I have written a number of articles concerning the car wash industry over the past few years. In them, I have sought to describe the dynamics behind the veritable wave of money flowing from private equity into the space: why the interest, why the big prices, the benefits and pitfalls of taking on a financial partner. Generally, I have counseled patience, waiting for the variables driving value to line up. Over my 25-year career as an M&A advisor, I have helped sell over a hundred businesses across a wide range of industries and of sizes from a few million dollars to billions. In the last five years my practice has focused in large part on the car wash industry, and I can say with no reservations that the time to sell a car wash has never been better. Going even further, gray clouds on the horizon could point to a decline in valuations or at the very least to a decline in sale proceeds.
It’s a bold statement to make, but let’s take a deeper look. The M&A market is driven by a vast and complex set of factors that boil down to a simple equation. The buyer has to have a reasonable expectation of making a fair return on their investment while the seller must determine that the proceeds they will receive are more attractive than retaining the business. We will take a close look at each of these elements, and a more detailed look at one factor in particular that has stood in the way of many potentially successful transactions.
• Buyers have access to plentiful, almost limitless capital at historically low prices. This capital comes from traditional commercial banks, private equity funds, sale lease-backs, or non-traditional banking sources such as mezzanine funds. Quite simply, the cheaper the money borrowed to transact, the more money that is left for the buyer and the greater their return (or the more they can pay to win the deal and the greater the proceeds for the seller).
• Technological and operational shifts in the car wash industry have led buyers to be more confident in the future performance of a site. Express exterior washes limit the number of employees required. POS systems allow for remote monitoring of operations and results. Monthly pass programs have smoothed revenue and muted the impact of inclement weather.
• COVID-19 did not kill the car wash industry. In fact, most operators I work with had record years in 2020. Buyers flock to the elusive business model that performs well in an economic downturn, and car wash has proved itself to be remarkably resilient. I certainly don’t mean to make light of the significant suffering and difficulties being endured through the pandemic, but it is clear that the car wash segment has weathered the storm better than most.
• The car wash industry continues to be fragmented. There definitely has been consolidation, but the largest player in the United States still only boasts about 1 percent of the market. There is plenty of room for growth both through acquisition and development. An initial investment is the foot in the door, but that is just the tip of the iceberg in terms of capital that can be fruitfully invested to grow a car wash business rapidly and profitably.
• There is a scarcity of good opportunities across many industries in the face of a tremendous amount of available capital. As private equity funds sit on about one trillion dollars of uninvested capital, quality targets are increasingly difficult to find. Car washes with exceptional cash flow and a strong real estate element fit the bill.
• Car washes and car wash businesses continue to grow. Ambitious owners continue to develop new sites. Given their inherent understanding of the business and the geography in which they operate, owners are well served growing through development. To oversimplify, you can build a car wash at 5X EBITDA which can ultimately be sold for 10X. This is a tremendous growth engine for a car wash chain, but getting full value before sites mature also represents one of the biggest challenges in getting a transaction for the entire chain across the finish line. This obstacle is discussed in more detail below.
• Sale leasebacks have caught on with not just the biggest players. Smaller operators are accessing capital for growth through selling the real estate of their business while retaining the business and the after-rent cash flow. This frees up capital to continue expanding, building a virtuous cycle.
• Buyers are getting more flexible in terms of making minority investments. This could be a path for sellers to retain control while taking some chips off the table or funding accelerated growth (and getting the proverbial second bite at the apple in a meaningful way).
GRAY CLOUDS ON THE HORIZON
• Interest rates have started to inch up despite government intervention designed to keep interest rates low. As the economy heats up (some are suggesting 2021 GDP growth as high as 6 percent), interest rates will most likely follow and continue to rise to more normalized levels.
• Competition for the best sites is getting more intense. It is true that car wash is a fragmented industry, but in certain desirable geographies, development by existing players and the introduction of well-financed new players has disrupted markets. Done rationally, development in a crowded space can actually make the pie bigger. Unfortunately, that construct only works to a certain point, after which all the players suffer.
• Political winds are changing. I’m not going to wade into the waters of what is right and what is wrong (though I know the answer), but if the current administration acts on its policy recommendations, we could see two dramatic changes that directly impact the car wash M&A market.
The capital gains tax rate (20 percent) could soon be eliminated for certain wealthy taxpayers. It could be replaced with the ordinary tax rate which the Biden administration would like to have at 39.6 percent for the same taxpayers (or even higher). Doubling the tax rate would clearly have a dramatic impact on after-tax proceeds enjoyed by a seller. It is impossible to say if this will come to pass or when, or if it could potentially be retroactive. But it is far more likely to happen now than under the prior administration.
Carried interest (the primary means by which PE managers get paid) of PE groups could soon be taxed at ordinary income rates instead of capital gains rates as it currently is. This means that the profit that accrues to the PE managers would be significantly diminished, which in turn means that to make the same amount of money, returns would have to be higher, potentially putting downward pressure on purchase multiples.
A CHALLENGING OBSTACLE TO A FAIR TRANSACTION
Car wash operators continue to grow their businesses by developing new sites. This is often an extremely efficient way of increasing profits. On the other hand, building a car wash requires a significant amount of capital and expertise and might not bear fruit for a long period of time, potentially years from when you start developing the site depending on where you are in the country. This means that an operator looking to sell will struggle to capture the future value of a developing site in a current sale and risks not being appropriately compensated for their effort and knowledge.
• This difficulty has dogged many transactions and has also caused potential sellers to hold onto businesses until new sites mature. Of course, this becomes a moving target. As a business succeeds and development accelerates, even more sites are not yet mature. I have been fortunate to work with a number of exceptional clients such as Tidal Wave and Cobblestone where we have developed real-world solutions to these issues.
• The options run from buyers paying full price for a site under development based upon its expected return, on one extreme, to sellers accepting nothing more than reimbursement for out-of-pocket expenses accrued to the date of close on the other extreme. Neither is likely and a number of potential compromises have evolved.
New sites can be retained by the seller of a chain’s mature sites and later sold to the buyer at a pre-determined price and/or time.
New sites can be purchased along with mature sites at a price reflecting build costs and then an earn-out added at a later time to reflect the performance of the new sites over time.
New sites can be acquired for cost along with mature sites but then augmented by a cash bonus upon opening.
Buyer and seller can simply compromise on a number between what was invested and what the seller believes the ultimate value to be.
I want to be clear here. This is an ideal time to sell a car wash or a car wash chain. The market is strong and faces challenges going forward. If you are an owner who has been waiting for the right opportunity to exit, now is tremendous. Many of the obstacles experienced in the past to reaching a fair deal have been removed. This isn’t to say that the laws of nature are turned on their head. Less optimal operations will still attract fewer buyers at discounted prices. But for solid operators who have thought about selling now or in the next few years, it is definitely worth the time to investigate an exit now.
George Odden is a partner with Ardent Advisory Group, a leading investment bank specializing in the sale of multi-site car wash chains. You can contact George atGeorge@ArdentAdvisoryGroup.comor call 310-848-4240.