Turbulent Times Means Big Profits for Some Dealer Groups
By Cliff Banks WardsAuto.com, May 4, 2009 8:00 AM

See related content: 2009 Ward’s Megadealer 100 list

Despite a short-term forecast for the nation’s top dealer groups calling for stormy weather, disappearing “blue sky” and uncertain operating conditions, the future promises to be bright for savvy dealers.

Public dealer groups will watch their stock prices skyrocket, while well-capitalized and financially disciplined private dealer groups will add to their empires and become rich beyond their wildest dreams.

But before the industry reaches those heights, there still is much unpleasantness to endure.

The fallout began last September when the first large group, the Bill Heard organization, went belly up after generating $2.1 billion in revenue in 2007.

Then Denny Hecker’s empire in Minneapolis was blown apart following lawsuits from Chrysler Financial and other captive finance firms. A civil court in Minneapolis recently ruled in favor of Chrysler Financial, saying Hecker owes the firm $476.9 million in one of a myriad of lawsuits. Hecker’s 26-store group now is down to two stores, both of which likely will be sold in the next few weeks.

In California, Mike Kahn lost his 11 stores after Nissan Motor Acceptance Corp. pulled its financing from his newly opened Toyota dealership. Construction was finished a week before the store was shut down. In fact, the grand opening sign was in one window, while a closed sign was in another.

Ray Childress, a powerhouse in Texas, also collapsed.

Other groups have been hit hard by plunging sales, pressure from floorplan lenders and high rent or facility payments on palatial dealerships built in the last few years.

Phil Villegas, a principal with Dealer Transactional Services LLC, a firm that handles the buying and selling of dealerships, predicts another 10 of the top-50 dealer groups could disappear due to bankruptcy and consolidation in the next year.

The public dealer groups also are feeling the pressure. They all are scrambling to avoid violating loan covenants with their banks. This means finding new avenues of capital, renegotiating debt with bondholders, selling stores, dramatically cutting payroll and expenses, stopping acquisitions and writing down the blue-sky (goodwill) value of dealerships.

Two of the public dealer companies, the Asbury Automotive Group and the Sonic Automotive Group, came close to breaking their loan covenants in the last few months when they both received “going concern” notices from their auditors regarding their ability to continue operating throughout 2009 due to growing debt. Combined, both groups generated more than $10 billion in revenue in 2008, selling nearly 200,000 new vehicles.

Asbury CEO Charles Oglesby

The “going concern” notices signaled the companies were in violation of their loan covenants, and possibly in danger of being forced to file for bankruptcy. However, both were able to obtain waivers from their lenders.

Asbury is in better shape at the moment, having renegotiated its debt late last year, obtaining some flexibility through 2012. CEO Charles Oglesby reassured analysts during a conference call on fourth-quarter and full-year 2008 earnings that he views Asbury’s future differently than do the auditors.

“Our liquidity remains strong with approximately $92 million of cash at year end and borrowing capacity of $116 million,” he says. “Fortunately, our financial partners see our future as we do. Despite the extremely tight timeline resulting from the late hour of our auditor’s opinion, our lending partners demonstrated their confidence in us and our viability with all 11 voting to provide us with waivers.”

Sonic’s situation is a bit more tenuous. After receiving its “going concern” notice in March, it convinced Bank of America, one of its primary lenders, to grant a with a waiver until May 7 on a $105.3 million debt.

Sonic also is negotiating with bondholders to restructure its debt. If it fails to either pay or restructure the debt, it will violate three loan covenants and may be forced to file bankruptcy.

At the moment, Sonic does not have the cash and is restricted from using an existing revolving-credit line to pay down the debt. Additionally, credit markets remain frozen hampering Sonic’s ability to raise cash.

Although the situation looks dire as the May date draws near, sources outside Sonic but close to the situation tell Ward’s they believe it is likely the company’s bondholders will play ball and allow the group to avoid bankruptcy. In other words, a restructuring of the debt is probable.

The stock price was as low as $0.72 a few months ago, but was trading in the $4.65 to $4.70 range in late April, which means investors are confident Sonic will survive.

Even if Sonic is able to renegotiate its debt by the deadline, it still has a lot of work to do. Including the $105 million outstanding debt, Sonic has $1.5 billion to pay off in the next 18 months and another $400 million after that. To help retire its debt, Sonic is planning to sell as many as 35 dealerships this year – that’s about 20% of its portfolio. But those deals will take time to close, especially in today’s environment.

Lithia Motors is another public group whose future could be classified as uncertain, mainly because of its large number of Chrysler dealerships. The company’s future is tied to Chrysler LLC’s future. If the auto maker goes into liquidation, it appears unlikely Lithia would be able to absorb the financial shock.

Otherwise, Lithia should be fine. It will retire the rest of its debt ($6.9 million) in May, having and has sold 20 of the 31 dealerships targeted late last year.

In addition to paying down debt, most of the public dealer groups plan to sell several stores – some of them may be top-rated brands, such as Mercedes, Honda, Lexus and Toyota – while halting acquisitions. The goal is to “preserve liquidity,” Oglesby says. “It’s an environment in which cash is king.”

They also have written down the blue-sky value of their dealerships. Blue sky refers to the value a buyer and seller might place on a dealership once the value of the hard assets are determined. It typically is calculated by multiplying a dealership’s pre-tax earnings by the multiple.

The multiple is a highly subjective number and takes into account several factors such as brand, market, location of competitors, facility condition, size of vehicle allocation, store history and almost anything else considered signifcant.

A few years ago, some brands were commanding unbelievable blue sky, selling for 15 to 20 times actual earnings. The public groups were on a buying frenzy for some of the top brands, which sent dealership values skyrocketing.

Now, much of that value has receded. For domestic-brand stores, the blue-sky value has disappeared almost completely.

In third-quarter 2008, AutoNation Inc. wrote down $1.4 billion, mostly due to the declining value of its stores. Meanwhile, Asbury declared a loss of $536 million in the fourth quarter, of which $492 million was because of plummeting values. Sonic discounted $658 million due to disappearing blue-sky value in the same period.

“Not amortizing the blue sky anymore likely will lead to unprecedented profits (for the public groups) next year,” Mark Johnson, president of MD Johnson Inc., a national mergers, acquisitions and advisory firm.

For private dealer groups, all of this is good news. In theory, dealership prices should be receding to a more reasonable level even for some of the top brands, meaning deals should start happening once the credit starts flowing again.

As more dealers are forced to file bankruptcy and close their doors, there could be some attractive stores available at attractive prices.

There are reports Tom Durant, owner of Classic Automotive Group, picked up Bill Heard’s Sugarland, TX, Chevrolet store for $13 million in bankruptcy court. To put this in perspective, the dealership sold more than 4,200 new vehicles in 2007, generating more than $219 million in revenue – good enough to be ranked 32nd on the Ward’s Dealer 500.

The public groups are selling, not buying, which, coupled with an environment forcing undercapitalized dealers to sell, means more dealerships on the market with less competition to buy stores.

The buyers are going to be groups with multiple franchises, a deep management structure and numerous sources of capital.

The industry could see current regional powerhouses – think Hendrick Automotive Group, Larry Miller, Ken Garff and MileOne – become much bigger and even more powerful. Once car sales return to more normal levels, a couple of the larger groups could go public. “It might be their only option to continue growing,” Villegas says.

Sheldon Sandler, the founder of Bel Air Partners, a boutique banking firm that represents dealers, says marginal players are “dropping like flies. But, when all this (downturn) is over, good dealers are going to become super dealers.”

Ironically, the public groups, even though they are getting smaller, are well-positioned for the future.

News that General Motors Corp. is shutting more than 2,600 dealerships in the next 19 months and speculation Chrysler will cut its dealer numbers by more than a 1,000 has public groups almost giddy.

“I hate to say it, but that is great news for us,” one dealer executive tells Ward’s.

Meanwhile, the public groups have cut expenses to where they can be profitable in a year of 9 million new-vehicle sales. They’ve trimmed inventory levels as much as 60% and reduced layers of management and cut the number of employees.

“Everyone got kind of fat,” Oglesby tells Ward’s in an interview prior to GM’s announcement.

“A time like this is a cleansing process. When you’re able to be profitable even at these low sales numbers, that’s pretty good. I think the future is very bright, especially for investors. Fewer dealerships means greater market share, a bigger service and fixed-operations market and increased sales.”

Another factor that will lead to increased profitability is the auto makers reducing production to levels that make sense.

AutoNation Chairman and CEO Michael Jackson tells analysts on the group’s first-quarter 2009 earnings call that GM’s recently announced 9-week plant closures this summer and dealer cuts, although “disruptive,” is a historic opportunity to fix the industry. “Tremendous capacity is coming out at the manufacturer level, the supplier level and the retail level,” Jackson says. “Most important is whose going out in the capacity. The irrational production is going out. The irrational dealers are going out. “When you get to the other side, even if volumes are lower because credit will not be what it once was and because the consumer is scared and more conservative, you don't need it to be highly profitable. And we'll have higher throughput, better margins, better pricing and a business model that builds the future rather than erodes the future.” The brighter future for the public groups already may be starting. AutoNation posted a $34.6 million first-quarter profit on $1.3 billion less revenue than in-like 2008.

AutoNation’s stock had dropped to just under $4 a share in recent months and was trading between $9 and $10 in early March. It since has climbed above the $17 level.

Group 1 Automotive announced an $8.4 million first-quarter profit on 32.2% less revenue than year-ago. According to company CEO Earl Hesterberg, Group 1 will exceed its cost-cutting target of $100 million this year by $20 million.

The group also slashed its inventory costs by $208 million in fourth-quarter 2008. Its stock price was $8 on March 9. Now it’s trading above $21.

The Penske Automotive Group, the nation’s second-largest dealer firm, has watched its stock price jump more than $7 a share even though it has yet to announce first-quarter earnings.

The message for would-be investors? The window for buying automotive retail stocks could be closing quickly.

cbanks@wardsauto.com