Value of franchise agreements to car dealerships

10th Oct '18 by LeoInvestorUK

5 comments 2197 reads

In this article I'm going to discuss the value attributed by Vertu Motors (LON:VTU) and Marshall Motor Holdings (LON:MMH) to their franchise agreements. I'll focus on VTU because they reported today:

https://www.londonstockexchang...

But first, why consider holding these shares?

The bull case clear rests on the strong tangible asset backing, strong operational (and disposal) cashflows, low valuation and opportunity for a snap-back when current issues with diesel supply and exchange rates resolve themselves.

Indeed the snap-back in pricing pressure on cars imported from the Eurozone should already be happening: GBP vs EUR has risen very strongly in the last week, likely after today's outlook comments from VTU was written. Today it is higher than at any point during VTU's H1 reporting period (let alone September) bar 10 days in April.

It is for the above reasons that I hold both Vertu Motors (LON:VTU) and Marshall Motor Holdings (LON:MMH) and modestly added to my holding of Vertu Motors (LON:VTU) this morning.

For the rest of this article I'm going to focus on the negatives and a particular concern many have over the sustainability of their business model. I'm going to drive this from an accounting perspective about the value of their franchise agreements.

As I see it, balance sheets are a minefield. Tangible assets such as property are generally held at book value until sold and therefore can be significantly undervalued. Debtors (and profits) can be manufactured by selling to the uncreditworthy. Goodwill can be manufactured by overpaying for acquisitions. Intangible assets such as goodwill, data and intellectual property never appear on a balance sheet except when converted to goodwill as part of an acquisition. Decisions on whether to capitalise investments are taken before the value / lifetime of those investments can possibly be known and some investments e.g. in advertising cannot be capitalised. Most assets are written down (depreciated or amortised) on an arbitrary basis that bears little or no resemblance to reality (e.g. on a straight line rather than proportional basis and over an arbitrary time period).

For these reasons, where there is any…

Unlock with Email

Unlock with Google

Already have an account?
Login here

JohnEustace

10th Oct '18

Good spot. Am I correct that if they were to amortise all the goodwill over ten years then their profits would be roughly halved?

rhomboid1

Great piece
Franchise agreements do not have ‘terms’ they are effectively perpetually altering sets of franchise standards that need to be achieved across all business areas inc premises,training, demonstration vehicles,courtesy cars , customer satisfaction(most important), sales targets, used car performance after sales etc etc

When Vertu buys a site it will be done with the permission/encouragement of the manufacturers concerned in the belief that they are a good operator & likely to continue so to be. For that reason I agree with treatment of them as a perpetual asset...especially as the price paid for goodwill on acquisition is generally related most to the likely profit to be derived over a modest number of years so is effectively underpriced as an acquisition because the seller had a non performance termination notice hanging over them if they couldn’t agree terms with an acceptable purchaser in the manufacturers eyes.

I listened to the analyst call this morning and Vertu Motors (LON:VTU) is high up my watchlist

LeoInvestorUK

John,

When I discovered this I looked at FY 2018 PBT of £24.7m, so £8.8m would be closer to a third. However looking into the tax situation, I am unclear whether / how much would actually be deductable, especially since they haven't so far. Or perhaps they have already deducted for tax purposes.
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/443526/Restriction_of_CT_relief_for_business_goodwill_amortisation.pdf

On likely FY 2019 post-tax outcome, yes I think we're taking about a half.

However Marshall Motor Holdings (LON:MMH) do the same thing so it doesn't help compare companies. And you could easily argue that it should have affected historic rather than current profits, or that EBITDA (or cashflow) is a better measure anyway.

mojomogoz

Great analysis.

I owned Vertu Motors (LON:VTU) until quite recently and then sold out around 50p. My buy decisions have been a bit wonky recently but my sells have been excellent! :) Anyway, I wrote this at the time:

https://www.stockopedia.com/content/i-just-dont-see-no-vertu-no-more-386024/

This is a stock I have analysed in great detail creating quite a complete financial analysis as I bought 2-3 years ago at a time when I decided to increase the depth of analysis I do and learn the practicalities of stock analysis (after being well versed in the theory and the application of by others of it due to past experience). Anyhoo...

My key concern is that I find it very hard to uncover financial evidence that Vertu add value so I cannot verify their wonderful presentational stuff on how they manage and ensure that they are growing returns for investors. The narrative is lovely and they write and present it beautifully. I'd like to see cash returns above reported earnings by now given how long they have been on go and from earlier acquisitions. Why's it not coming thro?

Additionally, since they started with Bristol Street Motors acquisition (2006/7ish) the actual volume of cars they sell has stayed roughly flat (the last time I analysed properly a year plus ago it was negative). Look at the volume of acquisitions they have completed in that time and the capital raised to facilitate it!

Obviously, the above point could be viewed as positive if they are aggressive in managing the quality of what they do and boost the retail price and margin per unit...and they have quite considerably...however its not as positive as it sounds. Why? Price inflation in motors has been high. The per unit growth in revenue at Vertu is nearly all down to higher prices from cheap second hand to selling more new cars and higher priced second hand. This has a lot to do with available finance deals. Before a Jag/Merc/Beamer was a car you needed to have some decent lolly to buy...now Joe Bloggs can have it if he takes the financing risk.

The rising price and higher churn nationally (more buying and selling in secondary market) as a result of above may continue and be positive for Vertu...but its not being created by Vertu excellence and brand.

What about safety through tangible assets? I wonder whether in distress there would be a large cash negative to pay out as a result of discontinuity in operations and the fire sale that would follow. There's a large stock of cars and that would experience haircut in price? The working capital flows have the potential to bring surprise and they are large relative to earnings/cash flow so could hit residuals.

Finally, recent acquisition of premium brands doesn't strike me as a management confident of their prior capital allocation decisions. It seems they are trying to chase a bit of the market (at high price) that they are very under exposed to. If their prior capital allocation strategy was strong they should be buying franchises of non premium cars that are much less glam at the moment.

Anyway, at today's price the probability is that a buyer will get the chance to sell at a higher price. Doom probably doesn't come and it's slow anyway. I can easily imagine 80p within the next 12-18 months if economic tailwind appears. However, I'm not tempted to play it again.

Best wishes
Paul

11th Oct '18

Apologies as a comment I made above is inaccurate. The dangers of saying things without reference to spreadsheets etc. This statement is incorrect as unit volume has grown:

"Additionally, since they started with Bristol Street Motors acquisition (2006/7ish) the actual volume of cars they sell has stayed roughly flat (the last time I analysed properly a year plus ago it was negative). Look at the volume of acquisitions they have completed in that time and the capital raised to facilitate it!"

Here is the segment from my spreadsheet analysis of Vertu Motors (LON:VTU) that caused me to misremember and make a false statement:

5bbf124591cb4Screen_Shot_2018-10-11_at_1

So unit volume is up slightly over double since acquiring Bristol Motors. However, when adjusted for volume they have acquired each year and also lost (closed down, sold on) the adjusted amount is less than they started with.

Maybe the above doesn't matter. I felt it did and it was the catalyst for making me a bit uneasy about my Vertu holding, particularly as I was struggling to find the improving trend on RoC they talk so eloquently about in reports and presentations.

The fact that they have been very focused on premium brand acquisition when their bread and butter non premium stuff is cheap as chips and unfashionable and Merc etc is hot hot hot makes me think that they have a historic capital allocation problem.

IMO the above hints at a capital allocation problem. They have raised a lot of equity over the years:

5bbf1406b69d7Screen_Shot_2018-10-11_at_1

The total value of equity raised is £145m against the current market cap of £145m! They stated last year that they are moving to debt to finance acquisitions from now on and year end debt was net £8.7m versus -£20.8m FY17.

On the face of it debt to finance acquisitions doesn't look clever based on past performance. Nor does equity, but at least that won't accumulate financial risks in the same way...so on balance they should stick to equity, just in case cash flows have a rough period. It was the decision to acquire again that was the final straw for me (I made a little over 20% plus dividends for holding) as I felt strongly that they should prove they are making sustainable growth in shareholder returns.

Anyway, I do not think Vertu is a basket case. I think management seem very competent in many regards for the space. However, I feel that 10+ years into existence they should be showing much more solid returns. Maybe this is just about to come through now that they have switched of the equity finance tap. But I feel that I can only have meaningful upside for cyclical or valuation reasons as there will be lack of organic earnings growth...which is what I thought made Vertu more than just a cheap punt in the past. There's decent odds that share price hits 60-80p in next year or so if tailwinds go their way but I feel I'd be in a market timing and macro punt with the potential for nasty downside despite NTAV if headwinds are present.

DOYR obvs

Paul

Value of franchise agreements to car dealerships

Unlock the rest of this article with a 14 day trial

About the Author

LeoInvestorUK

5 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...