No two dealerships are alike... Each dealership operates under its own unique set of circumstances, and even those within the same franchise group can differ markedly in financial performance and business structure. For those involved in valuation, loss assessment, or commercial disputes, it's important to appreciate the nuanced nature of this industry.
Buckle up as forensic accountants Dawna Wright and Vincent McGuire take a drive down memory lane and highlight three key takeaways from their experience in engagements in the automotive industry. These insights offer valuable guidance for anyone undertaking loss assessments or valuations in this industry.
From Engine to Exhaust — The Interconnected Parts Driving Profit
Automotive dealerships are as complex as the systems under the hood. They are often made up of several distinct businesses operating under the same roof. Their structure is often complicated, as it includes diverse revenue streams such as new and used vehicle sales, service and repairs, parts sales and finance and insurance ('F&I'). Many of the corporate structures also have significant property portfolios. Each of these operates differently and has its own drivers of revenue and costs.
Like the parts of an engine, these business units are interconnected. A change in one often affects the others. For example, a drop in new car sales might not only immediately reduce profit on new car sales, but also income from financing and insurance. Other departments, like servicing, may be less affected as they can still operate independently from new vehicle sales. Assessing economic loss and damage involves estimating the impact of an event on hypothetical profits. This is all the more difficult the more 'moving parts' there are in the financial model. We can't just look at vehicle sales in isolation and we also need to understand how those sales flow on to impact other parts of the business.
That's why we need to look closely at what really drives profit in each particular case. Metrics such as average gross profit per car sold, labour hours per servicing of each vehicle and labour cost per part sold are key to understanding what is behind the business. We also need to consider the rate at which finance products, accessories and after-sales servicing are bundled together with vehicle sales. These metrics do not operate in isolation; changes in one variable can cascade throughout the business, affecting multiple financial outputs and ultimately influencing the dealership's net profit.
Because of this complexity, detailed and integrated financial models are needed to accurately represent the dealership's operations and to support our expert opinions. These models typically incorporate detailed assumptions, multilayered spreadsheets and stress testing different 'what-if' scenarios. While such modelling can take time and effort, it is vital for reliable, well-supported expert opinions, especially when dealing with litigation and insurance claims.
Ultimately, the preparation of loss models for automotive operations is about more than just number of units sold. It requires not only technical expertise in financial modelling but also a substantive understanding of the interconnected structure within a dealership. This holistic approach enables the parties, the legal team and counsel, experts and the Court to better understand the valuation or quantification of loss, to arrive at informed conclusions.
Hit the Brakes and Break it Down — Understanding the Comparability of Dealerships
We are often engaged to calculate loss or value multiple dealership locations. While these entities may operate under the same brand, determining their individual profitability is rarely simple.
At first glance, it might seem reasonable to compare dealerships within the same brand. After all, they sell the same vehicles and may use similar financial reporting systems. However, assuming that dealerships of the same brand are financially comparable overlooks a key issue: the inconsistency in financial reporting practices and the impact of the specific dealer and location.
Dealerships often structure their accounts in ways that suit internal management and tax purposes and may not adhere to a uniform set of accounts. The recording of revenue and expenses may vary significantly between locations. For instance, one dealership may report manufacturer bonuses as 'vehicle sales,' while another might classify these as 'other income' or deduct them from expenses (such as cost of goods sold). Both dealerships may appear to be performing similarly, when in reality the underlying figures are not directly comparable.
This lack of standardisation means comparisons must be approached with a critical and investigative mindset. Simply comparing bottom-line profitability or gross margins or net profit without understanding how those figures were derived can result in misleading conclusions. As forensic accountants, we often need to adjust reported figures to ensure comparability. This might include re-allocating shared costs, correcting for internal transfers (such as internal service work on demonstrator vehicles) or removing one-off and non-operating items. It's also important to distinguish between fixed and variable costs depending on whether we're assessing loss or valuing a business.
Our experience is that these differences in reporting are not unusual, they are systemic. In large dealership networks, differences in accounting practices are common, even among locations with shared ownership or centralised administration.
On top of that, the dealer and location can also have a significant impact on profitability. Depending on the network, the dealer may have significant autonomy to create real-world operational differences impacting sales volumes and pricing strategies. Further, similar to other franchise models, the customer demographics specific to the dealership location can also lead to variations in performance.
It is clear from the above that the key to reliable results is a detailed forensic analysis, rather than surface-level comparisons.
Mountain Roads, Blue Skies and... a Valuation — The Blue Sky Valuation Method
When valuing businesses, we seek to identify whether an industry has any rule-of-thumb approaches. In the automotive dealership industry, one of the most well-known is the 'blue sky' valuation method, which estimates a dealership's intangible value, above and beyond its physical assets. This method aims to capture things like brand reputation, customer loyalty, location and ongoing profitability, each of which can influence the premium a buyer may be willing to pay.
The blue sky value is usually calculated as a multiple of adjusted pre-tax earnings, such as adjusted net profit or earnings before interest, taxes, depreciation and amortisation ("EBITDA"). The actual multiple used can vary depending on the dealership type (e.g., luxury versus mass-market), current market conditions and the dealership's financial performance.1For example, a profitable luxury dealership might attract a higher earnings multiple, while a less profitable mass-market dealership may get a lower earnings multiple.
The blue sky value is then added to the net asset value to arrive at the total value of the dealership.
Industry publications such as The Kerrigan Advisors' Blue Sky Report and The Haig Report by Haig Partners provide regular information on blue sky multiples. However, these publications are more applicable to the U.S. market, as public information for the Australian market is more limited.
Unlike traditional valuation methods, such as the income approach (which forecasts future cash flows), the market approach (which compares similar businesses) or the asset-based approach (which looks at the value of assets and liabilities), the blue sky method is simpler. Traditional methods typically involve forecasting future cash flows or assessing the fair market value of assets and liabilities, requiring detailed financial modelling and assumptions about growth, risk and discount rates. In contrast, the blue sky method just applies a multiple to recent adjusted earnings.
This simplicity can be appealing, and it can also produce higher valuations in cases where intangible qualities (like brand strength or customer relationships) aren't reflected in the financials. However, it can also mean the result is more subjective and less tied to quantifiable financial data, which can lead to wide variations in value.
Our view is that it's important to understand what valuation method has been used when comparing transactions for automotive dealerships (particularly when using the market valuation approach). Comparing a blue sky valuation to a traditional valuation method could be a case of apples to oranges, or more relevantly, Ford vs Ferrari.
The Chequered Flag
Working in the automotive industry has shown us that no two dealerships, or financial situations, are ever quite the same. Each engagement demands careful forensic analysis combined with commercial insight. The expert must have their hands firmly on the wheel — this is no time for backseat driving!
Footnotes
1: Business Valuation Resources, LLC (BVR), "What It's Worth: Automobile Dealership Value" – Second Edition, March 2016
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
