Let’s face it. For the last five or so years we had a great run in the car wash industry. Profits were up, car counts were up, and there has been a tremendous amount of M&A activity flooding the market with cash and buyers, pushing values ever higher. Private equity (PE) caught on to the power of the express model and particularly to the benefits of monthly subscriptions. I sell businesses for a living and over a 30-year career had not seen a market quite as frothy. I do not want to say my job was easy, but great assets were quick to sell and even troubled assets found good homes. We have been due for a correction.
Somewhere around the end of the third quarter of 2022 the world changed — quickly. You expect the ebbs and flows of markets, periods of great activity followed by periods of relative calm. Not this time. This time we ran into the proverbial brick wall. Transactions are still closing, to be sure, but things are different. Financing is harder to get and is dramatically more expensive. The private equity shops that have been growing their chains at breakneck speeds have had to throttle back and take a far more thoughtful approach to capital allocation. Patient sellers are holding out for better times while sellers of necessity are braving the uncertain waters and finding there is still an appetite for good washes and good chains, but perhaps not at the values of last year and not with the same buyer universe.
Enough doom and gloom. We have also seen some interesting trends to the positive. As I have written again and again, great sites will find great buyers, regardless of circumstances. Valuations may come down, but there is still a tremendous amount of dry powder on the sidelines that investors are looking to deploy. Additionally, the sale-leaseback market is still open. For those operators who own real estate, it is a powerful tool for financing a transaction. The market for sale leasebacks has tightened some, but not as dramatically as the banking market. Buyers are turning more and more to this as a tool to finance an acquisition, and operators are tapping that equity to continue growing, potentially benefitting from an environment of lower valuations.
When we take an objective look at today’s market for car washes, the changes we have seen over the last five or so years are dramatic. Of the top 10 conveyor car wash chains in 2016, eight were operator-owned and two were PE-owned. In 2022, all 10 were PE-owned. The top 10 represented about 3 percent of the total conveyor car washes in 2016, more than 10 percent in 2022. This rapid introduction of private equity to the industry dramatically increased purchase prices, dramatically increased the rate of greenfield development, and dramatically decreased the number of large operator-owned platforms available.
Typically, a private equity fund will enter a space with a large transaction, often at a premium price, and partner with the owner/operator/seller to expand through a series of smaller and less costly transactions. That first transaction is funded with a combination of debt and equity. Over the last couple of years debt capital providers have been quite generous in the amount of debt they were willing to lend and the terms (usually floating rate) were tied to SOFR (secured overnight financing rate) plus a spread of 5 percent – 6 percent. In March of 2022, SOFR was 0.05 percent, and it is currently a whopping 4.31 percent. In a short period of time borrowing rates went from about 5 percent to almost 10 percent.
Layer on top of this phenomenon the fact that PE craves growth and capital deployment to maximize returns and you end up in a tight squeeze. As a simple example, let’s say a fund spent $100 million to purchase a chain producing $7 million of cash flow. They were able to borrow $70 million and paid about $4 million in interest annually. They also deployed capital to buy new sites for development. All of a sudden interest rates on the $70 million go up to 10 percent. The annual bill is now $7 million, which is all of their cash flow. Aggressive development is a challenge at best. A fund could invest more equity, but that has a negative impact on their return, which is the report card they get from their investors. It’s a quandary many are facing today.
My example is extreme to illustrate a point, but the fact is that aggressive growth at high prices is exceptionally difficult to sustain in an inflationary environment. Don’t take my example as a sign that there will be wholesale bankruptcies in the car wash industry. There are other tools PE funds can use to weather difficult times such as sale leasebacks or raising minority equity or injecting more of their own equity. The message is that rapid expansion is far more difficult to achieve in our current environment. This will have the natural impact of lowering purchase valuations, and lessening transaction volume.
We all know that nature abhors a vacuum. The world is not going to simply wait for PE shops to continue their dramatic growth curve. Some other group is going to fill that void, but at a lower price level than we have seen in the recent past. To misquote Bill Belichick, it’s next buyer up. At least, that is going to be what happens when we end what I will call the Great Realignment of Expectations (GRE). There are sellers out there who just missed the window of frothy valuations, and there are people out there telling them they are still worth the multiples we saw last year. In some cases, it’s true, but mostly it isn’t. These sellers have unrealistic expectations to realize valuations that no longer exist in this financially challenging environment. The next layer of buyers will not be as aggressive as the last and until the GRE passes and sellers realize this, transactions will be materially harder to complete. We are in that GRE window now.
A big company could make a very big splash very quickly and change the way we look at our industry, but only if there was enough in it for them to move their needle.
There are some intriguing developments, however. For example, last month Circle K entered the market with a splash by acquiring True Blue. When you think about the potential synergies between a huge convenience store and gas chain teaming up with a car wash, it should give the existing players pause. The cross-marketing, co-locating, and employee-sharing opportunities make sense on both the revenue and cost side of the equation. Does Kroger enter the fray? QuikTrip? Exxon?
We in the car wash space tend to think of ours as a reasonably large industry, but in actuality we are pretty tiny. Apple sells enough iPhones in about a month to equal all the revenue at all the car washes in the country for a year. The entire car wash industry only generates about as much revenue as Carvana. A big company could make a very big splash very quickly and change the way we look at our industry, but only if there was enough in it for them to move their needle. They would have to have a vision that goes beyond how we see ourselves today. The next level of new entrants is more like the buyers we saw before the great PE influx, wealthy people looking for local cash flow, or 1031 buyers looking to deploy capital in a tax-efficient manner. These buyers have always been there; they have just been priced out of the market. They will fill the temporary void caused by a slowing of PE activity.
The fun part of this exercise is to predict what the future holds. I believe that PE is here to stay, will recover their ability to deploy capital, and will be an essential element of the future of the industry. Once the financing picture sorts itself out and more affordable capital is available, the funds who bought over the last few years will be back and growing, perhaps with a little more caution. There will be a number of synergistic entrants to the space such as Circle K. For the fuel vendors, electric vehicles will change the way they make money. Car washing is a profitable ancillary service that could be a part of the solution.
What about valuations? This may not be a popular view, but I think the bubble has burst. I predict that valuations will be down 20 percent or more across the board for the foreseeable future. There are fewer platform acquisitions available and they will continue to attract premium values, but current owners are going to evolve away from the land grab mentality that gripped the industry for the last five years as they find returns building greenfields and buying one-off geographically efficient washes for lower multiples. Great chains with critical mass in great geographies will always sell for wholesome multiples. I may be pilloried for offering what appears to be a dire prediction, but I see it as the beginning of a new pattern and new opportunities. A rational marketplace with a wide range of qualified and interested buyers paired with realistic sellers will lead to an efficient market where all participants can thrive.
George Odden is a partner with Ardent Advisory Group. As an investment banker for more than 30 years, he has worked for multinational banks conducting transactions valued in the billions of dollars, as well as having worked in the middle market helping small companies find the right partners to reach business owners’ goals. George now serves small and middle market clients, primarily helping private owners sell their businesses. He earned a BA from Cornell University and an MBA from Columbia Business School.