Lithia's L2 and Transformers: More Than Meets the Eye

Aug.28.07 | About: Lithia Motors, (LAD)

50 years from now, when you look back at your life, don't you want to say you had the guts to get in the car?
Source: The movie Transformers, Shia LaBeouf (playing character Sam Witwicky)

L2 and Transformers: more than meets the eye

Over the weekend I went to see the movie Transformers.  I know.  I am way behind the times.

"Transformers is so July, Jerry."  You must be thinking to yourself.

I don't get out much.      

But after having seen the movie, I have to say, it was pretty awesome.  And I am not saying this just because I used to play with Transformers (in between stock trades) when I was a kid. 

The cinematography was sick (really good).    

And the dollars generated by the movie speak for themselves.  Through the summer movie season, Andy Fixmer of Bloomberg News reported yesterday that Transformers ranked #3 at the box office, taking in a total of $308.6 million. 

And keep in mind Transformer's didn't come out until July 4th. While the #1 movie (Spider Man 3), which has raked in $336.5 million this summer, came out May 4, 2007.         

The movie Transformers has been well documented in the automotive press (because it was basically a walking commercial for General Motors).  And while I would love to go into my thoughts about effective advertising (something I do not think is being achieved in the auto industry right now), I really want to focus your attention on today's opening quote. 

For those of you that saw the movie, you might remember the scene.  One of the lead characters, Sam Witwicky (played by Shia LaBeouf) and his "girlfriend," Mikaela Banes (played by Megan Fox), were being chased by an evil robot police car.  And to their rescue came another robot car (a yellow Chevy Camaro he bought from a used car lot not realizing it was really a "transformer.") 

But Sam and Mikaela did not know what to make of everything that was happening (only that the cars were coming to life).  So as Sam's yellow Camaro (eventually known as Bumblebee) pulled up and the door swung open, Sam and Mikaela were faced with the choice of venturing into the unknown (jumping into the car), or taking their chances running from the evil "police car" on their own. 

This is when Sam turns to Mikaela (realizing something significant was happening) and said: 

50 years from now, when you look back at your life, don't you want to say you had the guts to get in the car?

L2 Grand Opening
Last week I got a call from Lithia's Chief Financial Officer (Jeff DeBoer) to introduce me to the company's new Director of Investor Relations, Dan Werthaiser-Kent.  And while we were talking, Jeff encouraged me to come out to the grand opening of Lithia's new L2 Auto concept in Colorado Wednesday. 

As you know I have been strongly opposed to Lithia's pursuit of L2. 

But good management teams always focus on educating analysts when they don't see eye to eye.

You can learn more about L2 Auto by going to the following link:

In my opinion, L2 is essentially a CarMax "knock off" Lithia's management appears set on pursuing. 

 It took CarMax nearly a decade to get the model down (it takes a long time when you are competing against a "loss leader" at franchised car dealers like late model used vehicles.")  And it was done with a finance arm right from the get go (something Lithia is not including in the initial model).

I watched Asbury lose millions on a far less risky venture when they tried to go with a one price no haggle used vehicle sales concept with just a few mobile homes in Wal-Mart parking lots.  So while investors tried initially to tell me that it could serve to "boost" Lithia's multiple, I tried to caution investors that this could lead to serious trouble down the road.   And sure enough it has.

Importantly, whether it is the right thing to do or not, it certainly puts a dagger into long time supporters of Lithia like myself.  As I have said for a long time, I always felt folks like Lithia and CarMax were trying to get to the same place (a superior store model). 

CarMax took a short cut to the superior store model by going the used vehicle route.  But they gave up a lot of the benefits that come with the franchise system (most notably the annuity business that comes with the parts and service bays). 

Lithia, on the other hand, I always thought was trying to work backwards.  Putting better systems and processes into the store while retaining the benefits of the franchise system.  And when you listen to management, sure sounds like they are doing just that.  I love hearing Bryan DeBoer (Lithia's Chief Operating Officer) talk about the company's vision and plans for things like a paperless sales process (down the road). 

Unfortunately, I have found it exceedingly difficult to put numbers to prove that management is actually creating the superior store model they articulate. 

Some of you may remember my rankings piece on July 10, 2007.  In the piece, I showed a number of key metrics (over a 6 year time frame) about all of the companies in the index.     

Here is a quick summary of how Lithia stacked up to the peer group of franchised auto retailers:

2006/2000 (% change) Lithia Peer Group of Franchised Dealers
Revenue per employee +4.7% +16.8%
Revenue per store +3.9% +30.0%
Gross per employee +10.7% +20.0%
Gross per store +9.8% +33.3%
Operating income per employee -3.7% +22.8%
Operating income per store -4.5% +39.2%
Click to enlarge

Source: company reports, efficient insights llc

Notice, Lithia's percent improvement (and at times declines) seriously lag its peers on every metric. 

This is what I want management to focus on.  Improving store and employee productivity. 

Not L2!

And why I proposed my own "L3" turnaround plan. 

And every time I hear management talk about how they can do so much more with an independent used store (without all the constraints put on them by the manufacturers) it just rubs more salt in the wound. 

Once again, then why have they been trying to pursue all these process improvements in the franchise model for the last decade (that I thought would make them far more competitive to a CarMax as they would have the processes with the added advantage of the franchise model).  They should have been building used car stores, or at the very least building cash while they developed the L2 plan, not buying Chrysler dealerships. 

Even worse, what do I get by investing in a company 10+ years behind CarMax in the development and roll out of a one price used store model?  Why don't I just buy CarMax's stock? 

This is why L2 is so painful to watch.  Because I just don't understand it.   

Having said that, there are very few people I respect more in the industry than Lithia's CEO Sid DeBoer.  And like I said, the process improvements Bryan DeBoer is trying to bring to the company sound amazing. 

And I have been in this situation before.  I remember Penske Automotive Group's CEO Roger Penske (back in March of 2003) trying to explain why their company should be a Strong Buy (at around $12 a share pre-split). But I kept an "Outperform" because I just didn't understand the company's expansion into Europe.  "No one knows how these block exemptions will impact dealers in the coming years" I boldly pronounced. 

Roger Penske did.  And the Sytner Group (Penske's United Kingdom arm) has cleaned up market share in the U.K.    

Or Ken Gilman (Asbury's CEO), spending years trying to explain to me that the company's focus on buying attractive luxury and mid-line import brands was going to reap big rewards down the road.  I only saw Asbury's struggling operating metrics (versus its peers), technical debt default, and failed one price used vehicle Wal-Mart experiment.  It was a great example of where I respected the heck out of the CEO (always straightforward and really respected analyst independence), but I just did not understand what was going on at the company.           

So at this point, I kind of feel like Sam Witwicky (transformers).  There is something really strange happening around me (L2) as the cars are coming to life.  And Lithia's management has pulled up and said: "jump in the car" (well at least invited me out to tour the new L2). 

So as you read this email, I will be boarding a plane heading to Loveland Colorado for the grand opening of L2 tomorrow. 

I don't want to look back 50 years from now and say I didn't have the guts to get in the car. 

I just hope I am choosing the right car.