Whenever we analyze and research companies, we always think it is important to give credit where credit is due. That's why we'd like to start off this note by congratulating TrueCar (NASDAQ:TRUE) for publishing 22 press releases since the beginning of 2015 (as of 3/1/15). This is no easy feat - there have been fewer than 40 trading days so far this year, meaning that TrueCar has managed to provide investors with a press release every 2 trading days… what an incredible accomplishment!
Without these press releases, how else would investors know that "Owen Wilson's voice [is] to be featured in TrueCar commercials," and that "TrueCar TV ads featuring Owen Wilson as the 'voice' of the brand [are] now live." It must have been a slow news month over at TrueCar if they had to press release on Owen Wilson's voice twice. Perhaps soon the company will provide us with timely updates on what CEO Scott Painter ate for lunch (we hope Chipotle, Yum!).
Sometimes we can't help but wonder if TRUE management thinks that TRUE's stock value is based on a multiple of "press releases" rather than on a multiple of earnings. With the stock sporting a $1.4B valuation despite generating $48M of GAAP net losses in 2014, it certainly seems as if TRUE's valuation is grounded in nothing but hot air! Famed short seller Jim Chanos was once quoted as saying "the biggest mistake people make is being co-opted by management." So while we mention these press releases in jest, we are always wary of companies that bombard investors with irrelevant information.
With almost a year of public company results under its belt, we thought it was a good time to dissect, and analyze TrueCar's business model, financial results, and current business momentum in detail.
Egregious valuation and aggressive addbacks
TrueCar currently sports an enterprise value of ~$1.4B, which puts the company at the heroic valuation of ~7x 2014 revenue. The company generated 48M of GAAP net losses in 2014, and managed to turn a whole $10M of "adjusted EBITDA." Examples of some add backs that turned almost 50M of losses into 10M of "EBITDA" include a whopping $29M of stock based compensation and $10M of "warrant expense."
TRUE's add back of warrant expense it pays to USAA struck us as being very aggressive. In the absence of this add back, TRUE would not have even generated any "adjusted" EBITDA in 2014. While we do not necessarily agree with the practice of adding back employee stock-based compensation to earnings, we acknowledge that it has become standard practice at most public firms today. However, last we checked, USAA is not an employee of TrueCar. In fact, USAA is a "supplier" of TrueCar, sending leads TrueCar's way, and in exchange receiving payment from TrueCar for generating those leads. So we find TRUE's practice of adding back USAA warrant expense to be particularly aggressive from an accounting perspective.
A simple analogy would be a lemonade maker saying - "sorry, even though I'm in the business of buying lemons to make lemonade, I'm going to have to add back the cost of lemons I buy… because… why not?" Perhaps this is why the CFO of TrueCar was recently featured in a WSJ article about "tailored accounting at new IPOs" (by the way - how press hungry do you have to be to voluntarily give a sound bite in an article with the headline "Tailored Accounting at IPOs Raises Flags"?). We are somehow not surprised the company did not issue a press release on that article.
Signs of momentum slowing in two simple charts:
While the sell side is quick to point to TRUE's revenue growth as a sign of health in its business model, we see two glaring red flags that any growth investor should be laser focused on.
First, despite a massive blitz of national TV advertising over the past year, unique visits to TRUE's website dipped sequentially in 4Q for the first time since 2Q12. This was also despite a very robust and healthy auto market in 4Q14 (auto sales were up mid-teens in 4Q14 y/y). This was a meaningful change from trend and cannot be explained away by a weak market for autos. And the seasonality argument does not work either - 4Q13 saw higher UVs than 3Q13 and TV ads had not even been blown out yet. We hope that the company is not relying on the "voice" of Owen Wilson to fix this alarming trend.
TRUE Unique Visits
Source: TrueCar Investor Relations Deck
While management quickly dismissed this dip, claiming that the company focuses on the quality of its website traffic and its conversion rates rather than on the number of visits to its website, again we remind readers to avoid being co-opted by management. At this life stage of the company and in a healthy and robust auto market, one would expect unique visit growth to be humming along very nicely given all the investment TrueCar is making into sales & marketing (the company spent $129M on S&M in 2014). If TrueCar was really disrupting the way people buy autos and becoming a "way of life" for car buyers as we are expected to believe, the unique visitation momentum would certainly not be turning negatively sequentially after only 3 quarters as a public company and in the middle of an incredibly robust auto sales cycle.
US Auto Sales SA - Solid Performance in 4Q:
We also point users to the case study of Pandora as to what happens when unique visit growth stagnates or inflects. Pandora's stock price has been hammered since its engagement metrics began to show signs of slowing over the course of 2014. See below:
Second, we point readers to a key metric that has gone overlooked by sell side analysts covering this stock. This metric is the unit growth (monetized leads) per franchise dealer. Why is this metric relevant? Because ultimately, TrueCar gets paid by dealers. Despite management throwing out hundreds of different TAM metrics that end with "Billion" or "Trillion" and creating confusion around how TRUE actually makes money, let's keep things simple and remember that the vast majority of TRUE revenues today come from dealers.
So in order to grow revenues, TRUE needs to either add new dealers, or generate greater volumes from its existing dealer network. Here, the TRUE growth trajectory tells a story of a business that is rapidly losing momentum and running out of steam:
Source: Our analysis/estimates (using average of prior quarter/current quarter franchise dealer count and unit count all derived from TRUE public filings)
TRUE has added roughly the same amount of franchise dealers each year (its franchise dealer growth has been running in the mid to high-20%s growth range for several quarters). So the trend in units per franchise dealer above cannot be explained away by claiming that it takes time for new dealers to ramp volumes. Instead, the chart above can be explained by two factors. Either the new franchise dealers TRUE is adding are far less productive than its historical franchise dealer network suggesting it has already penetrated its best dealers and incremental returns will suffer (i.e. it is expanding into lower traffic dealers/lower quality dealers), or it is simply seeing a deceleration in terms of customer usage of TrueCar certificates. Both points are strongly negative for TRUE as they point to deterioration in the growth trajectory of the company.
Keep in mind that the top-line algorithm for TRUE growth is simply: growth in franchise dealers plus growth in units per average franchise dealer plus growth in monetization. TrueCar has been able to add dealers at a robust clip for the past several quarters, which meaningfully supported top-line growth.
And this "dealer growth trap" is what we believe will cause the great experiment that is TrueCar to ultimately fail.
The "Dealer Growth Trap" in a Chart (Illustrative):
There is simply a functional limitation to how many dealers TrueCar can add to the TrueCar network without making itself irrelevant within its network! Each incremental dealer that comes onto the network reduces the value of the TrueCar network for the existing dealers on the network. In a hypothetical world in which every dealer joined TrueCar and competed by dropping prices, the advantage of being part of the TrueCar network would diminish to zero and no dealer would ever be willing to pay $300 for TrueCar's leads. The added fee for a lead would have no value in a world of perfect competition. In this world, every dealer offers the same price, so consumers would be indifferent between dealers and would simply go to their nearest dealer. In this hypothetical world, dealers would obviously also hate TrueCar as TrueCar would effectively force industry profits to zero.
Clearly, this state of the world cannot happen - the last time TrueCar threatened the profitability of dealers, the company almost died. This speaks to how fragile this business model is - a company that was left for dead back in 2012 is now sporting a cool $1.4B valuation despite still being economically unproven. So TrueCar has to be very careful at this juncture in managing its growth as it needs to continue to be relevant within its existing dealer network.
With its units per dealer rapidly decelerating as we outline above (and actually inflecting negatively in 4Q), the other levers TRUE can use to juice growth include boosting monetization (and as we discuss below, this is very unlikely given TRUE is already a bad deal for dealers in our opinion), or adding more dealers (the economic logic of this is unsound as discussed above). The laws of economics are going to cause an abrupt halt to TrueCar's revenue growth rates, which in turn will cause investors to massively reevaluate the company's current valuation.
Today, TrueCar currently has ~8,500 franchise dealers, representing almost 30% of total franchise dealers in the United States. We believe that TRUE management has generally talked about getting to ~10,000 franchise dealers over the course of time, so we think they are already coming up on their ceiling in terms of new dealer growth. Their commentary on the 4Q14 earnings call said as much, with the CFO subtly acknowledging the laws of economics by saying that "obviously as the network grows, the overall growth rate in the network slows."
Management is trying to make the claim that all is well and healthy in terms of organic growth trends within the existing dealer network, however the chart we laid out above shows that units per average dealer has decelerated from ~56% y/y growth back in 3Q13 to only 12% y/y growth in 4Q14. Investors need to be very mindful of the underlying volume growth at franchise dealers compared to overall top-line growth. In 4Q14, units per dealer were up only 12% versus the transaction segment top-line grew 42%. Dealer count grew 28% y/y in 4Q14 so drove the bulk (~70%) of the top line growth in the quarter. Given the laws of economics we described above, top-line growth over time will rapidly converge to the level of underlying franchise dealer unit growth. As of today, that is running at 12% y/y, well shy of the >30% growth rates management has guided the Street towards in 2015.
The chart below provides a summary of why TrueCar is potentially already a questionable value proposition for any dealer. According to TrueCar itself, the average discount that a TrueCar.com customer receives relative to MSRP is ~10-11%. The average customer walking into a dealership pays around an 8% discount to MSRP (at this point in human history, everyone knows to pay less than MSRP at a dealer - and if you didn't know that, shame on you!). Therefore, the average TrueCar.com customer results in around $781 of gross margin compression for a dealer. The TrueCar.com customer also results in a charge of $299 that the dealer must pay to TrueCar for the lead. In other words, TrueCar effectively adds $1,080 to dealer expenses based on our math.
Source: Our estimates and analysis
It would take a massive increase in volumes (better inventory turns) or a massive reduction in other costs to justify that type of margin compression. Keep in mind that a dealer's gross profit per new car is often well below $1,000 per car - so the TRUE deal already appears to be a potentially money losing venture for the dealer. TRUE management claims that this $1,080 investment is a long run good deal for dealers, with dealers having the opportunity to make this and more back over time by improving inventory turns and cutting sales commissions to floor staff. We disagree. In our view, the dealer is going to need to "make back" some of these losses elsewhere, and we worry that this means consumers that think they are getting a great price are ending up losing out on other sides of the deal (trade value, F&I, etc.).
We spoke with a number of dealers who told us that TrueCar leads end up being major money losers for their businesses. Therefore, we question the value proposition for dealers, and we certainly doubt that the company can continue to expand its network to more dealers without facing pressure on the fees it charges. In other words - we see pricing pressure on the horizon and at the very least, seriously question how the company can drive monetization up further.
Perhaps this comment from a dealer helps illustrate the problems dealers are already seeing with TrueCar:
Source: The Truth About TrueCar Savings (Comments Section)
The Value Proposition to Consumers
While not the focus of this research, we did want to point out that the TrueCar value proposition to consumers is also dubious. This blogger put together a rather thoughtful piece that talks about TrueCar and how it's pricing has evolved over time. In short, the blogger shows that after TrueCar changed its pricing practices following dealer backlash, deals to consumers are far less attractive than they used to be. Therefore, this blogger's view (and we tend to agree) is that TrueCar ends up serving as a typical annoying lead gen internet company - you provide your information, and suddenly you are bombarded and harassed by dozens of calls and emails from dealers trying to sell you a car. We don't know about you, but we absolutely despise when this happens!
In this regard, TrueCar's model today is really no different than any other lead gen business model given that the pricing is not as compelling as it used to be. Just take a quick trip to TrueCar.com and read the fine print at the bottom of the page - TrueCar.com only offers a "Target Price" - which is not an advertised price but rather an "example of what you can reasonably pay". Furthermore, the company claims on its website that between April 1, 2014 and June 30, 2014, the annual estimate savings of MSRP presented by TrueCar Certified Dealers to users of TrueCar was ~$3,221. For a company that prides itself on its data & analytics abilities, we were wondering why that savings figure is not more up to date and why that data is based on such a narrow window of time. We are also wondering why it is buried at the bottom of the website. For a company that believes "truth and transparency is a better business model," we would think that a key metric such as average savings a customer can achieve would be prominently featured in the middle of the landing page, rather than 3/4th down the page with a footnote caveat.
In our view, the value proposition to consumers is loose and obscure - the consumer does not know what price she is paying before she goes into the showroom and has no guarantee that the car she wants will even be there. These screen shots (which are admittedly biased) help elucidate the aspect of the model described by the blogger:
Competitive Pressures Mounting
Competition to TrueCar is mounting rapidly. First of all, we saw that General Motors, a powerhouse in the auto space, has already launched its own version of TrueCar for its dealer network. The cost of GM's offering: FREE for dealers. We are surprised this article did not make headlines. Maybe GM needs to hire TRUE's crack PR team to help get more distribution of its major company events!
GM is doing this as a service to its dealerships. This is a no-brainer in our opinion. OEs are very focused on keeping their dealer networks happy and healthy, and offering them a free lead gen business is a great idea in our opinion. Furthermore, GM's launch of this product also speaks to how low the barriers to entry in this space are. The GM report suggests that they were able to build this product in-house rapidly. The company has already signed up 1,800 of their 4,300 dealers, and has already helped sell 15,000 vehicles within one year of launching. For context, TrueCar.com generated just over 230,000 vehicle sales this year. However, GM is just one OE in the context of dozens, so its 15,000 1st year milestone is actually quite noteworthy. GM's ability to replicate TRUE's business model speaks to the simplicity of TrueCar's technology, its lack of pricing power, and the lack of any moat around its business. Not only that, but GM's product has better conversion rates than any other 3rd party product. It seems like the real disruptor here is GM!
GM said it worked with dealers to give them an alternative. Unlike the third-party sites, Shop-Click-Drive resides on the dealer's Internet platform, and it is free for them to use. The close rate for Shop-Click-Drive is higher too-30%, compared with at best 22% at third party sites, according to Ms. Carney. So far, about 1,800 of GM's 4,300 dealers have agreed to participate in the program, she said. She declined to discuss how the program's margins compare to those of traditional sales channels. In its first year of operation, Shop-Click-Drive helped sell about 15,000 new vehicles.
On the used car vehicle side, TRUE has talked up potential for beta testing a trade product this year and launching more fully in 2016. We note that venture capital interest in this space has been incredibly robust, and we see the potential for near-term profits in this space as being highly constrained as a result. Beepi, Carlypso, and Shift all raised gigantic sums of money recently and have created a very challenging competitive environment for TrueCar.
The Red Flags from the Earnings Call
We were struck by the tone on the 4Q14 call. Given TrueCar's trading multiple and our experience in growth stocks that trade at sky-high valuations, we believe that the market expected a sizeable revenue beat. In our opinion, management appeared aware of this point, and struck a defensive tone on the recent earnings call. We think it is important to not only analyze numbers, but to also analyze what management is saying, and management's word choice. Here are some comments from the call that caught our attention.
I see the competitive moats around our business as rock-solid
Our take: The GM article above seems to suggest otherwise
I want to be clear that management is extremely confident in our near-to medium-term ability to precisely manage and forecast our business
Our take: In our experience, lead gen businesses are notoriously volatile and difficult to forecast… let's be clear, this is the exact opposite of a contracted revenue business - even their subscription products are very short-dated in nature.
Our results are very intentional…
Our take: Well we would certainly hope that they were not unintentional!
CFO Comments - Lots of Donts and Buts
Don't get too distracted with UV growth
Our take: In our experience, a CFO telling us what not to get distracted about is always a red flag
Data revenues were slightly below some of the analyst models… but don't worry about it
Our take: Again, telling investors what not to worry about is always a red flag.
Obviously, as the network grows, the overall growth rate in the network slows. But that's okay…
Our take: when a growth company that trades on a revenue multiple on the hopes of one day generating positive net income talks about slowing growth being "okay", we always raise our eyebrows.
And perhaps our all-time favorite red flag from the earnings call - the classic "our guidance is back-end loaded" comment. In our experience, these types of comments often point to elusive growth that is based on the hope that weakening trends can be solved with a Hail Mary pass in the final seconds of the game:
Note that we believe our revenue will be slightly more back-end loaded in 2015 than in prior years
We worry that management is more concerned with how their performance metrics shook out relative to "analyst models" instead of being concerned about how to generate healthier levels of profitability at their young company. Ultimately, we think management teams should first focus on being operators and business builders rather than hitting refresh repeatedly on Yahoo Finance to see their latest real time stock price.
We think management would be well served to worry less about its stock price and more about its business model. Therefore, we do not see Mr. Painter's recent stock purchase of 70k shares (which was of course press released) as a sign of health in this company. Rather, we see this as a sign of Mr. Painter trying to instill confidence in a stock that is setting up to be highly vulnerable this year. This is not the first time we have seen the CEO of a new public company take a position in his stock only to be proven wrong a few quarters later.
We find it highly irregular for a public company to put out a press release that "corrects" analyst estimates. We wonder how much time management is spending "correcting" or worrying about analyst estimates versus actually trying to drive profitability at TRUE:
And on scottpainter.net -
We think this Tweet to Jim Cramer perfectly captures TRUE management's fixation on their stock price:
The Mystery of the Contradictory Cost Guidance
We're also very unsure about whether the guidance management recently provided the Street is realistic. We wonder whether management simply provided an in-line guide in order to prevent further bleeding in its stock price. In January 2015, Mr. Painter is on the record at the Automotive World Congress claiming the following:
TrueCar will invest $150 million in developing new products this year. The company also plans to spend $100 million on consumer advertising this year to endorse the app and its brand, Automotive News reported last week.
Management guided to $285M of revenue in 2015 at the midpoint, and ~$28M of adjusted EBITDA, implying ~$257M of total expenses ex-D&A (285 - 28 = total expenses ex-D&A, given interest and taxes are likely zero here). However, based on the comment above, it appears that Painter has claimed TrueCar is going to spend $250M on just new product development and consumer advertising this year - accounting for $250M of the total $257M expense ex-D&A budget baked into TRUE guidance. In other words, that math implies TrueCar has built in no other expenses - potentially ignoring COGS/overhead/G&A/other pieces of sales & marketing beyond consumer advertising. For readers who are interested, we note that Goldman Sachs published a research report on 2/17/15 (a 4Q Preview note) in which it also flagged the potential for higher investment/expenses as a result of Painter's conference comments.
We suppose some of the investment is going to come through capex rather than through the P&L (this is a neat trick we have seen a few recent IPOs pull so that R&D spend expense can flow through D&A and be "added back" to "adjusted" EBITDA). Nonetheless, we think Painter may have contradicted his own guidance provided on the earnings call by claiming he is going to spend $250M on R&D/consumer ads. We therefore wonder if a massive guide down to earnings is on the horizon… based on TRUE's expense levels described above, the company would be on track to neutralize any incremental revenue it generates this year through increased spending. And if our thesis on revenue deceleration is accurate, then the company's spending coupled with decelerating revenue could result in very negative EBITDA levels this year.
We think it is always important to put these things in context by auditing management's long-term track record of success. During our research, we came across a previous Painter startup called CarsDirect.com. According to reports, the company raised $350M of VC in 1998 with the purpose of "cutting out the middleman" and selling cars directly to consumers. This article suggests that CarsDirect's business model involved purchasing vehicles from dealers then selling them to consumers - an arrangement that this article says "has built in disadvantages." According to reports, Painter resigned as CEO of the company a year after raising the capital due to pressure from investors. He then went on to start a company called Build-to-Order which, as the name implies, was an auto manufacturing start-up that was going to design, build, and then sell custom order cars to consumers through the internet. According to reports, that venture failed.
The LA Times article indicates that "Painter's greatest asset may be his knack for salesmanship." Given the current valuation of TRUE versus its current earnings, we tend to agree.
For the reasons outlined above, we think TRUE revenue is going to decelerate materially. We also think TRUE is potentially setting up to spend far more this year than what it initially told the Street in its guidance. We think this stock is poised to plummet.
An appropriate comp to TRUE is Bankrate (RATE), a similar internet lead gen business which currently trades at ~12x EBITDA. Given our uncertainty as to how much EBITDA TRUE actually generates in 2015, we think the value of the company is somewhere between $120M (10x FY14E EBITDA) and $360M (10x FY15E guidance EBITDA). This values TRUE at around $1.50 - $4.50/share, representing ~85% downside from current levels. The catalyst for re-rating is a material deceleration in TRUE top-line growth that we expect will occur this year AND/OR a material downward revision to TRUE earnings as a result of higher than expected expenses. A third catalyst we have not explored in this report is a slowdown/inflection in US auto sales, which would also put tremendous pressure on TRUE's volumes and pricing power.
As a result, we think TRUE is one of the most compelling short opportunities in the market for 2015.
Courtesy of: OKMovieQuotes
Yes "Voice" of Owen Wilson. We do.
This article was written by
Disclosure: The author is short TRUE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author of this article is a private fund manager. At the time of publication, funds and accounts managed by the author were short TrueCar (TRUE). Such funds and accounts may buy and sell securities of TRUE (and other companies mentioned in this article), including by covering short positions in TRUE and/or changing to long positions in TRUE, both before and after the publication of this article and without giving further notice to any party. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article represents the opinion of the author as of the date of this article. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents.