How America's auto retail giants transformed and navigated the recession

In two tumultuous days in September 2008, Lehman Brothers and mega-insurer AIG collapsed, and Bank of America acquired Merrill Lynch, which was on the verge of sinking.

The Wall Street panic and credit crunch that ensued devastated the U.S. auto industry. Apocalypse loomed. The publicly traded titans of American auto retailing were gravely exposed. One question stood above all: Could they avoid bankruptcy?

Several of the key players in that era spoke to Automotive News reporters.

An ominous signal from the West Coast was the first hint to Group 1 Automotive executives in Houston that they needed to prepare for disaster.

In the third quarter of 2007, the company's California dealership operators spread word of a housing crisis.

"We started to see behavior in California with customers using, basically, home equity to finance car purchases," said CFO John Rickel.

When Rickel assessed how California's housing woes could affect the broader business, he had visions of a financial tsunami. In February 2008, Rickel gave the company's general managers a bleak forecast for the industry and the U.S. economy, adding a powerful call to action: "Get your house in order because it's going to get tough."

If he hadn't already done so, AutoNation CEO Mike Jackson emerged as a voice of the industry in 2007 and 2008. He had a clear objective: Change the way automakers indiscriminately pushed inventory onto their dealers. He famously told GM CEO Rick Wagoner at the Detroit auto show in January 2007: "You're not going to stuff me like a Thanksgiving turkey!"

Jackson said last week: "I go back into 2006 or 2007 when I first was privately warning the manufacturers, particularly the domestics, that they are living on borrowed time, that they had structural problems, that this was not going to have a happy ending and that they needed to make significant changes — I basically ran into a brick wall."

At Sparks Steak House in New York City, Oglesby won Monaghan over by outlining his ideas about the future of auto retail, which involved technology, training and restructuring of compensation — and with the promise that Monaghan would be in the running to replace him as CEO.

"At that point, it was perfect," Monaghan said.

But the job proved to be more of a challenge than expected. Asbury was ill-prepared for any sort of crisis, let alone the Great Recession.

It turned out the company was paying dividends it couldn't afford and carrying too much debt. The management structure was bloated and lacked basic control mechanisms a dealership group at its scale required.

"When I got to Asbury, I felt a sense of deja vu," said Monaghan. "It felt just like AutoNation had been when I joined that company seven or eight years earlier. I just jumped in with both feet."

Monaghan initiated many of the same changes he had made at AutoNation. But the most important act the CFO undertook in his first few months was to completely restructure Asbury's financial support.

Months before Lehman Brothers collapsed, Asbury replaced its nexus of 20 or so regional banks with Bank of America, JPMorgan Chase, Wells Fargo and an assortment of the captive finance companies — a smaller group of big players that knew the space.

The public groups all spotted warning signs, but the events of September 2008 were more traumatic than expected.

"We were battening down the hatches, preparing for a very rough period from 2007 into 2008," said Jackson. "I remember being on [CNBC's "Squawk Box"] in the summer of '08 where I said something like ... things are going to get a hell of a lot worse before they get better. Now what finally happened with the bankruptcy with Lehman Brothers, that total catastrophe, was far worse than anything I even imagined."

During Group 1's fourth-quarter 2008 earnings call, CEO Earl Hesterberg was reflective. He told analysts the company knew the economy would significantly worsen after the Lehman Brothers' bankruptcy "but had hoped that similar to earlier financial blowups, this would be a somewhat temporary reaction."

Any such hopes were dashed by the end of October, though, when it became clear that the fourth quarter was in a "much steeper decline than we had anticipated," Hesterberg said.

The industry sales rate was down more than 35 percent from the year earlier in October, November and December.

"In looking back at history in prior recessions, we don't believe anyone could have realistically predicted the rapid decline to the levels we saw in the fourth quarter," he said then.

As the economy unraveled, Rickel worried that the company would violate its debt covenant, which could put its loans and bonds in jeopardy. To quell rumors, Group 1 took the unusual step of posting detailed calculations of its debt covenants on its website for investors to see.

Nonetheless, the value of the company's debt fell rapidly as investors shunned anything connected to the auto industry. Group 1's convertible debt was linked to the sinking stock price. And the convertible debt and its fixed-rate bonds were trading at deep discounts.

Management decided to buy back its assets, ultimately taking back $100 million of its convertible bonds for just $40 million, or 40 cents on the dollar. The company also bought back some of its senior notes at a 20 percent discount.

"The combination of that allowed us to take about $180 million off of our balance sheet and really firmed up our ability to pay debt," Rickel said.

Jeff Dyke had just been promoted to executive vice president of operations for Sonic Automotive in October 2008 but was in no mood to celebrate. Dyke said he hardly had time to grab a cup of coffee in his new role before things got really ugly. He remembers the banks essentially being closed.

"There were a lot of questions about, 'Oh, good Lord, what are we going to do? Bankruptcy? Or are we going to issue equity?"

A month later, Sonic came to agreements with more than 85 percent of bondholders to refinance its debt and ultimately avoid going under. With the new deal, Sonic could postpone its $90 million debt payment until 2012, but it took on higher interest rates on $86 million in debt and higher quarterly fees. It also issued 857,000 shares of stock to raise $4 million.

Roger Penske, the then-72-year-old CEO of Penske Automotive, described the fourth quarter of 2008 as "one of the most challenging periods on record in the automotive industry." His company posted its first quarterly loss in a decade.

Robert Kurnick, who had been president since April 2008, said the personnel cuts that began in November was the low point for Penske, then as now the nation's second-largest dealership group. To this day, hiring decisions at Penske require senior level approval.

"Every time somebody comes to me with a request for somebody new, I always say, 'Be very, very careful,' " Kurnick said. "Because November 2008 doesn't seem that far away to me, and the next cycle, you don't want to be in a similar situation where you have to take out large portions of the work force."

Jackson says AutoNation was ready when the storm hit.

"I'm going to strain your belief here," he said. "I arrive in AutoNation in 1999; I have a meeting, and I say we need to run a disaster scenario and see what it means for the company and make a disaster plan.

"So, somebody says, 'You mean if the selling rate falls to 14 million?' I say, 'No, let's say the selling rate falls to 10 million. What happens to the company?' Everybody says, 'Well, Mike, that will never happen,' and I said, 'I'm the new CEO, and you've got to crunch the numbers.' So we do, and it was ugly.

"So then I said, 'We're not going to make some plan that's going to sit on the shelf; we are going to change the company so that we can perform in a disaster scenario. We are not being swept away by some disaster.' Out of that came what I call the diversification strategy."

That meant: one-third American brands, one-third Asian and one-third German. The geographic split would be: one-third East Coast, based in Florida, one-third central, based in Texas, and one-third West Coast, based in California.

"If I had not done that," Jackson said, "we would not have made it through the storm, because AutoNation was 75 percent domestic the day I walked in. And what did the industry selling rate fall to in the great crisis? 10 million."

As Group 1's sales continued to plummet, the company got serious about inventory management, trying to limit vehicles on lots to what each dealership truly needed. That meant the executive teams took "pretty desperate phone calls" from automakers, Rickel said. Chrysler, for example, called senior executives at their homes at night, asking them to take more cars and trucks. "We basically had to explain to them we couldn't transfer their liability to our balance sheet," he said.

At the worst part of the downturn, just a few large dealership groups still had open floorplan lines, and Group 1 was among them, Hesterberg said.

"That's why they kept calling us. I think a lot of smaller dealers, if they didn't lose their floorplan, they probably just shut it down and put themselves on hold," he said. "We had more than enough inventory, but many of the OEMs saw us as an open floorplan line throughout the entire crisis."

In early 2009, Sonic's future may have been the bleakest of the public groups. The company's stock price had dipped below $1 a share, closing at a low of 95 cents on March 6. Auditors doubted Sonic could continue as a "going concern." Bankruptcy for the third-largest automotive retailer seemed a real possibility.

President Scott Smith, Dyke and CFO David Cosper hit the road in the spring of 2009, visiting every Sonic store, reassuring staff that they were going to be OK — but admitting that times were tough.

Dyke recalls a conversation he had with Cosper during the recession. The CFO told him, " 'Listen, when you use the copy machine, quit pushing the color button. Do black and white.' We just took that attitude and did anything we could to tighten our belt."

For Bryan DeBoer, president of Lithia Motors, the problem was obvious.

"Our company was 73 percent domestic sales, primarily General Motors and Chrysler," he said. "Most of the newspapers were talking about the dissolution of those two companies. There was a fair amount of fear, obviously, with 73 percent of our base of business going bankrupt."

Hundreds of millions in cost was jettisoned by the public groups. Penske Automotive had made a number of moves since fall 2008 to conserve cash and slash expenses. It cut about 10 percent of its global head count, or 1,500 workers, suspended its quarterly dividend, reduced executive and director pay and suspended the company's 401(k) match in the U.S.

By June 2009, it also had reduced inventory by about $500 million from a year earlier but continued to look for ways to cut overhead. Since the company leased most of its real estate, it sent letters to landlords asking for rent reductions and suspensions, which Kurnick said helped with expense control.

In September 2008, Group 1 had implemented a plan to cut $100 million in selling, general and administrative expenses in 2009 compared with 2008 levels. By February, it had boosted the target to $120 million.

Hesterberg and his team resized the group and did many things "you don't ever want to have to do."

"You basically had to pull every lever you could find because we didn't know how far it was going to drop," the CEO said.

Group 1 even eliminated the match on its 401(k) plan, which Hesterberg called "just the worst thing you can ever do. In many cases, that's a retirement plan basically for our employees."

Every quarter, the executive team evaluated how quickly it could bring back the match.

"People on the front lines out in the dealership ... a lot of them are not high-income people," Hesterberg said. "They rely on our ability to continue to pay them a competitive wage and benefit. We had to cut back further than we wanted in 2009."

In July 2010, Group 1 brought back 401(k) matches at half the pre-recession level and resumed full matching in January 2011.

The company was still fending off pressure from automakers to take more cars, but the strategy was succeeding. By the end of March 2009, the company had reduced inventory by $209 million from the year-end 2008 level. It had slashed new-vehicle stocks by approximately 7,000 units, considerably more than its initial target of a 6,000-unit reduction.

The net loss Asbury posted in the fourth quarter of 2008 was its first since going public in 2002. The stock price plummeted from around $13 a share to just under $3.

Between October 2008 and September 2009, the company sliced $100 million out of its cost base, or about 15 percent. Asbury also moved its headquarters from New York to suburban Atlanta, axing a quarter of its corporate staff, and shuttered regional office after regional office.

But in March 2009, two weeks before Asbury was to file its 10-K report, accounting firm Deloitte issued a "going concern" notice.

The auditors worried that if Asbury violated its debt covenants with lenders, it would go under. The notice delayed the 10-K filing and raised the alarm on Wall Street.

For management, it was a punch to the solar plexus. "It wasn't the banks that caused the crisis at Asbury — it was the auditors," Monaghan said.

Asbury's lending agreements allowed the banks to call back all their loans unless the company could get 51 percent of its syndicate to grant relief. Oglesby and Monaghan immediately went to talk to the banks.

"The 'going concern' opinion questioned our viability going forward and gave the banks the right to unwind our floorplan and credit lines," said Monaghan. "It also caused us to postpone our year-end earnings release, which alarmed Wall Street."

But more than half of the lenders quickly agreed to loosen the covenants, and within a week, all of them had.

"That was probably the single biggest 'take a deep breath' moment, and from there, we were off to the races," Monaghan said. "We knew we could do it. We just needed some time."

Jackson emerged as a key adviser to the U.S. government as it pondered the future of the auto industry.

"I engaged with the automotive task force in Washington, D.C., made many trips to Treasury, and I made the following passionate plea: This is the opportunity to address the structural issues in the industry that exist, and we cannot let it go by, but the industry is worth saving — don't throw it away."

Jackson insisted that the 10 million selling rate the industry had plunged to was misleading. He said he told the task force: "We have demand in our dealerships of a selling rate of 13, 14 million units a year, but we have no credit to finance the customers. So this is a financial crisis that has restricted volumes on new-vehicle sales. So yes, restructure the industry, absolutely, but don't structure it to 10 million units."

The feds asked Jackson to prove it — and he could.

"We had the scale from coast to coast, and we had the systems, and we had traffic counts, and we had the credit profiles," he said. "We were able to show what was being turned down by the banks to make a compelling case that the 10 million was because of the financial crisis, not because of the crisis in automotive."

"Automotive is worth saving," Jackson said he told the task force. "And that probably was a factor in the decision to dothe deal with Fiat and save Chrysler. So I think AutoNation really served the industry, not only our own company."

On March 31, 2009, Sonic disclosed a $658.8 million fourth-quarter loss from continuing operations (a $4.8 million loss from continuing operations when factoring adjustments). But a day later, Smith told analysts that despite a nosedive in new-vehicle sales, the dealerships were performing well as they turned to used vehicles and parts and service for revenue.

But looming for Sonic was an early May 2009 due date on $90 million in debt and lots of uncertainty whether the retailer could restructure that debt.

"The situation that we find ourselves in today is not the result of Sonic's inability to service our debt or a reflection of our ongoing ability to generate cash," Smith said April 1. "Rather, it's a result of a weak capital market condition and the current inability to look to the capital markets to refinance our existing debt maturities."

Today, Dyke says: "There's not many times in history that you kind of look over the edge of the cliff and say, 'Holy cow, this could be it.' Because if you go back and look at our company, our stock price went below $1. How many companies had their stock price drop below $1 and either don't go bankrupt or get bought up and survive something like that? We always look at ourselves — we're the Little Engine That Could."

By June 2009, Sonic put 15 stores up for sale and stopped most facility projects. Dyke said discipline in facility decisions has stuck with the company when it weighs expensive improvements.

By September, Sonic had raised about $266 million from a sale of stock and convertible debt notes, which it used to refinance debt.

Lithia sold about 33 stores in 2008 and 2009. It also cut employment at headquarters.

"We had to right-size our teams," said DeBoer. "We went from about 550 people to 245 people at corporate, who believed in our value base, which is that our customers are our customers for life. Along with that, we began our diversification. We were at about $2 billion, $2.4 billion in revenue at the time, and we had been butting up against that number for years. We began to think about how we diversify from having such a domestic plan."

So Lithia cut the dealerships, but, DeBoer said, "Our earnings and our revenue really did not fall because our cultural fulfillment began to take hold and our people began performing at much higher levels."

Meanwhile, by 2010, Lithia was at 60 percent domestic and 40 percent import/luxury.

Slashing expenses helped Penske Automotive turn profits in the first and second quarters of 2009. Indeed, Penske's finances were in relatively good shape — so much so it began looking for opportunities amid the chaos. One was the Saturn brand, which was on the chopping block at General Motors as the automaker faced bankruptcy reorganization in June 2009.

On June 5, Penske announced it had signed an agreement to buy Saturn from GM by the end of September, subject to due diligence and regulatory approvals. Kurnick said Saturn was unique and attractive, with nearly 350 dealers in its network. The deal included Saturn parts, the right to distribute vehicles and parts through the Saturn dealer network and that GM would continue to produce the Aura sedan and Vue and Outlook crossovers on a contract basis. At the same time, Penske was in talks with Renault Samsung Motors to become the successor manufacturer for the Saturn vehicles.

"I thought it was sort of a very interesting way of accessing the U.S. market," said Kurnick. "Not only do you have the existing dealer market, you're able to have all the warranty and the service for the units in operation under brand and under Saturn. And then you had the ongoing parts operation, which put us in a situation where we thought we could be profitable fairly quickly."

Still, the deal fell through.

"Ultimately, we couldn't get a deal from Renault Samsung that made good economic sense for us," said Kurnick.

The balance sheets of the public groups were improving, but overall market conditions were not. During Group 1's third-quarter 2009 earnings call, Hesterberg pointed out that lenders were rejecting more applications and requiring higher down payments to make up for reduced loan-to-value ratios and increased interest rates.

"The credit markets are really the lifeblood of the automotive industry. That's what made business so dire," he said.

Many of the automakers' captive finance arms, as well as banks and other lenders, funded their operations by selling loans off as securitized receivables or packaging loans and selling them off in the asset-backed securities market. In good times, the theory was that a package of many thousands of auto loans was a safe investment; a few loans might go sour, but most of the borrowers in any given package would pay their loans in full and on time.

But that theory was proving false in the mortgage market. As concerns spread about consumers' ability to pay their auto loans, "packaging became toxic," Rickel said. "Nobody wanted to buy an automotive security, even though the issue ultimately was proven to be mortgages and home-backed items."

At that point, consumers, especially those in the subprime segment, struggled to obtain auto loans.

Still, a year after Lehman Brothers failed, the publics had managed to restructure for a much smaller market. New-vehicle sales were tracking at a 10.4 million annual pace, down dramatically from the 16.2 million in 2007, but exceeding Group 1's worst-case forecast of 10 million.

The company could switch from playing defense to playing offense. Rickel said that because of the "cost reductions being so proactive, the fact that we never lost money in any quarter [of 2009], the fact that we generated over $100 million of operating cash flow in 2009," the company was well-positioned to start thinking about expansion soon after the economy began to rebound.

In 2010, Group 1 was back in acquisition mode. Indeed, the six public groups that grew out of the industry revolution in the 1990s were weathering their first big storm.

Today, Sonic's Dyke praises the management team, including founder Bruton Smith, then CEO, who remained calm in the darkest days. Bruton Smith was one of the visionaries of the movement to form publicly owned auto retail giants.

"He never even blinked during that whole thing. It was just a nonevent for him," Dyke said. "Whether behind the scenes he was concerned or whatever, you would never see that out of him. He was just so strong. For us, it gave us a lot of strength, a lot of confidence, a lot of courage, and we plowed through and came out the other side a cleaner, leaner company."

Indeed, the Great Recession changed business practices at the groups. Before the crash, Sonic didn't own any of its real estate. Today, it owns more than 45 percent, Dyke said.

"We've spent a lot of time shoring up our balance sheet, creating cash and putting ourselves in the position of strength versus a position of weakness," he said. "So, if this were to happen again today, we would be fine, and we wouldn't have some of the struggles that we had in the past.

"We all came out of that time stronger, wiser, better people. And our company is just a much stronger company today than it was then. It's now allowing us to do things like EchoPark," he said, referring to Sonic's used-only stores, "to invest in technologies and to do some things that we wouldn't have been able to do before."

DeBoer says Lithia used the crisis to change its top-down culture.

"Our earnings had tailed off, and we had become more of a ... company where our leaders were looking to corporate for answers, and different parts of the company were responding different ways," he said. "Starting in late 2008 and 2009, we began to challenge our field teams and operations to really think on their own."

Would the change have occurred without the crisis?

"Being faced with nonexistence changes your perspective and makes you more proactive the rest of your life," he said. "Without that, I don't think our team would be as proactive and innovative as we are today."

Monaghan, who retired as Asbury's CEO in January, says: "It was nowhere near as bad as it seemed. Nowhere near. There was only one quarter where we generated operating loss, and we never left cash-flow positive."

Rather than halt the innovations Oglesby had used to entice Monaghan over steak and scotch, the recession forced change at Asbury on an accelerated timeline. Asbury's stores were united under a common dealership management system. By the first quarter of 2009, Asbury was experimenting with salary-plus-commission pay plans. A renaissance was underway.

"My predecessor had this great line. He said, 'We are not going to waste the recession,' " Monaghan said. "We just did things; we didn't play around; we didn't waste time. It was a very bizarre, healthy time for the company."

During Group 1's fourth-quarter 2009 earnings call, Hesterberg noted a silver lining to the tumultuous period.

"This is the first recession that has affected the automotive retailing industry since the automotive retailing groups went public more than 10 years ago," he said. "And it's given us the opportunity to prove what we have been saying for years about the stability, flexibility and resiliency of our business model."