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Auto-Dealership IPOs Entering Rough Terrain

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To say that

First Team Automotive

and

Sonic Automotive

have lousy timing would be polite.

Both big automobile-dealership owners are aiming for initial public offerings at a time when nearly every other publicly traded peer sells for less than its IPO price. Disappointing earnings, concerns by auto manufacturers about the growing influence of these companies, worries over investing in cyclical businesses and the simple newness of the concept have combined to depress stock prices.

Given the environment, investors may want to pass, at least for now, on these latest offerings. Just take a look at what investors have seen so far in this sector.

Cross-Continent Auto Retailers

(XC)

went public at $14 a share in September 1996. Today, it's trading at about 8 1/8.

United Auto Group

(UAG) - Get ETRACS CMCI Agriculture Total Return ETN Report

sold its shares at $30 each in October 1996. Now, they're trading at about 21 3/4.

Lithia Motors

(LMTR)

is trading just below its December 1996 IPO price of $11 a share.

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Add to this group the industry's biggest player, Wayne Huizenga's

Republic Industries

(RII:NYSE), which has watched its stock plunge 27% this year.

Why the meltdown?

The most basic problem stems from a few cases of disappointing earnings. United Auto Group said in February that its first-quarter earnings would fall short of analysts' expectations and then didn't even meet the upper end of the new range it provided. Cross-Continent in June disclosed that its second-quarter and full-year earnings would fall short of what analysts expected.

John Hughes, an analyst with Minneapolis-based

Dain Bosworth

, says the earnings disappointments by these companies cascaded through the still relatively small industry. Lithia Motors, for example, beat estimates in the year's first two quarters, but its stock still has suffered. So even in an optimistic scenario for First Team and Sonic, the negative sympathy may be more than they could overcome. Dain Bosworth was involved in Lithia's IPO.

Another problem is that auto makers remain uncomfortable about the clout these new mega-dealers are gathering. "Do they want to lose some degree of control over the distribution network?" asks Walter Fitzgerald, an analyst with New York-based

Brean Murray

, which took part in the United Auto Group IPO.

Honda

and

Toyota

have gone as far as to sue Republic in an effort to stop it from buying some dealerships.

Then there's the cyclical question. For prognosticators who believe an economic slowdown is bound to occur, especially after such a long expansion, now would not be the time to invest in companies so tied to the economy. "The Street certainly has concerns about the cyclical nature of these companies," says Hughes at Dain Bosworth.

There's also the simple fact that the mega-dealer concept remains relatively new. "Wall Street is still trying to get a handle on how these auto dealers should be valued," says Hughes. It's unclear, for instance, whether these companies can actually build national brands.

In Sonic's case, there are other questions as well. Its chief executive, Bruton Smith, promises to spend only 50% of his time on Sonic business. The remainder of his time will include running his other publicly traded company, race-track operator

Speedway Motorsports

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, whose stock price has been flat this year.

First Team's filing is for up to $50 million in stock, while Sonic's is for up to $104 million.

Charlotte, N.C.-based Sonic filed Aug. 8, and Orlando, Fla.-based First Team filed its initial registration statement with the

Securities and Exchange Commission

in June. Offerings usually occur two months after the initial filing but can take longer. First Team did not return a call seeking comment, and Sonic declined to comment, citing the "quiet period" surrounding the deal.

Despite the many reservations, most observers agree that the future will bring more mega-dealers. "This is an idea whose time has come," says Fitzgerald at Brean Murray. "The distribution system is very inefficient."

Indeed, there are far too many dealerships, which makes for slimmer profit margins. In addition, many dealerships need updating badly, which carries a big price tag. "The single dealership owners are getting to an age where they want to go play golf," which leaves it to either the manufacturers or mega-dealers to finance the modernization, says Fitzgerald. And he doubts that the manufacturers want the job.

But even if the time has come for mega-dealers, it appears it's still too early to invest in them.

This story was originally published on Aug. 18, 1997.