For the past four years I have been writing and speaking about the wave of M&A activity flooding the car wash industry. During that time, we have seen a dizzying number of new entrants try their hand at acquiring and operating car washes. The reasons for this phenomenon are well documented but primarily revolve around the superior cash flow characteristics of the exterior express car wash as well as the availability and relatively low cost of capital. Add that to the industry norm of owning the property where the wash is situated, and it is no great surprise that smart money is lining up to enter the space.
ENTER INSTITUTIONAL CAPITAL
In the past, most transactions transferred one or two washes from one owner/operator to another.
The introduction of institutional capital dramatically shifted that dynamic as private equity (PE) firms entered the market with their virtually bottomless pit of cash. It’s important to remember that a PE shop doesn’t make money unless they deploy the capital they manage. Of course, the largest examples in the space are Leonard Green’s acquisition of hundreds of sites under the Mister Car Wash label and the acquisition of International Car Wash Group (ICWG) by Roark Capital. But outside of those dramatic transactions, there have been dozens of other PE players entering or trying to enter the space.
About three years ago we entered a period where PE shops were simply trying to accumulate assets. This move to stake out a claim in the space led to high Valuations have flattened out or even started to decline.valuations and frankly little differentiation between high- and low-quality assets or among chains and individual sites. When the real property under an operating site can be sold for close to half or more of the purchase price, there seemed to be little reason to exercise discipline. As there were so few chains of significant size, when one came to market, buyers were stretching to make it happen so that they could have a platform from which to build an empire. Would-be acquirers were convincing themselves that the addition of an aggressive monthly membership program or simply a new coat of paint could unlock a deep well of hidden value. They then bid based upon those rosy assumptions, pushing valuations up. Some of them got it right and have put together thriving businesses while others overshot the mark and are struggling under a barely manageable debt load.
Clearly, I am speaking in generalizations, as there have always been shrewd investors who didn’t get caught up in the hype. Those investors either didn’t enter the space because they discerned that prices were too high or they attacked the market by accumulating several individual sites or small chains. This path often yields more reasonable prices as the smaller transactions may be done off-market or through a very limited sale process. It is also a ton of work. Ironically, small transactions are at least as hard to close as large ones, so the amount of effort required to get a series of transactions done can be daunting as well as time consuming and expensive. Since many PE funds have limited ownership horizons before they look to exit an investment, this approach can be difficult.
On the other side of the transactions are the car wash owners. Their expectations were driven to new heights by the headline multiples that they imagined or even heard were being paid. Naturally, they believed their washes were worth the same or more. These expectations caused many quality chains that could have sold for high prices to go unsold. Certainly, that’s not the end of the world as those owners still operate successful businesses and generate cash flow. I do believe they have missed the peak of the market, though, as from what I have seen, valuations have flattened out or even started to decline.
So that sets the stage for where we are today. Sophisticated buyers are still keenly interested in acquiring car washes. The dynamics have changed, however, as we have moved from a game of checkers to a game of chess. The land grab of 2018 has given way to a more nuanced and complicated range of options as the reality of the car wash industry sinks in, which is that meaningful growth most often comes from acquisition or development, not same-store growth. Also, the cost of bringing a mismanaged site up to a modern standard is high both in terms of cost and down time. Owners who expect to be paid on the potential of a site rather than the reality are finding these arguments are less persuasive with buyers than they once were.
The introduction of PE buyers to the industry has also dramatically reshaped the financing available to the market. Car washes were most often funded through a combination of equity (usually about 20 percent to 25 percent) and mortgage debt (the other 75 percent to 80 percent). This debt almost always required the sale-leasebacks are becoming a tool for normal operators.personal guaranty of the owner. Large chains were built this way, with each site being a separate legal entity. The good news for this type of structure is that it tends to be inexpensive to the borrower. The bad news is that they are on the hook personally if something goes sideways; they are often saddled with significant principal payments that limit flexibility, and they must start over every time they buy or develop a new site. PE buyers will more often take out a cash flow loan that is secured by the sites, but not personally guaranteed. This is more costly in terms of interest rate, but dramatically more flexible in its financial terms. This allows for more rapid expansion, often without the use of any additional equity.
Very few commercial banks were interested in providing cash flow financing to car wash chains. That mindset is changing and there are several large institutions willing to underwrite substantial loans. There are also smaller, niche lenders who have financed PE transactions for decades that are willing to play now. The introduction of institutional money to the car wash industry has dramatically increased financing options. Most owners, however, will struggle to avail themselves of this capital as they don’t know the players, or even how the game is played, or have a history with these financing sources.
The first wave of transactions has happened, with large prices paid and savvy owners happy as they ride off into the sunset. Those who were not part of this wave because they didn’t want to sell then or didn’t get the price they wanted are proving to be tougher nuts to crack. It’s not just a question of cashing a check and moving on. Most PE funds require control as a cornerstone to a transaction. That means they must buy more than 50 percent of the equity of the company(ies) they are acquiring. Even this practice is evolving, as the possibility of bringing in an equity partner for a minority stake is becoming more common. For a PE fund anxious to enter the space with precious few opportunities, thinking creatively has become key, and the possibility of buying a minority share in a thriving chain has become attractive. For the seller, bringing in a minority equity partner allows them to take some chips off the table, spread their risk, and diversify their holdings all the while retaining control. It’s not as simple as it sounds, as there are a multitude of subtleties to deal with in a minority transaction, but it is an interesting tool.
Finally, sale-leasebacks are becoming a tool for normal operators, not just the behemoth chains. It is possible in this market to pay off the debt on a site simply by selling the property and entering into a long-term lease with the buyer. What remains is the non-rent cash flow as long as the lease is in place. Many PE shops utilize this financing tool as part of their transactions as it allows them to pay a higher price. There is no reason an owner can’t look for the same financing.
In summary, the car wash M&A world has become more complex. There are more options, more players, and more cash chasing deals than ever before. Sellers who can navigate the range of possibilities will often be able to find a solution tailored to their needs. Buyers may indeed be more disciplined, and prices may indeed be flat or even slightly declining, but the right deal is likely still out there; it just takes a little more sophistication and finesse to find it. Great car washes are still worth a ton of money, but there are more and increasingly complex ways of extracting that value.
George Odden and Jordan Geotas are partners with Ardent Advisory Group, a leading investment bank specializing in the sale of multi-site car wash chains. You can contact George at George@ArdentAdvisoryGroup.com (phone: 310-848-4240) or Jordan at Jordan@ArdentAdvisoryGroup.com (phone: 602-708-3232) or visit the firm on the web at www.ArdentAdvisoryGroup.com.