Finance and Insurance - The Profit Center I would like to make myself clear on a few items of interest before I get too deep into the sales processes at any dealership, including: automobile, recreational vehicles, boats, motorcycle, and even furniture or other big ticket items. A business has to turn a fair profit in order to stay in business. I believe that they should make this profit and use it to pay better quality employees a premium wage in order to serve you better. The financial strengths or weaknesses of any business can definitely have a dramatic effect on your customer service and satisfaction. I do not, in any shape or form, wish to hurt a dealerships profitability, as it is essential for his survival. I merely want to advise people how to negotiate a little better in order to make the profit center more balanced. Let's get right down to this! Every dealership has a finance and insurance department. This department is a huge profit center in any dealership. In some cases, it earns more money than the sale of the automobile itself. Profits are made from many things that most buyers do not understand. You as a consumer should understand the "flow" of the sales process to understand the profit centers that are ahead of you. Most negotiating from the consumer seems to stop after the original price is negotiated and agreed upon. Let's examine just a small portion of what leads up to that point. The first thing that every consumer should understand is that when you go to a dealership several things come into play. One of the most important things that I could point out to you is that you are dealing with a business that has been trained to get the most amount of money from you as they can. They are trained and they practice these tactics everyday, day after day, week after week, month after month, and year after year. Let me point out a couple of important facts that I have said in this paragraph. First, you'll notice that I said a dealership and not a salesman and secondly, I emphasized times of day after day, week after week, etc. etc. This was done to let you know that the salesman is working very closely with the sales managers in order to make as much money as he can. Your interests are really not their objective in most cases. One tactic that is used heavily in the business is that the salesman says he is new to the business. This may be true or not, however; keep in mind that he does not work alone. He is working with store management, who gives him advice on what to say and when to say it. These guys or gals are very well trained on how to overcome every objection that you may have to buying from them. They have been trained in the psychology of the buyer and how to tell what your "hot buttons" are. They listen to things in your conversation that you may say to one another as well as to the salesman. They are trained to tell their desk managers everything that you say and then the desk manager is trained to tell the salesman exactly what and how to answer you. A seasoned salesman does not need as much advice from his desk and may negotiate a little more with you directly without going back and forth. The process of negotiation begins the moment that you walk into the front door or step foot out of your car and begin to look at vehicles. Different stores display inventory in different ways. This is done for crowd control or more commonly known as "up control". Control is the first step in negotiating with a customer. Ever who asks the questions controls the situation. Let me give you an example: A salesman walks up to you and says "Welcome to ABC motors, my name is Joe, and what is yours?" The salesman has just asked the first question- you answer "My name is George." He then asks you what you are looking for today, or; the famous "Can I help You?" As you can see, step after step, question after question, he leads you down a path that he is trained to do. Many times a well trained salesperson will not answer your questions directly. In some cases, they only respond to questions with other questions in order to avert the loss of control. An example of this could be something like you asking the salesman if he has this same car with an automatic rather than a stick shift. Two responses could come back to you. One would be yes or no, the other could very well be something along the lines of: 'don't you know how to drive a stick shift?" In the second response the salesman gained more information from you in order to close you. Closing means to overcome every objection and give your customer no way out other than where do I sign. The art of selling truly is a science of well scripted roll playing and rehearsal. We have established that the negotiating process begins with a series of questions. These questions serve as two main elements of the sales process. First and foremost is to establish rapport and control. The more information that you are willing to share with you salesman in the first few minutes gives him a greater control of the sales process. He has gathered mental notes on our ability to purchase such as whether you have a trade in or not, if you have a down payment, how much can you afford, are you the only decision maker (is there a spouse?), how is your credit, or do you have a payoff on your trade in? These are one of many pieces of information that they collect immediately. Secondly, this information is used to begin a conversation with store management about who the salesman is with, what are they looking for, and what is their ability to purchase. Generally, a sales manager then directs the sales process from his seat in the "tower". A seat that generally overlooks the sales floor or the sales lot. He is kind of like a conductor of an orchestra, seeing all, and hearing all. I cannot describe the entire sales process with you as this varies from dealer to dealer, however; the basic principals of the sale do not vary too much. Most dealerships get started after a demo or test drive. Usually a salesman gets a sheet of paper out that is called a four square. The four square is normally used to find the customer's "hot points". The four corners of the sheet have the following items addressed, not necessarily in this order. Number one is sales price, number two is trade value, number three is down payment, and number four is monthly payments. The idea here is to reduce three out of the four items and focus on YOUR hot button. Every person settles in on something different. The idea for the salesman is to get you to focus and commit to one or two of the hot buttons without even addressing the other two or three items. When you do settle in on one of the items on the four square, the process of closing you becomes much easier. One thing to keep in mind is that all four items are usually negotiable and are usually submitted to you the first time in a manner as to maximize the profit that the dealer earns on the deal. Usually the MSRP is listed unless there is a sales price that is advertised (in may cases the vehicle is advertised, but; you are not aware). The trade value is usually first submitted to you as wholesale value. Most dealers request 25-33% down payment. Most monthly payments are inflated using maximum rate. What this all boils down to is that the price is usually always negotiable, the trade in is definitely negotiable, the down payment may be what you choose, and the monthly payment and interest rates are most certainly negotiable. If you do your homework prior to a dealership visit you can go into the negotiation process better armed. You still need to keep two things in mind through this process. The first item is that you are dealing with a sales TEAM that is usually highly skilled and money motivated. The more you pay the more they earn. The second item to remember is that you may have done your homework and think that you are getting a great deal and the dealer is still making a lot of money. The latter part of this statement goes back to the fact that it is essential for a dealer to make a "fair" profit in order to serve you better. Once your negotiations are somewhat settled, you are then taken to the business or finance department to finalize your paperwork. Keep in mind that this too is another negotiating process. In fact, the finance manager is usually one of the top trained sales associates that definitely knows all the ins and outs of maximizing the dealerships profit. It is in the finance department that many dealers actually earn more than they earned by selling the car, boat, RV, or other large ticket item to you. We will break these profit centers down for you and enlighten you as to how the process usually works. Remember that finance people are more often than not a superior skilled negotiator that is still representing the dealership. It may seem that he or she has your best interests at heart, but; they are still profit centered. The real problem with finance departments are that the average consumer has just put his or her guard down. They have just negotiated hard for what is assumed to be a good deal. They have taken this deal at full faced value and assume that all negotiations are done. The average consumer doesn't even have an understanding of finances or how the finance department functions. The average consumer nearly "lays down" for anything that the finance manager says. The interest rate is one of the largest profit centers in the finance department. For example, the dealership buys the interest rate from the bank the same way that he buys the car from the manufacturer. He may only have to pay 6% to the bank for a $25,000 loan. He can then charge you 8% for that same $25,000. The dealer is paid on the difference. If this is a five year loan that amount could very well be $2,000. So the dealer makes an additional $2,000 profit on the sale when the bank funds the loan. This is called a rate spread or "reserves". In mortgages, this is disclosed at time of closing on the HUD-1 statement as Yield Spread Premium. This may also be disclosed on the Good Faith Estimate or GFE. You can see why it becomes important to understand bank rates and financing. Many finance managers use a menu to sell aftermarket products to you. This process is very similar to the four square process that I discussed in the beginning. There are usually items like gap insurance, extended service contracts, paint and fabric guard, as well as many other after market products available from this dealer. The menu again is usually stacked up to be presented to the consumer in a way that the dealer maximizes his profitability if you take the best plan available. The presentation is usually given in a manner in which the dealer wins no matter what options are chosen. With the additional items being pitched to you at closing, your mind becomes less entrenched on the rates and terms and your focus then turns to the after market products. Each aftermarket item can very well make the dealer up to 300-400% over what he pays for these items. Gap coverage for example may cost the dealer $195.00 and is sold to the consumer for $895.00. The $700.00 is pure profit to the dealer and is very rarely negotiated down during this process. The service contract may only cost a dealer $650.00 and is being sold for $2000.00. The difference in these items are pure profit to the dealer. You see, if you only paid $995.00 for the same contract, the dealer still earns $345.00 profit from you and you still have the same coverage that you would have had if you had paid the $2000.00. The same is true for the gap coverage. You are covered the same if you paid $395.00 or $895.00 if the dealers costs are only $195.00. The only difference is the amount of profit that you paid to the dealer. Another huge profit center is paint and fabric protector. In most cases the costs to apply the product are minimal (around $125.00 on average). In many cases the dealer charges you $1200-$1800 for this paint and fabric guard. As you can see, these products sold in the finance department are huge profit centers and are negotiable. I also have to recommend the value of most all products sold in a finance department. It is in your best interest to get the best coverage possible at the best price possible. Always remember this: The dealer has to make a fair profit to stay in business. It just doesn't have to be all out of your pocket.
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Energold "Bought Deal" Financing After the close on December 2nd, Energold (EGD: Canada) announced that it had entered into a "bought deal" financing with a syndicate of underwriters to raise CAD $15 million. The terms are a unit at $3.70 with a 2 year half warrant at $4.50 that is callable at $5.25. I had no idea that such a financing was imminent and was shocked to hear about it. After having spent a few days thinking it over, I want to talk about what this means for the company. In particular, I want to talk about "bought deal" financings. What is a "bought deal" financing? It is a method of raising capital where the underwriters promise to raise a certain amount of capital for a company on agreed upon terms. If the underwriters are unsuccessful in raising the capital, they are forced to purchase the shares themselves on the agreed upon terms. Naturally, brokers do not enter into these agreements unless they are confident they can find investors for the shares-hence the terms are unnaturally attractive to the purchasers. You may wonder why companies choose to participate in such transactions. To start with, it guarantees a company that the deal will be completed on set terms. Rumors of imminent financings have a dirty habit of leaking out. Although investors are not supposed to trade on inside information, aggressive funds often maliciously push shares lower. Companies are then forced to re-price the deal. "Bought deals" eliminate this risk. However, choosing a competent broker also can significantly reduce this risk. It's not exactly a secret who the bad apples are in the fund community. Bought deals also save companies the headache of doing a marketed road-show. Meeting with a few dozen prospective investors is time consuming and expensive. Management teams often prefer to focus on their business and leave the marketing to brokers. If this means that they give up an extra percentage or two on pricing terms, they see it as worth saving them the hassle. To understand why I HATE "bought deals," let me walk you through the mechanics of how they ACTUALLY work. I realize that this is a bit too much 'inside the game' for some of you, but please stay with me-it's important to understand this. The deal usually starts with something as innocent as a large fund calling a broker asking if he knows of any sizable blocks for sale. The broker then checks around and says that there's nothing for sale, but he thinks the company may be willing to do a financing-it never hurts to ask right? The buyer then commits to buying shares if the company wants to raise capital. This is the critical moment. The broker cannot call up a $140 million market cap company like Energold and ask to raise $4 million. Instead, he offers to raise something meaty, like $15 million. The hook is that there's no effort for the company. No planning, no travel, nothing. They just get a check in the mail. Ask your board if they are interested? Dangerous words indeed. It's the crack cocaine of the Canadian market. No one ever says no. Most boards take the money when it's offered. There's a bit of squabbling over terms, but the broker is the one who can walk away from the transaction. They price the deal where they think it will be easy to raise the money. Think like a buyer for a second. You wanted a million shares of Energold. The stock was at 4.05. From past experience, you figure that you will run the stock up to 4.50 to complete your position. Furthermore, it will take you two months to do it and your average price will be 4.30. Suddenly, your favorite broker calls you to say that you can have your million shares at 3.70 and you also get a half warrant at 4.50. Interested? Of course you are. Heck, the terms are so good; you'll take $5 million worth. The broker signs the deal with the company, but can they sell the other $10 million worth? Brokers aren't stupid. They know which clients have been buying shares lately. They know the fundamentals of the company. They know they can syndicate a bit of it to friends. They don't do a "bought deals" unless they're pretty damn sure they can sell it, but they are never completely sure. After the market closes, the scramble begins. You have until the open the next morning to sell $10 million worth of stock. As soon as the stock opens, you know it will get slammed-you have a $10 million time-bomb on your hands. For a small broker, that's a big risk to take. What do you do? To start with, you call the largest shareholders. It's a very attractive proposition for a guy like me. I can buy 200,000 shares at 3.70, sell 200,000 shares that I already own at say 3.80 and pocket a $20,000 gain immediately. Even better, if the shares go up and the warrants get called, I will make at least 75 cents a share or another $75,000. This is only a small piece of my position, if I thought I could sell more shares at around 3.80, I could take a much larger allocation. This is called flipping. It's the closest thing in the galaxy to free money. Actually, it is free money. Naturally, I got the call just after 4pm. This is the first that I knew of the deal. I get to see a lot of really amazing deals that very few other funds get to see. This is because I have a reputation for not doing what I just talked about. I am not a flipper. Sure, it's attractive to cleave off a free warrant, but if you start doing that, you never get to see the very best deals. Those are reserved only for people who are long term shareholders. I am a long term shareholder. I want to get into the deals that everyone fights for. Even more importantly, I want to get my full allocation of shares. You cannot cross the line. Once you are a flipper, you are always a flipper. I chose not to participate in the deal. Still, the brokers offered me the courtesy of participating. I could add to my position, or flip stock. They know that as a large shareholder, they have to let me participate. Otherwise, I could get angry and aggressively dump stock. As soon as it goes under the deal price, the deal is pretty much dead. No one wants that. After the brokers have been through the large shareholders, they start calling people who they think may be interested. They call people who have traded the stock in the past. They call whoever they can think of. Eventually, they get desperate. There are flipper funds. These guys just flip stock to get the warrants. They do the financing and immediately short out the restricted shares from the deal. The broker even sometimes facilitates the stock loan from other clients to get the deal done. These flipper funds see the free warrant and calculate a value for it. My Bloomberg says that the warrant is worth 44 cents, so I will use that value. Let's say that from experience, the flipper fund figures it can short the stock at 3.60 or better. This means that they will lose at most 10 cents on the common stock, but they lock in the 44 cents of option value. Net-net, their model says they make 12 cents on the trade (10c loss + 22c gain on the half warrant per unit). If their execution skills are good, they may make a good deal more money. In four months when the legend comes off, they use their new free trading shares to repay the short. In the process, they've earned a 2 year warrant. If they play their cards right, they make or lose a few cents per share over hundreds of deals. They have no idea what most of these companies do. It doesn't matter to them. All they know is that they've acquired a diversified basket of warrants. Enough of these warrants will hit for the flipper fund to earn a nice return for investors. Sometimes, even the flipper funds won't touch the deal-it's just too dodgy. Sometimes the broker dangerously overestimates the demand for the deal. In a blind panic, he calls everyone he knows. "Can you do me a favor and take $100k of this crap off my hands? I'll make sure you get a good allocation on the next deal." Some brokers will try anything. On the opening bell, the flippers start selling stock. The flipper funds start getting short. If there's no real demand, it will show right away. Then the broker is stuck with it because no one will step into a deal going bust. After fees, the broker probably won't lose too much money, but his balance sheet is jammed with paper that no one seems to want. The stock will limp for a long time until it has found the level where buyers reappear. This is why I passionately HATE "bought deals." The company gets bad terms and if the deal isn't popular, the shares are capped for months. If it breaks pricing, the shares can take a dive as flipper funds panic to hedge off their longs. Damn near anything can happen in the short term. What will happen on this Energold deal? I have no idea. Initial indications are that the shares have been well placed with a few large funds. The fact that the shares dropped on Friday means that at least someone is flipping stock to take the free money. Can you blame them? Eventually, these shares will find a happy home and the company will again trade on fundamentals. When a company does a "marketed deal," real buyers show up because they want the deal. The flippers don't usually get a piece and the broker doesn't end up eating the deal if it doesn't work. The deal is priced based on an order book of firm bids. It's just a smarter way to do things. Sure, it takes work and it takes time, but it's a collaborative effort where the right people get to participate. "Bought deals" make investors feel like they've just been gamed. So why did Energold do this deal? They needed the money. They have a very aggressive growth plan for 2011. They have the demand and they want to take market share. Per meter pricing is screaming higher and they want more rigs turning. Look at the third quarter balance sheet. There's only $9.3 million in cash. Each rig costs over $600,000 when you include spare parts and working capital. The company could add rigs piecemeal as they earn the money, or they could opt for a capital raise. The advantage of raising capital is that you can order a few dozen rigs simultaneously and have them built during the winter. They are then delivered in the spring and they start cash flowing right away. 2 Year Chart Of Energold From Bigcharts.com Another way to think about it is that the company intends to grow the rig count roughly 30% next year by growing the share count by only 12%. If you think of it that way, it's not the world's worst bargain. Of course the company could use debt, but this is a cyclical industry. You cannot risk the company just to save a few shares. I'm frustrated to see the company raise money at $3.70. I feel that by waiting another quarter or two, they would have gotten a much better price. At the same time, such a raise would have pushed some of the growth back into 2012 as the rigs wouldn't be delivered until the fall of 2011. In the end, saving a dollar on this deal just isn't that much dilution in the scheme of things. At least they didn't raise money when the shares were $2.50 a few months back. What I am really annoyed by is the "bought deal" nature of this financing. I HATE "bought deals." For months, I've been saying that I wanted a chance to buy a pullback in the shares. If this deal is like other "bought deals" I've witnessed, I may get just such a chance. The company is doing great. You can argue the merits of raising money at these terms, but I still like the business. I just passionately HATE "bought deals."




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