Wherever Warren Buffett goes, investors follow. Such is the power of the Oracle of Omaha's reputation. True to form, Berkshire Hathaway's recent purchase of the Van Tuyl car dealership group has pushed up the share value of large dealership companies. Some of these new investors may simply be front-running Buffett, buying up equity in dealerships they think Berkshire may acquire. But for anyone who thinks now is the best time to buy into car dealerships, a quick reality check may be in order.
Perhaps the biggest reason to think twice before following the Oracle is that the U.S. auto market is returning to its traditionally sustainable sales peak of between 16 million and 17 million units per year. While auto sales have been one of the few bright spots in the retail sector during a slow economic recovery, there's no reason to think that will last. Much of that growth is due to the expansion of auto credit, particularly through subprime lending and longer loan terms, so there may not be much juice left in the tank for further growth.
Another question is whether the "moats" that protect auto retail are as strong as some analysts believe. Certainly, auto retail enjoys bigger profits and stronger regulatory protection than other parts of the industry, but that simply makes it a target for long-term disruption. Though peace has been made between dealers and online lead generators such as TrueCar, the threat of consumer dependence on Web-based leads remains a concern for dealers, pushing them to invest in areas outside their core competency.
As the Internet breaks down the information advantage long enjoyed by dealers, upfront profits on new cars are eroding and being replaced with service contracts and financing. The growth in financing profits has in turn attracted attention from federal agencies, which have launched a "regulatory onslaught" against allegedly exploitative and discriminatory practices.
Meanwhile, the ultimate "moat" in auto retail -- the franchise system -- is under attack by Tesla Motors. Though tiny by industry standards, Tesla's assault on what it calls the monopolistic nature of auto retail has added free-market allies to its environmentally conscious fan base. As Tesla knocks down the walls between automakers and consumers, other retailers, from Costco to EBay, are watching with interest.
It's unlikely that Buffett -- who called his latest move the first step in a larger push into auto retail -- is unaware of these factors. Indeed, the fact that his initial buy-in is just part of a broader consolidation play suggests he foresees tough times ahead for auto retailers. Scale is a critical advantage in new car sales, as is a diversified brand portfolio. If sales volume stalls and credit starts to tighten, more marginal players will come under pressure and provide Berkshire with acquisition opportunities that could unlock huge scale.
The advantages of scale extend to Buffett's other investments, including Geico auto insurance and, to a lesser extent, automakers General Motors and China's BYD. Berkshire's dealerships will almost certainly sell Geico insurance, but they might also provide a retail opportunity for BYD's long-standing U.S. market ambitions. Synergies such as these, as well as a consolidation strategy built around the maturation of the U.S. auto market, make auto retail a logical fit in Warren Buffett's portfolio. But that doesn't mean it makes sense for yours.
Edward Niedermeyer, an auto-industry consultant, is the co-founder of Daily Kanban and the former editor of the blog The Truth About Cars. This column was distributed by BloombergView.