February 04, 2020 - 10:29am EST by
2020 2021
Price: 35.00 EPS 0 0
Shares Out. (in M): 113 P/E 0 0
Market Cap (in $M): 4,000 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 4,000 TEV/EBIT 0 0

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·         The market does not understand the business quality and long-term earnings power of CarGurus.

·         CarGurus has greater selection, better transparency on price and dealer reviews, and more relevant search rankings than competitors Autotrader and Cars. We think competitors cannot replicate the CarGurus model because they would risk significant revenue declines by switching from their pay-for-placement business model to CarGurus freemium business model.


·         Due to CarGurus superior customer experience, competitors’ inability to respond, and the network effects between dealers and consumers, we think it is inevitable that CarGurus becomes a monopolist.


·         CarGurus has significant pricing power. In 2018, CarGurus had 60% share of time spent on U.S. online automotive marketplaces, but only about 15% share of revenue. We think CarGurus will eventually earn its fair share, which will result in significant earnings growth due to a primarily fixed cost structure.


·         We estimate in 5 years CarGurus U.S. business will have approximately $1.4B revenue (50% revenue share of online automotive marketplaces), $650MM of operating expenses, and $5 of earnings power, but this estimate could prove to be very conservative. The monopolist automotive marketplace in the UK is Auto Trader Group, which has a $6.5B enterprise value in a 5MM used car market. The U.S. used car market is approximately 6x larger than the UK market, so an equivalent business in the U.S. would be worth approximately $40B, which is 10x larger than CarGurus current enterprise value.


·         In addition to the U.S. opportunity, CarGurus is replicating its superior business model in Canada, the U.K., Germany, France, Spain, and Italy. These countries have incumbent marketplaces with mediocre customer experiences and pay-for-placement business models that are susceptible to disruption. In time, CarGurus international opportunity could be as large as their domestic opportunity.


·         CarGurus is the leading U.S. online automotive marketplace and focuses primarily on connecting consumers and dealers of used cars. The company was founded in 2006 by Langley Steinert, who previously co-founded TripAdvisor and owns approximately 24% of CarGurus.


·         Online automotive marketplaces have high utility for both consumers and dealers:

1.       They allow consumers to aggregate the relevant inventory of available cars across dealers and find the vehicle that best suits their needs and transact with a well-regarded dealer. According to Cox Automotive 2018 Car Buyer Journey, the average U.S. consumer spends 15 hours shopping/buying a vehicle. Approximately 65% of this 15 hours is online and 70% of online time is spent on automotive marketplaces.

2.       The economics of dealerships depend on sales volume, gross margin, and customer acquisition efficiency. To achieve a high return on their marketing investments, dealers must find in-market consumers; yet because car purchases are infrequent, only a small percentage of consumers are shopping for a car at any given point in time. Traditional marketing channels, such as TV, radio, and newspaper, can effectively target locally but are inefficient in reaching the small percentage of consumers who are actively in the market to buy a car. Online automotive marketplaces provide dealers with a large, engaged, and attractive audience of in-market consumers.

·         CarGurus has a freemium business model: dealers can list their inventory on CarGurus marketplace for free and receive anonymized emails from interested customers or they can pay a subscription fee to access interested customer’s contact information (name, phone number, email address) and for listing the dealership’s contact information and website. Typically, a dealer going from free to paid subscription will be able to sell significantly more cars as more connections can be made through a wider variety of channels. The success of the paid subscription is evidenced by the number of paying dealers in the U.S., which was approximately 27k at the end of 2018.


·         In addition to the U.S., the company currently operates online marketplaces in Canada, the U.K., Germany, Italy, and Spain.

Industry Structure

·         Incumbent online marketplaces like Autotrader and Cars were founded by print media companies who adopted the traditional pay-for-placement listings business model (i.e. the more you pay the higher your search results ranking). This model results in dealers constantly trying to outbid each other because +90% of customer traffic occurs on the first two pages of search results. However, this model also results in a mediocre customer experience due to 1) limited selection as smaller dealers can’t afford to list their inventory and larger dealers list only part of their inventory, 2) limited transparency on price and dealer reviews as these incumbent marketplaces can’t criticize the selection and reputation of their largest and most profitable dealer subscribers, and 3) search results lack relevance to customers because they are sorted based on how much dealers pay and not car pricing and dealer reputation.


·         CarGurus uses a different model that offers a superior customer experience versus competitors:

1.       They provide customers with the largest selection of car listings available on any of the major U.S. online automotive marketplaces as dealers can list inventory on CarGurus marketplace for free. CarGurus currently has 40k dealers and 2.4MM used vehicle listings on their website (1.9MM used vehicle listings from paying dealers) compared to Cars and Autotrader of approximately 18k dealers and 1.7MM vehicle listings.

2.       Using proprietary technology, search algorithms, and innovative data analytics, the company provides consumers with unbiased third-party validation on car pricing and dealer reputation, which is used to generate a car’s Deal Rating (Great Deal, Good Deal, Fair Deal, High Priced, or Overpriced), as well as other information such as price history, time on site, vehicle history, etc that aids consumers in finding great deals from the best dealers. CarGurus has a deal rating distribution of 5% and 15% being Great and Good Deals, respectively. Competitors like Cars and Autotrader have a deal rating distribution of 20% and 40% being Great and Good deals, respectively, which therefore lacks usefulness.

3.       The company sorts organic search results based on a car’s Deal Rating, which enables consumers to quickly find the most relevant car for their needs. Cars and Autotrader pay-for-placement search ranking generally results in the most overpriced and therefore least relevant cars being shown first (in order for dealers to afford the high vehicle listing fees they have to have higher priced cars).

·         The company also has a strong value-proposition to dealer subscribers. Dealers currently pay approximately 40% less for CarGurus than competitors, but CarGurus delivers almost twice the lead volume and the leads have higher conversion rates (the consumer is more comfortable with the deal since CarGurus has provided validation around price and dealer reputation). We think dealers are currently generating a 4x return on investment by subscribing to CarGurus versus competitors.


·         CarGurus marketplace has powerful network effects. The largest inventory selection offered by dealers and a better customer experience attracts a large and engaged consumer audience. The value of robust connections to this audience incentivizes dealers to become paying subscribers or risk losing market share to competing dealer subscribers. Having more paying dealers provides the company with profits that can be used to attract even more consumers, which in turn increases the amount each dealer subscriber pays. The cycle repeats. Also, driven by these networks effects, the company continues to amass more data, which is used to continuously improve search algorithms, the accuracy of Deal Ratings, the customer experience, and ultimately, the quality of the connections between consumers and dealers.


·         We think competitors cannot replicate the CarGurus model because they would risk significant revenue declines by switching from their pay-for-placement business model to CarGurus freemium business model. In the freemium model, incumbents would have to provide free leads to dealers to incentivize them to come onto the platform and therefore reduce the number of leads to currently paying dealers. Next, they would have to rank their best paying customers’ inventory and say it is either fairly priced or overpriced, which moves their high search ranking result on page 1 or 2 to a lower ranking where there is a fraction of the traffic and leads. We estimate that Cars and Autotrader generate nearly 2/3 of revenue from 1/3 of dealers and switching to CarGurus freemium model would eliminate hundreds of millions of revenue as the companies couldn’t raise prices on the 2/3rds of dealers to offset the lost revenue from the 1/3 of dealers.


·         Incumbents also face reverse network effects by not replicating the CarGurus model. Their inferior customer experience is resulting in declines in traffic and leads to subscribing dealers. Dealers are responding by eliminating their subscriptions; in Q3 2019, Cars subscribing dealers declined -20% year over year. The reduction in subscribing dealers reduces selection on the marketplace and further reduces the customer experience, which in turn will likely lead to further reductions in traffic, leads for subscribing dealers, and subscribing dealers. The cycle repeats.


·         Due to CarGurus superior customer experience, competitors’ inability to respond, and the network effects between dealers and consumers, we think it is inevitable that CarGurus becomes a monopolist.

Google Algorithm Change

·         We think Google’s recent algorithm change will have a minimal impact on CarGurus long-term traffic. We estimate that Google organic search traffic is approximately 30% of CarGurus total traffic.


·         We also think Cars’ claims that CarGurus is using blackhat SEO techniques to boost organic search traffic is really a campaign designed to give dealers a playbook to push back on CarGurus recent price increases.


o   CarGurus can’t control India hosted sites linking to CarGurus


o   CarGurus dynamic rendering/cloaking is actually dynamic pre-rendering, which is a lesser known technical SEO best practice suggested by Google (and therefore not a violation of Google’s guidelines)


o   The other CarGurus blackhat SEO tactics mentioned, Cars does as well


·         We think the Google algorithm change didn’t expose nefarious techniques at CarGurus, but instead Google simply gave websites with unique content a higher premium, which benefited Cars due to their editorial department.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Lapping 2019 traffic comps affected by Google algo change

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