Vroom (NASDAQ:VRM) is another online used car e-commerce platform aiming to disrupt one of the largest US industries, with so far Carvana (CVNA) being one of the few winners in this area.
The company is looking to benefit from the same market with e-commerce penetration of this huge and tricky market still coming in below or at around 1%. This potential is very encouraging, yet the losses incurred in the near term are very high as it is the question of how and how much money such a business can make. The numbers reported by Vroom currently are not convincing to me.
The Business - Helping People Find Their Drive
The header of this paragraph is the mission of Vroom as it simply aims to create a better way to both buy and sell vehicles. The company reveals that the market for used vehicles totals more than $800 billion in 2019, comprised out of some 40 million units being sold, with e-commerce penetration being less than a percent. The potential market is huge. Not only is the market larger than new auto sales, it furthermore is larger than the grocery industry, and despite the size of the market, the penetration of less than a percent is far smaller than other industries. On average, e-commerce penetration in retail industries comes in around mid-teens.
The company is an e-commerce platform which allows for a personalized interface, in contrast to peer-to-peer platforms and notably legacy dealers. The company relies largely on data science and experimentation to run its operations, used in both buying cars from consumers and selling to them. This has real implications for the business as this requires inventory and thus pricing risks as well, making the company not just a platform, yet actually a business which relies on inventory levels as well, thereby requiring quite some capital in the meantime.
The IPO & Valuation
Vroom initially aimed to sell 18.75 million shares in a range between $18 and $20 per share as solid demand allowed shares to be sold at $22 per share, resulting in gross proceeds of $412 million in connection to the offering.
With 112.7 million shares outstanding following the offering, the equity value of the company amounts to nearly $2.5 billion at the offer price. The company ended the first quarter with $170 million in cash, and other than vehicle floor plan loans (equivalent to approximately that cash position), the company does not have any debt outstanding. Factoring in the existing net cash and gross proceeds from the offering, operating assets are valued around $2.0 billion at the offer price.
So, what does the actual business look like? The company sold nearly 19,000 e-commerce cars in 2019, a more than 89% increase compared to the year before. This is impressive as the number of vehicles for sales rose just 45% to just shy of 5,000. Somewhat problematic is that gross margins on each unit fell by a quarter for the year to levels just shy of $1,700 per unit. This translates into gross profits of just $32 million, important to recognize.
These revenues are very high, of course, as this is a low-margin business. Total revenues rose 40% to $1.19 billion as the P&L statement revealed gross profit of $58 million, nearly twice the $32 million number calculated above, as the $32 million number only involves the e-commerce operations with the discrepancy caused by the TDA (traditional car sale operations) and wholesale operations.
Even if we use the $58 million reported gross profit number, that is just small compared to the $185 million SG&A expense, not even including $6 million in depreciation expenses, interest rates and taxes, as a net loss of $275 million is reported at the same time.
So, basically, the company is an old-seasoned car sales business and e-commerce under a roof. E-commerce made up 49% of sales in 2019 and approximately 55% of gross profits. The penetration of this is increasing rapidly with wholesale and TDA largely stagnant, while e-commerce revenues rose 95% in 2019.
In the first quarter of 2020, total revenue growth accelerated from 40% in 2019 to 60% for the quarter, as e-commerce growth accelerated to nearly 160%. Similar growth rates were reported in terms of gross profits of e-commerce, up 62%, thereby making up 78% of total gross profits.
Despite the fact that the real growth is stronger than the reported growth, a quarterly gross profit of $18 million is modest. With SG&A growing 60% to $58 million, this expense base is still three times the gross profits, making it hard to create a road to profitability.
Of course, with shares doubling on their opening day, currently trading at $44 and change, expectations are sky-high at an operating valuation of around $4.5 billion, equivalent to about 3 times sales. While this might sound reasonable to some, I keep stressing that, while the potential is huge, even if the company becomes profitable, it is a low-margin business.
Final Thoughts
I have some real doubts on this IPO even as going online is the future for used cars as well. Truth of the matter is that Vroom is burning through a great deal of cash. Furthermore, other initiatives have been seen on this front as well. A company like TrueCar (TRUE) has been public for a long time and has seen its share price truly being depressed (as the same applies to Cars.com (CARS)), as one has to understand that Vroom reports losses to the rate of $200 million per annum currently. While this might sound reasonable to some growth investors, with revenues trending above a billion, that revenue number is misleading as gross profit potential is limited as well.
On the other hand, other online platforms such as Carvana have become success stories, with shares having risen from levels in their teens in 2017 to +$100 at the moment. Carvana reports revenue growth of around 100% in 2019, with revenues trending at +$4 billion a year, making it roughly three times as large. Gross margins are far higher at half a billion for low double-digit numbers.
With an enterprise value seen around $7-8 billion, Carvana trades at around 2 times revenues, while it has similar growth and higher margins and lower relative losses. This makes the essentially 3 times sales multiple look steep. While Vroom is growing a bit quicker, the other metrics do not look that good, making it an easy avoid as shorting momentum induced IPOs with limited float is a particularly risky endeavor.
The comparison to Carvana and the fact that the company is led by a former Priceline.com executive is encouraging, yet the cold hard numbers reveal a long road to even breakeven as the low revenue multiples are quite misleading, given the margin structure of this business and its business model.
Hence, this remains an easy avoid there as investors seem to be eager to extrapolate potential increased penetration of this business model in its industry, all while expecting to demonstrate on solid margins, as the company is a long way from achieving this.
If you like to see more ideas, please subscribe to the premium service "Value in Corporate Events" here and try the free trial. In this service we cover major earnings events, M&A, IPOs and other significant corporate events with actionable ideas. Furthermore, we provide coverage of situations and names on request!
