The DCH deal: How Lithia will absorb its new asset

CEO Bryan DeBoer will transform Lithia Motors Inc. with his planned purchase of DCH Auto Group Ltd. But it won't be easy.

Lithia is the smallest of the publicly traded dealership groups, as measured by 2013 new units retailed, selling mainly Detroit 3 brands in smaller markets in the West, Midwest and Texas. By adding DCH, it will jump in the size rankings, break into Eastern U.S. and major metro markets, and diversify its brand portfolio so that Toyota and Honda stores make up 47 percent of its sales.

The transformation brings challenges, though. DeBoer will have to blend two quite different cultures and improve DCH's underperforming profit margins in metro markets -- markets in which Lithia has almost no experience.

And the transformation won't stop there. Lithia will hunt for more acquisitions, DeBoer said.

"This deal will allow us to look at two growth models: one in metro markets and one in smaller, rural markets," DeBoer said in an interview with Automotive News.

"Our balance sheet doesn't get too stressed by this deal," he said in a separate conference call with analysts and reporters. He added: "We're not looking at this as adding loads of work" for Lithia's personnel, so they would still be able to evaluate other potential targets.

Once the deal closes, which is expected to be in the fourth quarter, there might be "a slight honeymoon period of 90 days or so" as Lithia absorbs DCH, but the acquisition team will then resume scouting deals, DeBoer said. "We look at this as an opportunity to deploy capital and be more discerning on what we choose," he said. 

Lithia, of Medford, Ore., will pay about $340 million in cash and another $22.5 million in Lithia stock to acquire DCH, of South Amboy, N.J. 

Detroit 3 brands make up 51 percent of Lithia's sales. Chrysler Group vehicles alone accounted for 29 percent of its 2014 sales. In contrast, 80 percent of DCH's sales are import brands. Lithia, the nation's eighth-largest dealership group in new-vehicle sales, has 101 stores in 12 states. DCH has 14 dealerships in Southern California and 13 in New York and New Jersey. 

"It's hard to imagine two dealership groups that are more different than these two are," said Alan Haig, president of Haig Partners, a dealership buy-sell advisory firm in Fort Lauderdale, Fla. 

DeBoer acknowledged that blending those two cultures will take time. 

In previous acquisitions, Haig says, Lithia routinely replaced the target company's management with its own people. That won't happen in this case. DCH Chairman Shau-wai Lam is expected to join Lithia's board. George Liang, president of DCH, will stay on, reporting to DeBoer. 

That reflects Lithia's inexperience in large metro markets. Liang said: "Bryan told me they don't have the expertise to do it and that's why they want to keep our team intact." 

Lithia also plans to keep the DCH name on its metro stores. If Lithia later buys a store in a major metro market, it would likely get the DCH name, DeBoer said. 

But DCH has its flaws. Its profit margins lag the public groups', Wall Street analysts say. In contrast, Lithia's first-quarter earnings presentation trumpeted an adjusted net margin of 2.5 percent, topping all publicly traded dealership groups.

DeBoer said there are opportunities to boost DCH's margins. In used-vehicle sales, for example, DeBoer said 70 percent of the used vehicles DCH sells are the same brand that the dealership group sells new. The implication: DCH is wholesaling, at a lower profit, trade-ins of other brands. 

Lithia can trim some of DCH's finance and insurance administrative costs and hopes to boost profits with F&I products that DCH does not offer, such as a lifetime oil change program, DeBoer said. 

Lithia also can learn from DCH's strengths and apply the lessons to its stores in smaller markets, say in the area of pricing. "We recognize the pricing sensitivities in metro areas are more acute," making it more critical "to be transparent with your customers." 

He said it may take two to five years to understand "which levers to pull" to reap all the potential benefits of the DCH acquisition. On a pretax basis, Lithia expects to achieve a return on its investment within five years. 

But Brodie Cobb, executive chairman of Presidio Group, a dealership brokerage in San Francisco, said the need to manage the integration will soak up management's time. For that matter, Lithia also has to integrate six other stores it purchased this year and two that DCH bought. 

Cobb doubts Lithia will be looking for its next target that soon. "I think it'd be very hard to do something in the near term, whether that's 90 days or nine months," Cobb said. "But they are ambitious" and with the DCH deal Lithia's DeBoer has sent "a real signal to the market that they are a real player."