Experts see softer blue sky values this year

Blue sky multiples for dealership acquisitions will be mostly flat this year, buy-sell advisers say.

They cite several intertwined reasons for the softness:

1. More dealerships are being offered for sale, tilting the supply-demand equation.

2. New-vehicle sales are expected to peak, so no rising tide will lift all dealerships' revenue boats.

3. With growth slowing, buyers are pricing buy-sell deals on current earnings, not anticipated higher earnings.

The last point essentially means a rethinking of how blue sky values are calculated.

Blue sky is the intangible value of a dealership, expressed as a multiple of adjusted pretax profit. Multiples vary based on a dealership's location and other factors. They are based on actual adjusted earnings by normally performing stores.

"When a market is growing more slowly, it's harder for a buyer to achieve the profit improvements that may exist in a dealership because it's simply a harder market to operate in," said Erin Kerrigan, managing director of Kerrigan Advisors in Irvine, Calif. "Buyers are less willing to pay a really high multiple on an underperformer" in the belief that they can turn the store around.

A few years ago, new-vehicle sales were growing rapidly and buyers were willing to price acquisitions based on "pro forma" earnings, or anticipated higher earnings, Kerrigan said. But buyers are cautious now as many see a new-car sales plateau. They prefer to base blue sky multiples on current profits.

Adviser Alan Haig said, "They are aware we're nearing the end of this upward swing in new-vehicle sales, which drive profits."

Blue sky multiples peaked last year and, on average, declined by 1 percent at the end of the fourth quarter, said Haig, president of Haig Partners in Fort Lauderdale, Fla. It's the first decline he has seen since 2009.

The multiples are still healthier than in prior years, but are under pressure from the economic cycle and because more dealerships are coming up for sale, said Haig, author of the Haig Report.

Overall blue sky multiples "are still very strong today compared with historical levels," he said, but "we believe there's a chance they will begin to decline as we get closer to new-vehicle sales leveling off or falling."

In addition, "Buyers have more opportunity now to buy more stores and they don't have to stretch as far as they had to in 2014 and 2015 to make a deal," Haig said.

Kerrigan, author of the Blue Sky Report, said blue sky multiples are "at peak levels and not likely to rise significantly" because "we are at peak earnings for the industry and we're likely at an earnings plateau."

In her latest report, Kerrigan raised the blue sky multiple for only one brand: Subaru, putting it at 4.5 to 6 times earnings, up from 4 to 5.5.

"It led the nonluxury segment in sales and market share growth and it increased average sales by franchise by over 200 units in the last two years," Kerrigan said. "It was the top import brand in Seattle and Portland, so they're overtaking Honda and Toyota in certain big markets."

She added coverage of Buick-GMC, based on clients' requests, setting its multiple at 3 to 4.

Haig raised Buick-GMC's multiple to 3.25 to 4.25, from 3 to 4, citing lower gasoline prices spurring demand for trucks.

But he reduced Audi's and BMW's multiples to 7 to 9, from 7.5 to 10. Haig said the decline in new-vehicle profit margins along with what dealers perceive as "onerous facility requirements" have slightly reduced demand for these dealerships.

He slashed Volkswagen's blue sky value -- which he has estimated on a flat basis, rather than a multiple, since the diesel-emissions scandal erupted in September -- to $0 to $2 million, from a previous range of $250,000 to $2.5 million.