The Market Mid-COVID - Buying or Selling a Car Wash
By George Odden
The act of selling a car wash or a chain of car washes is complicated and emotional. And that’s in the best of times. Layer on top of that a global pandemic that has thrown uncertainty into almost every element of our business lives and the bar for success has gotten a lot higher. That doesn’t mean transactions won’t close. As I have written in the past and still believe, the best assets get sold regardless of circumstances. Also, there will be a group of businesses that for whatever reason struggle to the point they must sell even though the timing or pricing may not be ideal. But, for the majority in the middle, things have gotten tricky.
The challenges are on both sides of the table. For operators, numbers will almost certainly be down for March, April, and May, in some cases dramatically. Most
I have spoken to have seen improving results and a trend toward normalcy, which is a welcome relief. PPP loans, for those fortunate enough to qualify and get their paperwork in early, have provided cash through the most difficult times. In some instances, commercial banks have gone to interest-only payments to further ease cash challenges. Overall, owners are still scrambling and licking their wounds, but the light at the end of the tunnel doesn’t appear to be a train.
Mergers and acquisitions are at their core an exercise in the allocation of risk.
I highlight that sentence because it is at the center of understanding how COVID-19 will impact M&A and how we will fight through it. The buyer universe has changed over the last few years to include many more private equity funds. The good news is that they are rational, unemotional beasts seeking a return for their investors, and if the numbers work, they can transact. They traffic in risk. They understand some of the risks and bake them into the transaction documents or purchase price. They also understand that there are risks they haven’t identified and do their best to minimize the potential impact of that pool. I don’t mean to be disparaging; some of my best friends are PE professionals. It’s just that we understand how they make money and succeed so we can understand how they will be likely to behave. They have years of experience buying companies, as well as bruises from deals that didn’t go well, and their business judgment ultimately plays a significant role in pulling the trigger or letting the opportunity go.
So let’s take a look at some of the risks this buyer pool is trying to understand right now:
The world appears to be getting back to some sort of normal and car volumes seem to be improving. Clearly, trailing 12-month numbers will be off of last year. Also, new washes will be slower to get traction. How much slower? Will the volumes ever completely recover? What happened to monthly memberships? Will they come back?
Ongoing COVID-19 Risk
What if the pundits are right and there is a second wave of the virus, equal to or more severe than the first? In my home state of Arizona, cases are jumping at their highest rates each day. Now, I’m not getting into politics here, and I’m not predicting anything. Plenty of equally unqualified people seem to be doing that for me, but the threat of a COVID-19 rebound, perceived or real, impacts buyers’ appetites to assume risk.
The financing markets are nuts right now. The cost of money (the interest rate) went up dramatically when the lockdowns started. The good news is that they seem to be trending in the right direction, though not all the way back to where they were before. Big names such as Boeing have been very successful in tapping the public debt markets. If only that meant something to us. We in the car wash world reside (for M&A purposes) in the leveraged loan market. That market has also seen an improvement in pricing, but the volume of new issues is still extremely low by historical standards, and S&P recently came out predicting more defaults than at any time in history. More risk means more cost to the borrower and lower leverage. That lower leverage is often made up through more equity from the PE fund, which adversely impacts their returns and, consequently, the purchase price they are willing to pay.
Thus far, the government has intervened financially to try and calm the markets, provide liquidity, and assert a commitment to continue to intervene in the face of a continuing crisis. This intervention has been extremely helpful to business owners and employees, and the stock market as well. A sense that there is a steady hand at the wheel of the Fed has buoyed both debt and equity markets. What if they don’t continue on this path? Or what if they do, but in a way that for some reason is less advantageous to the car wash market? If there is a new president after the election, will he have the same priorities? I would hate to pull on that thread for fear of the whole sweater unraveling.
Now that I have you thoroughly discouraged, take heart. There is plenty of good news too as PE players are highly incentivized to deploy capital, and they have other tricks up their sleeves to do so effectively. Speaking in broad generalities, the typical PE firm makes most of their income from their “carry.” The carry is an equity return that rewards the PE managers with a percentage of the upside once the investors have reached a threshold return. It’s a very strong incentive to do lucrative deals, as they will get little if the transaction performs poorly, but it is an incentive to deploy capital, as they will definitely receive nothing if the money is not spent. There is a ton of money sitting on the sideline right now ready to be deployed and precious few strong opportunities. So, what mitigates some of the risks the PE buyers see?
Recent Operational Improvement
Make no mistake, the improvement in operating results gives deal-hungry PE firms quite a bit of comfort. It’s not perfect, but it’s a great start.
Loosening Financing Markets
PE players are experts in raising debt. They likely have deep relationships with lenders and can access pools of money that would not be available to you. Even in tough times they can make something happen, although in this market the terms are not likely to be as advantageous as in the recent past.
Using more equity to acquire a business definitely hurts returns, but a little short term pain may be worth getting a prime asset, particularly if it is likely that equity can be repaid with debt in the near term.
Creative Deal Structures
A market with uncertainty demands creativity when executing a transaction. Examples of creative solutions may be earn-outs where the seller stands to receive additional purchase consideration at some point in the future if the business improves. Another creative path may be a buyer only acquiring a minority stake today with the ability to acquire more later, after agreed-upon projections have been met. It’s possible, depending on the firm, that they could start a transaction by providing a loan to the company rather than buying equity. It would allow them to deploy capital while getting their foot in the door and proving they are constructive partners.
I have focused quite a bit on a conventional PE buyer as they are in the space and anxious to grow. They are also sophisticated buyers who can offer skills that can benefit a business moving forward. They are not, however, the only buyers out there. This market dislocation may be an opportunity for one operator to buy another, or for someone who understands the real estate market well to enter a new space. Wealthy families are much more flexible in how they invest and could be spectacular long-term partners as they generally have a greater ability to hold an investment for longer. It’s critical in difficult times not to be myopic, but to be open to a broad range of possibilities.
Bottom line, we are in a period where it is understandably difficult for players to accurately assess and allocate risk. Buyers reduce risk by lowering price, lowering leverage, insisting on strong legal terms, and asking sellers to hold more equity. Sellers reduce risk in much the opposite way, though you could argue that lower leverage benefits both camps. There are structural tools that I have outlined above which can help bridge the gap, or one side may simply take the plunge and assume a disproportionate share, possibly for a very good reason.
The last solution is simply time. Time to let the financing markets stabilize. Time to let the virus run its course. Time to let business get back to normal. The things that make the car wash industry a great investment will more than likely still be there. Some people can’t wait, or don’t want to wait for whatever reason, and there is a deal out there for them.
But if you can wait, that may make a lot of sense.
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 at George@ArdentAdvisoryGroup.com or call 310-848-4240.