14 July 2022

After the uncertainties through the Covid lockdowns, the automotive retail sector as a whole has been experiencing strong trading conditions of late. We have seen this most clearly in the used car sector, given the supply side challenges for new models, but overall there has been buoyant demand combined with improved working capital cycles, delivering both good profitability and positive cash generation.

However, there is once again uncertainty ahead for retailers, with cost-of-living pressures threatening demand, continued cost prices impacting margin, the impact of inflation to factor in, anticipated changes to the agency model and further electrification of new car stock.

Of course, changes can present opportunities, but businesses must also be mindful of potential threats. It would seem, then, an opportune time for shareholders to consider how they best wish to navigate forwards.

There are clearly several dealer groups committed to expanding their regional and national presence who will be seeking to further develop and enhance their businesses going forward. And the ‘buy and build’ model works well in motor retail: as cost pressures impact performance, a larger efficiently run group should be able to withstand this better than a single site.

We expect many of the larger groups to continue to seek acquisition opportunities, albeit becoming increasingly strategic in their choice of targets – deeply considering location, OEM relationship and overall quality of proposition, alongside financial metrics.

There will be shareholders who have been in the sector for a number of years, and have experienced many of the motor ‘cycles’, who will be seriously considering an exit from the sector – seeking to maximise the return for the value that has been built. If you are one of those who have decided to sell the business, how do you go about doing this?

Motivating factors

Selling the business can be approached from different angles based upon the motivating factors for the seller. Is a buyer lined up? If so, are they an existing player in the regional or national motor retail market or are they a new entrant, perhaps from overseas or another market? Do you have an existing relationship with this buyer? Might another party see more value in your business?

What about if a buyer isn’t lined up? How do you drive interest in your business? Do you wait for potential acquirers to come to you, or should you be proactive?

Consider, too, the dynamics on the sell-side. Are there a large number of shareholders with conflicting views or a small handful of aligned shareholders? Are you hoping to keep the news that the business is up for sale quiet or is this to be publicly announced?

Depending on whether a buyer is or isn’t lined up, there are different ways to approach a sale. A ‘controlled’ auction process which is led by a corporate finance advisor (approaching interested parties on a confidential basis) can generate significant competitive tension to assist in driving value and ensuring a range of potential acquirors have been approached. Alternatively, you might want to reach out only to a sole party or small handful of parties, often already lined-up and well-known to the business, with the intent of keeping news of a sales process quiet and more targeted.

Whilst the ‘quiet’ option can be appealing, in reality, given that you are probably only going to sell your business once, it is worth considering the controlled auction process. This can offer a route to ensure that valuation is maximised through presenting well prepared information to a range of potential acquirors in a competitive process. Parties know that they have to put their strongest proposition forward, or some other party will complete the acquisition in place of them.

It’s certainly worth considering both options and seeking appropriate advice.

Preparing to sell

Preparation is key when selling a business. Value is driven by a plethora of factors, from minor to major, and it is important to ensure that the business is prepared for an upcoming sale where it will be subject to a scrutinous diligence process.

Diligence typically covers financial, commercial and legal aspects of the business but can extend to tax, IT, management, environmental, HR, etc. It is therefore important to consider every aspect of the business in terms of its readiness for sale, and getting the house in order. In doing so it is useful to consider what information would be helpful to a buyer, and to identify what is already in place and what can be implemented in advance of a sale.

Focusing on financial information is key. A buyer will expect a financial model which provides monthly P&L, balance sheet and cash flow data with particular emphasis on EBITDA (earnings before interest, tax, depreciation and amortisation) and cash conversion. With time and focus, a potential vendor should prepare a clear set of monthly financial management accounts, which include clear KPIs, and which highlight any non-recurring costs/income, and clearly set out divisional results.

Examples would include analysing performance between new and used cars, and analysing interest to show stocking and non-stocking amounts. It is also worth reviewing accounting policies with your adviser and considering how they would compare to a potential buyer’s view.

In addition, trying to quantify the impact of Covid or any historical restructuring on the overall ‘trend’ of business performance is key: coming out of a period of disruption directly into different disruption means that buyers struggle to clearly understand the ‘normal’ trading potential of a business (particularly if it was restructured during Covid). Any analysis that assists with this is key.

Legal information will also be in high demand throughout a sale process, so it is beneficial to ready any documentation that is likely to be required. This will include property documents such as titles and leases, share documentation and more. Building on this, if the business owns property, making sure this is fully compliant with all appropriate requirements and well documented is key.

For those wishing to conduct an auction process, selecting advisors will be an important first step. Advisors should be considered based upon existing relationships with the business, credentials in the sector and transactions completed at a similar size.

Among a number of other factors to consider when preparing to sell will be the impact that a sales process will have on the day-to-day operational capability of the business. It is important to ensure that appropriate resource is available to serve both the smooth running of the business and the sale process. It is also worth contemplating factors such as transaction costs (advisors, corporate finance, lawyers, tax, etc) as well as how you intend to shelter news of a sale process from incumbent staff.

Timing of the sale

In an ideal world, the right time to sell a business is when all beneficial factors align: the market is buoyant, the business is being approached by a number of interested parties, the business is experiencing bouts of good publicity, strong financial performance is underpinned by growth, existing shareholders are ready to sell, etc. Of course, we don’t live in an ideal world.

A key influence is the financial performance of the business. Demonstrating growth to a potential buyer is hugely important as this will help them to get comfortable with their ability to generate future returns. It’s important to understand how the business is performing in comparison to the overall market: relatively modest growth in a period where the market is buoyant is hardly going to attract high levels of interest.

Ask yourself if now the right time to sell in the face of the current market. The sector is transitioning into a period of suppressed demand and rising costs. Although this has not resulted in a dissipation of M&A activity, it does increase the importance from the sell-side of demonstrating that good historical performance is indicative of good future performance, particularly against potential industry headwinds.

At present, there are a number of consolidators committed to the sector who will need to continue to grow through acquisition. Set against the uncertain times coming, shareholders would be well advised to consider whether now is the right time to consider an exit.

If you are in a position of seeking to sell in a downturn, or at least more challenging economic conditions, the key element is to demonstrate out-performance against the sector. There may be other factors you can also point to – such as alternative use property valuations (assuming that can be argued as a positive).

Dynamics that impact value

How do you know what value you should be achieving for your business? Ultimately the market will drive value, but to what extent will depend on whether the process is competitive or not: a competitive auction process means that the valuation has been fully market tested, as opposed to negotiating with one party who made an unsolicited approach.

All facets of the business will contribute towards valuation but, breaking this down into simple terms, valuation is likely to be based upon either a multiple of EBITDA or (net) assets dependent on what the key driver of the business is and what underpins it.

In the scenario of an EBITDA multiple, a bidder will require a normalised EBITDA figure in order to understand what the normal level of EBITDA is for the business they’re acquiring. Examples of normalisation adjustments are accounting for the impact of Covid (ie lost income), removing staff costs for exiting shareholders (where they genuinely do not need to be replaced), and pro-rating profits for sites acquired part way through a year which will generate profit for a full year on a continuing basis. Normalisation adjustments will be subject to financial due diligence.

Financial performance is a key determinant in value with a business that is growing and outperforming the market being able to achieve a higher multiple and higher valuation than an equivalent scale business which is not.

Diving deeper into the dynamics that impact on value, the brands that are being represented by the retailer can have a big part to play. High quality brands and strong, long-term relationships with these brand owners will increase value. Non-quantifiable factors also impact value, with things such as the quality of internal controls, staff training, the ability to retain and motivate staff (particularly in times with staff shortages), HR, compliance and reputation in the market all being relevant.

Property is a significant factor, too. Owning freehold is often seen as significantly more appealing than operating sites under a leasehold arrangement. The scale of the portfolio in terms of the number of sites operated and the locations in which these sites are based can have a positive or negative influence on value. Buyers are often looking to add locations, brands and services to their portfolio that they don’t currently operate. Well-invested sites are also beneficial when it comes to valuing properties as this reduces the level of work and cost required by the buyer.

In terms of approach to valuation, alongside EBITDA multiples, the motor retail sector will consider net assets plus goodwill, or even property valuation plus goodwill. All of these rely on EBITDA to some extent, and effectively also give greater value for entities which have a freehold property underpin. In understanding valuation, it is important for a vendor to understand the difference between ‘enterprise valuation’ and ‘equity valuation’. Equity valuation is the price paid to the equity shareholders, and so is clearly the most critical.

External economic dynamics

When coming to sell a business, external economic dynamics should be considered that are relevant to both the motor sector and the wider economy. Weaker economic conditions, as we seem likely to experience in the near future, can lead to a lack of buyer confidence and a shift in strategic focus away from M&A to protecting the current operations of the business.

Both demand and supply are currently being impacted in the motor sector which, over time, can have a sustained impact on growth in the market. Demand is vulnerable to the increase in fuel prices being experienced since the conflict in Ukraine. Supply continues to be impacted by the lack of new vehicles available to retailers, with semiconductor shortages central to the production problem.

Long-term impacts on the sector are being felt from both Covid and Brexit, with the latter contributing towards staff shortages which are driving people costs to new highs. Staff retention is becoming a key focus for retailers in the market, with the ability to replace staff no longer as straightforward as it once was.

The emergence of the global pandemic Covid-19 in the early part of 2020 heightened the challenges being faced by operators in the automotive industry. There has been an impact on all aspects of the industry, from manufacturing to the supply chain and the ability to operate showrooms during periods of national lockdown. In the period between lockdowns many businesses enjoyed significant retail sales, which indicated that there was pent up demand in the economy for this type of purchase. However, cost of living increases are appearing to threaten these post-Covid levels of demand.

However, the sector how shown agility in dealing with many of the issues it has faced in recent years, and challenges often stimulate positive change. In terms of M&A, there is clear commitment to the sector across OEMs and retail groups, which will continue to support M&A for the right, well prepared businesses, across the cycle.

All of these dynamics can impact on the absolute value of the business, its attractiveness to potential buyers, and the willingness of buyers to move with their M&A ambitions. As with so many things in life, timing can be everything.

Author Helen O’Kane is corporate finance partner for M&A at BDO. She has over 20 years M&A experience, and has been a lead advisor on transactions at BDO since 2003

Tags: BDO, dynamics, EBITDA, Helen O'Kane, preparation, selling a business, timing