving profit margins. Wall
Street’s lack of enthusiasm for the PTARs also comes at time when the franchised dealer industry just finished posting record profits in 1998, enjoyed record unit sales in the first nine months of 1999, and continues to face favorable near-term fundamentals. It
begs the question — “how will Wall Street react when the automotive industry enters its next down cycle? Will the shrug-of-the-shoulder turn into the cold shoulder?”
It’s possible that PTAR share prices might show some resiliency. That’s because, save for a couple of exceptions, the under-performance of automotive retailing stocks is not the result of a flawed business
model or poor implementation, but simply a case of overly-lofty expectations as to what synergies and cost savings could be accomplished within a reasonable time frame. As
analysts, investors, and operators continue to learn the dynamics, realities, and restrictions of automotive retailing, expectations will likely be tempered even as actual performance improves.
¹ The seven publicly traded companies are: AutoNation, Sonic Automotive, UnitedAuto Group, Group 1 Automotive, Lithia Motors, CarMax Group, and Hometown Auto Retailers. Rush Enterprises and Fidelity
Holdings were not included in our analysis of PTARs because Rush deals exclusively with heavy-duty trucks, construction and farm vehicles while Fidelity has major interests
outside of the automotive industry.
Total revenue growth for the seven major PTARs more than doubled in 1998. Acquisitions closed, or in the pipeline, thus far in 1999 suggest that total PTAR revenue will nearly double again this year.
In addition to acquisition-fueled growth, financial analysts were quick to note that several of the PTARs posted significant same-store sales growth numbers. That, plus improved profit margins, gave analysts another
basis on which to reiterate or strengthen their “buy” recommendations. Those buy recommendations went unheeded, however, as the majority of PTARs continued to under-perform the market. Perhaps investors were rightly noting that the same-store sales
and margin improvements posted by the PTARs wasn’t all that impressive when taken in perspective and that future same-store growth and acquisition plans face high hurdles.
Sales and profit-wise, the first nine months of 1999 was the “best-of-times” for auto dealers. The average dealership nationwide enjoyed a 13 percent sales increase and pre-tax profits jumped 28 percent to a
new record. In that bright light, the performance of the PTARs becomes less dazzling.
Future revenue growth in automotive retailing faces certain limitations even if the economy remains exceptionally strong. Automotive retailing is a mature industry and, with the revenue for many established stores having reached its geographic potential, future growth will be predominately driven by local market factors and the current popularity of the dealer’s franchise, not management performance. Thus, it is unreasonable to expect the PTARs to consistently report rising same-store sales. To believe otherwise is to confuse “consolidation of
ownership” with “dealership network consolidation.” With very few exceptions, the PTARs have not been a force in reducing the number of dealerships operating within a market area. Indeed, in some cases, they have added to the number of same-make franchises that otherwise would have been operating in a given market.
In any event, network consolidation, in and of itself, has not been, and will not be, a major source of same-store sales growth. A net loss of 250 dealerships was recorded nationwide last year. That “consolidation”
provided the average dealership with only a 0.8 percent increase in potential revenue.
Likewise, future consolidation will provide only minimal revenue growth for those
dealerships that remain. If the manufacturers are completely successful in accomplishing
their announced dealership rationalization programs by 2005, the nationwide net loss of
dealerships would be in the neighborhood of 2,500. That would provide annual average
revenue growth of less than 2 percent for each of the remaining dealerships.
And, if history is a guide, regional
dealership consolidation will fail to keep pace with regional swings in the economy. For
example, in New York average new unit sales per dealership fell during the past twelve
years even though the state’s dealership count was reduced by 8 percent (a net loss
of 118 dealerships). Meanwhile, Florida, which had an increase of 111 dealerships (+13
percent), enjoyed an increase in new vehicle registrations per dealership. The data reveal
that the states with high sales-per-dealership achieved that status by way of high
individual sales growth rather than dealership consolidation. Not surprisingly, the PTARs
have concentrated their operations in those very same high-growth,
Lacking a strong “growth through
consolidation play”, increases in same-store revenue for franchised dealers will have
to come from total industry growth, which is not a particularly bright prospect. The
underlying rate of demand for new vehicles is projected to grow by less than one percent
during the next decade. In times past, price increases could be counted on to provide an
offsetting boost to industry revenue during periods of flat unit sales and, more recently,
the more upscale mix of vehicles being sold allowed for increased per-unit revenue.
Significant real new vehicle price increases, however, are clearly a thing of the past and
the richness of the sales mix is reaching logical limits. At the same time, enhanced
vehicle quality has, and will continue to, depress dealership service and parts revenue.
Those realities have already shown up in
industry statistics. Total dealership revenue per new unit sold rose a modest 2.2 percent
last year. That compares to average revenue-per-unit increases of eight percent in the
1980’s and six percent in the first half of the 1990’s. In the first nine months
of this year, the increase in dealership revenue on a per new unit basis was only 1.1
In sum, the PTARs will have to rely on
acquisitions to achieve substantial revenue growth. And those acquisitions may become more
difficult to put together. For one, the generally weak stock prices of the PTARs will
reduce buying power. Secondly, successful auto retailers have shown, and investors are
catching on to, the wisdom of selective acquisition, concentrated within a market area –
and the prized plums are quickly being picked. Third, and most importantly, manufacturers
continue to monitor the speed at which operators acquire additional franchises and market
share. As both public and private dealer groups become increasing large, they are more
likely to bump up against the manufacturer-imposed limits.
Conclusion: Both same-store and
industry-wide revenue growth will be very modest in the years ahead. Analysts looking for
a positive spin should take note of the stability of the revenue stream. The franchised
dealer industry suffered a decline in sales in only four of the past thirty years. In
addition, the industry, as a whole , hasn’t recorded an operating loss in decades.
Thus, a well-run publicly traded automotive retailer should be able to avoid severe
revenue declines and post fairly consistent profits throughout the business cycle.
Minor cost savings and modest margin
improvements have been tweaked from many of the dealerships acquired by publicly traded
automotive retailers, however, a few of the acquired dealerships have shown a decline in
both revenue and operating margins. (Those PTARs willing to buy under-performing
dealerships have naturally achieved the best improvements in existing-store performance.)
In total, none of the public companies have posted financials that represent a major break
from the cost structure underlying the typical single-point dealership. Namely, a 12
percent gross, a less than two percent pre-tax return, a 6.5 percent new vehicle upfront
gross, and a $1,600 new vehicle cost-to-sell, half of which is accounted for by people
Granted, some of the public companies tout
their three percent return on sales, double the industry average of 1.5 percent, but it is
important to keep in mind that there have always been numerous single-point dealerships
realizing a three percent return and that’s with accounting that often strives to
reduce reported profit (LIFO, personal items on the books, rent factors and management
fees paid within the family, etc.). To date, the operating models of the publicly traded
retailers are little different from those of the traditional dealer. The only bold
experiment tried by a couple of the public companies – the used vehicle superstore
– proved unsuccessful. Those operations are now being adjusted to more closely
conform to that of the traditional dealer model.
Nevertheless, one or more publicly traded
automotive retailers will likely develop a superior business plan and, with sharp
execution, significantly outperform the traditional, privately-funded, dealer network in
the near future. Size, plus some degree of market area dominance, provides the PTARs with
a potential leg up in inventory management, brand building, customer relationship
marketing, and e-commerce initiatives. Even so, the synergies and economies provided by
consolidating ownership of the dealership network are dwarfed many times over by that
which is possible from a true manufacturer/dealer partnership and consumer centric
Conclusion: The biggest potential
savings in automobile distribution costs are not under the singular control of either
dealer operator or manufacturer. Thus, publicly traded automotive retailers operating
within the traditional franchise system will not be able to significantly reduce
distribution costs by themselves. Costs savings could be achieved in partnership with the
manufacturer, but for that to occur the publicly traded automotive retailers will need to
share in the savings. When such a profit sharing arrangement between manufacturer and PTAR
comes about, it will be the watershed event that breeches existing dealer / manufacturer
relations for all time.
Table: Average dealership size by
state & PTARs as a percentage of dealership population by state
Publicly Traded Automotive Retailers Avoid Over-dealered Markets
PTARs as percent of total
By Herb Walter and Tom Webb
Herb Walter is a
PricewaterhouseCoopers partner and head of the Financial Advisory Services automotive
industry group. Tom Webb is a PricewaterhouseCoopers manager within the Financial Advisory
Services automotive industry group.