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Commentary

Berkshire’s Entrance Won’t Radically Alter Dealership Landscape

Buffett will increase the competition for acquisitions, but there are still plenty of opportunities for the publicly traded dealers in this fragmented market, writes Morningstar’s David Whiston.

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 Berkshire Hathaway (BRK.A) (BRK.B) announced Thursday that it is acquiring privately held auto dealer Van Tuyl Group and intends to buy "a lot more dealerships over time" per Warren Buffett under the brand Berkshire Hathaway Automotive. Based on U.S. new vehicle sales volume, we estimate that Van Tuyl is the fourth-largest dealer in the U.S. yet only had 0.8% of 2013 U.S. new vehicle share. The franchise dealer stocks are all rising dramatically Thursday but we do not expect public dealers to be acquired by Berkshire anytime soon, if ever. We do not plan to change any of our dealers' fair value estimates from this news because we do not want to speculate on acquisitions.

The dealer space is highly fragmented with  AutoNation (AN), the largest dealer in America, having just 1.9% of new vehicle share last year and the six public franchise new vehicle dealers having only 5.4% share per our estimate. The U.S. dealer sector is consolidating at a gradual rate with over 17,600 dealers so we think Berkshire will have many acquisition targets beyond the public dealers to buy. Many of these businesses are family-owned groups and owners either do not have children who want to run the business or the children cannot afford to buy out their parents. Other dealers are just tired of spending a lot of money on large store imaging requirements constantly imposed by automakers and would rather sell their business to a firm with deep pockets that can afford the capital expenditure. Berkshire, as a large firm willing to do roll-ups to widen its dealer business, can be another potential buyer along with the other public franchise dealers. Berkshire's entrance will make acquisitions more competitive for the dealers we cover, but we think the industry's fragmentation is large enough that all players will have enough targets to satisfy their M&A ambition.

We think if a dealer we cover sold to Buffett, it would most likely be owned by a family who wants to sell for cash but retain control of its business, because Buffett likes these types of situations. However, any firm is a target.  Asbury Automotive Group (ABG), for example, was previously owned by a private equity firm and could be willing to be acquired again, but it is not family- owned so it may not be as attractive to Berkshire. CNBC quoted Buffett on Thursday saying "I don’t think we'll be buying (AutoNation)." On the family side this leaves  Penske Automotive Group (PAG)   Sonic Automotive (SAH),and  Lithia Motors (LAD). All of the public firms have their own strategies they are focused on and may not be interested in teaming up with Berkshire or relinquishing ownership. Selling may be up to a family even in the public space and thus very difficult to predict. 

If Berkshire acquired a public dealer, we think Lithia Motors is the most likely choice for Buffett because it is family-owned, has one of the strongest moats in our dealer coverage, and the CEO (the grandson of the founder) is reasonably young at 47. Lithia's rural market focus creates what we call efficient scale in our moat framework and could be of interest to Berkshire. We don't see a reason for the DeBoer family to sell Lithia, however, as we think the company is doing well on its own. 

The Smith family controls Sonic Automotive. Its founder, chairman, and CEO is 87 and several of his sons, including president Scott Smith, 46, are active in the company. Sonic is amid a major stand-alone used vehicle store strategy and the Smith family may have no interest in selling since it has its own vision. Roger Penske, 77, controls Penske Automotive Group but has said in the past that he has no plans to retire. 

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David Whiston does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.