Buy-Sell Q&A: Where the Automotive M&A Market is Heading

Q: Are there any risks that dealers need to be aware of that could impact their profitability and valuations?

A: The short-term threat we see is the possibility of a recession. Some economists are predicting that we will likely have a recession in 2023, which would reduce demand for vehicles and potentially hurt the incredibly high vehicle profits dealerships enjoy today. As earnings fall, valuations also fall.

In the Haig Q4 2021 report, we highlighted some mid- to long-term threats that dealers will need to consider:

Tesla and other new entrants: Tesla has now become the number one luxury brand in the United States, and its next product launch, the Cybertruck, is aiming at the hearts of domestic brands. Other new entrants, such as Rivian Automotive and Lucid Motors, are also entering the market, as well as new brands launched by traditional OEMs, such as Polestar. These new entrants are likely to experience mixed results in the market, but there is a good chance that competing dealerships across the country will lose customers and profits as a result. Perhaps a greater threat to dealerships is that new entrants may push traditional OEMs to impose the agency model on dealerships (see below).

The agency model: Traditional OEMs have found that millions of customers are willing to go to a website, order a vehicle and wait for it to be delivered. And these OEMs are also seeing that they no longer need to produce millions of vehicles for dealer stock lots, guess which vehicles customers will actually want, and then advertise and provide incentives in order to encourage customers to buy the vehicles. Their profits per vehicle are much higher when they only produce what customers want to buy. And finally, they see that retailers are making huge profits. This new set of facts is causing a number of OEMs to reconsider their relationships with their dealers and consumers. Ford’s plan to split into two divisions, the Model e division which will only produce electric vehicles and the Blue division which will only produce internal combustion engine (ICE) vehicles is an example of a potential agency model in game. Customers looking to purchase an electric vehicle will need to order from Ford’s Model e website.

It does not appear that customers will be able to purchase Model e vehicles directly from dealerships. This is a profound change as the OEM will now set, instead of “suggest”, retail prices and the OEM will be the point of contact with customers. The customer can choose which dealer will deliver the vehicle, but the price will be determined by Ford, who will also decide how much to pay the dealer. The buyer will become Ford’s customer, rather than the dealer’s customer. This agency model, where the dealer becomes an agent and not a retailer, is common in other parts of the world. We understand that dealers in these regions make much less profit than dealers in the United States. And Ford isn’t the only one to think so. OEMs have envied Tesla’s market valuation that relies in part on this direct-selling model.

Electric vehicles: Some dealerships are concerned that electric vehicles require far fewer parts and maintenance than ICE vehicles, which will hurt their service departments.

Consolidation: Although still a very fragmented industry, automotive retail consolidation accelerated in 2020 and 2021. Groups like Lithia Motors, Group 1 and Asbury Automotive Group bought dozens of stores to expand their nationwide network of dealerships, along with digital retail tools that will allow them to sell and serve customers who prefer online shopping. These car groups and other dealerships are increasingly convinced that large scale will matter more in the future than in the past. They plan to offer consumers a greater selection of vehicles and more ways to shop than smaller dealerships can offer. If successful, they will gain market share and delight their OEM partners and shareholders. Their gains would come at the expense of smaller dealers who cannot match these capabilities. Haig Partners offers potential solutions to resellers for each of these issues. But due to space constraints, we cannot explain them in detail here. However, you can read more about these remedies on pages 14 and 15 of the Haig Q4 2021 report. These risks are real. However, dealers are very resilient and we expect them to find ways to mitigate these risks. We are still optimistic about the franchise system.

Haig Partners offers potential solutions to resellers for each of these issues. But due to space constraints, we cannot explain them in detail here. However, you can read more about these remedies on pages 14 and 15 of the Haig Q4 2021 report.

These risks are real. However, dealers are very resilient and we expect them to find ways to mitigate these risks. We are still optimistic about the franchise system.

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