CARS.COM INC CARS
July 20, 2017 - 7:41am EST by
mip14
2017 2018
Price: 23.25 EPS 3.22 (Normalized) 3.22 (Normalized)
Shares Out. (in M): 72 P/E n/a n/a
Market Cap (in $M): 1,665 P/FCF 7.2x 7.2x
Net Debt (in $M): 650 EBIT 330 330
TEV ($): 2,014 TEV/EBIT 6.1x 6.1x

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  • Understated Earnings
  • accelerating growth
 

Description

 

Situation Background:

Cars.com ("CARS") is one of the leading digital marketplaces for buying and selling cars (~82% used / ~18% new).

CARS is a high-margin internet asset that should experience secular growth as dealer advertising budgets shift to digital.  Revenues are generated primarily by subscription advertising revenues from approximately 21,000 franchise and independent car dealers (80% of revenues).  The dealers pay to list their inventory online; there is a base pricing package and various upselling options for premium placement.  The rest of revenues come from website display advertisements (18% of revenue) that are primarily sold to OEMs and other small adjacencies (2% of revenue) 

 

Cars was spun out of TEGNA on May 18th; TEGNA primarily owns TV broadcast assets, which typically have very different holder bases than internet assets.  Our historical analysis of spinoffs suggests that selling pressure tends to be more acute in situations where the spinoff is a much different business than the parent.  Another factor is that research analysts covering the parent do not generally publish on the spin if it is in a sector that the analyst does not cover.  In this instance, we have not yet seen anything published by analysts covering the parent (the only firm who has published is an obscure firm named Barrington).  We also believe that misleadingly high headline multiples on consensus combined with general concerns around the auto market have weighed on the stock.

 

Thesis:

 

We believe Cars.com is one of the most compelling spin-offs we have seen over the past few years

  • Expected returns are very attractive (38% 3yr base case IRR) and we expect the equity to be supported by catalysts
  • We expect short-term catalysts from investor discovery and an acceleration of growth as the business laps the issues from the problematic website re-platforming

  • We believe the equity will be supported over the intermediate term by the significant step up in cash flows from affiliate agreements rolling off in 2019 & 2020

 

Misunderstood Valuation: We believe CARS is materially cheaper than it appears at first glance

  • CARS shows up on screens as a reasonably priced (10.6x 2017E EBITDA adj. for non-recurring EBITDA) to somewhat expensive asset (22.1x 2018E EPS)
  • However, on our estimates, CARS is trading at 5.9x normalized EBITDA and a 13.9% cash flow yield (15.1% if tax reform lowers the tax rate by 10%)

  • These valuations are quite low given that this is a unique internet asset with sticky revenues, strong margins, and a secular growth profile

  • Below, we lay out the drivers that cause our estimates to materially exceed the consensus view.  For reference, our EV/EBITDA multiple deducts $301mm from the EV to reflect the company’s ongoing tax shield (which we view as an excess asset when calculating pre-tax metrics).  This is further explained in point 5 below

  1. Income Statement Projections: We estimate $12.5mm of public co costs and $12.8mm of increased spend on marketing/sales are partially offset by $8.3mm of revenue growth

  2. Non-Cash Revenue: We remove the $25.2mm of non-cash revenue that is amortizing into the income statement as a result of the contract with affiliates

  3. Affiliate Arrangements: We believe the most misunderstood portion of the CARS thesis is the potential uplift from the expiration of affiliate contracts

  • To understand the affiliate arrangements (which constitute ~27% of revenue today), it helps to quickly refresh on the history of Cars.com

    • Cars.com was originally part of Classified Ventures, a consortium of media companies including Tribune, Gannett, McClatchy, Graham Holdings, and AH Belo

    • Cars.com was sold through the media companies' existing sales force (selling a dealer an advertising package combination of TV, radio, newspaper, and Cars.com)

    • Over time, Cars.com began selling directly to consumers in geographies where the consortium did no business

  • The direct sales force thus developed a well-established playbook for inheriting legacy clients, increasing market penetration, and upselling premium products

  • In 2014, Gannett (now TEGNA) purchased Cars.com from the rest of the Classified Ventures group for an implied price of ~$2.5bn

  • We believe that PE buyers would have paid a higher price than Gannett, but the group wanted to sell to a member to preserve the affiliate relationships

  • In the purchase agreement, the affiliates received the right to take a 40% commission on their sales of Cars.com (end price to the consumer is the same as direct)

  • The six affiliate arrangements expire in October 2019 (4 of 6 arrangements) and June 2020 (2 of 6); we expect a significant uplift in cash flows as a result

  • Price: Cars.com will receive 67% more revenue for each sale as they will keep 100% of list price (rather than 60% under the current arrangement).  We expect a revenue increase of ~$90mm as a result of price increases alone

  • Volume: The direct sales force has historically been able to penetrate and upsell clients to a far greater degree than the affiliate sales force.  Our diligence suggests there is 20%-40% upside from increased penetration and upselling additional products (we model a 21.2% uplift, or ~$48mm of revenue)

  • Margins: Additionally, we believe the incremental affiliate revenues are likely to come through at very high incremental margins based on our work: (1) Sales Force Cost - Our research suggests that ~150 additional sales people are needed to cover affiliate markets ($16.5mm of cost assuming ~$110k per head), (2) Marketing: Diligence suggests the transition will likely come with an incremental ~$10mm of marketing spend, (3) COGS: Incremental COGS should be very low as the technology platform is highly scalable (we estimate a 90% gross margin on incremental revenue), (4) Elimination of Costs (Revenue Affiliate Share): CARS pays its affiliates ~$9mm a year for major account sales it does at a central level

  • We estimate incremental EBITDA margins on affiliate revenues of 83.3% (though this is really 76.7% adjusting for the revenue share)

  1. Cost Cutting: While 2017 will see increased public company costs (~$12.5mm), we believe there are opportunities to reduce IT spend

  • We have been told that one of the major benefits of the recent re-platforming that the company did is the increased flexibility on IT spending

  • Industry contacts suggest there could be $20mm of savings from increased cloud utilization, outsourcing more services, and cutting headcount

  1. Cash Tax Shield: CARS will receive a significant tax benefit from intangible amortization stemming from Gannett's purchase of Cars.com

  • CARS' headline GAAP earnings are depressed by ~$75mm pre-tax due to amortization of acquired intangibles from Gannett's purchase of the rest of Cars.com

  • This non-cash charge depresses headline earnings (resulting in an artificially inflated P/E) and we of course ignore this in our cash flow estimate

  • Independent of GAAP accounting, the company is receiving a significant tax benefit from the amortization of these purchased intangibles. This dynamic bolsters cash flows by lowering the cash tax rate to ~25%-28% (vs the effective tax rate of 38% for GAAP accounting)

 

Comps:

 

Private Transaction Comps: AutoTrader US is the best private transaction comp to CARS (the two companies are the largest players in the marketplace)

  • In 2010, Providence Equity Partners bought a 25% stake in AutoTrader US from Cox Enterprises (privately held)

  • In 2014, Providence sold the stake back to Cox at a price described as ~6x revenue ($1.8bn for the 25% stake)

  • A 6x multiple on our normalized revenue implies the stock is worth ~132% more (without taking into consideration CARS’ unique tax attributes which are worth another ~18% of the market cap)

  • Market multiples have certainly increased since 2014, although the perceived growth trajectory for the penetration of digital auto advertising is likely lower now

  • Given that Cars.com is a fairly unique business, there are not that many comparable companies (AutoTrader is the only relevant transaction comp we see)

 

Prior Sales Process: We think the prior sales process (where Gannett purchased the other 73% of Cars.com at an implied $2.5bn valuation) is the most relevant transaction comp

  • The $2.5bn price ignores the valuation drag from the ~5.5yr affiliate agreement at the time of the transaction

  • The negative PV of these agreements (which are set to run off soon) should have been in the range of ~$300mm based on the excess commissions

  • In addition, press reports suggested that there were PE buyers interested at higher valuations (have seen $3bn mentioned)

  • Our diligence supports the view that private equity would have paid a higher price than Gannett, but we understand there was a strong preference to sell the business to one of the media parties given the desire to preserve the affiliate relationships (keeps jobs, helps with selling other media products, etc.)

  • We suspect the business is worth more in a sale today as revenues have increased by ~25% and market multiples are now meaningfully higher

 

Public Comps: Cars.com does not have any great public comparables, so we look to a mixture of online auto marketplaces & other digital marketplaces to triangulate

  • We would expect public investors to value CARS based on a mix of earnings multiples, cash flow multiples, and EBITDA multiples

  • The publicly traded peers below seem to generally trade at EBITDA multiples in the mid-teens and earnings multiples in the low-to-mid 20s

  • While pinning down a precise multiple is difficult, we expect CARS to ultimately trade at a modest discount to peer valuations with similar mid-term growth (15-20x cash flow)

  • The modest discount reflects higher leverage at CARS and a lower multiple for the CFs from the amortization tax shield (15yr CFs rather than perpetual)

  • In addition, there is some risk to CARS' revenue growth given the recent traffic and revenue issues following the re-platforming

  • However, CARS could certainly trade at 20x+ should revenue growth accelerate to the mid-term mgmt target of 5%-10% revenue growth

 

Catalysts:

  • Investor Discovery: We believe the core principles of our underlying thesis will become increasingly evident to the market as investors study the business

  • Mgmt has been vague around the uplift from affiliate contracts rolling off, and they also have not done much to highlight that cash flows exceed earnings

  • We would expect increased disclosure by the company over time to be a positive

  • We would also expect a ~$1.7bn market cap equity to attract significant analyst coverage over time, which we would expect to be a net positive

  • Revenue Re-Acceleration: Investors studying CARS' recent revenue performance and disclosure around traffic & dealer counts may have concerns around LT-growth

  • We believe the issues here were driven by the re-platforming of the website, which was highly mismanaged and led to a material deterioration in search traffic

  • The deterioration in search traffic drove a decline in organic dealer count, as savvy dealers would have seen an increase in CARS' cost per lead

  • Given CARS' refusal to negotiate on price with most dealers, it appears that some dealers dropped CARS

  • As a result dealer count went from organic growth of 4% in 2015 to an organic decline of 4% in 2016

  • However, we believe traffic has stabilized and started to grow now that the new platform is up and running (i.e. CARS taking market share back even if comps are not yet positive)

  • The rebound in traffic should also get some boost from the increased business investment in 2017 (which we have built into our normalized margins)

  • There are some short sellers who have been making a bear pitch on Cars.com.  The short interest is higher than normal here (~18%) and we have observed that many  internet businesses have higher short interest than the rest of the market (a number of L/S funds tend to be significantly overweight internet in their long portfolio and need industry shorts to pair with them).  We have spoken with short sellers and believe the short pitch is shallow and reflects limited diligence

  • In effect, the bear argument amounts to “why should a declining internet asset trade at 11x EBITDA?”

  • The simple answer is that: 1) we believe the business is not declining and 2) we see the company trading at 6x normalized EBITDA, not 11x.  We saw one quarter of slight revenue growth (with an estimated ~2.8% organic revenue decline) and this was driven by a temporary traffic issue.  Cars.com has years of consistent revenue growth (including CY 2016).  Publicly available data from similarweb.com suggests that CARS has taken significant traffic share since the start of the year (up 2.2% in the comp group of Cars.com, Autotrader, CarGurus, and TrueCar) as the company recovers from the idiosyncratic one-time issue of the website replatform.  The sequential trends are also consistent with improvement on a month-by-month basis through June.  We believe additional spending on marketing will only improve the traffic trends ahead of the much easier comps of H2.  Given these factors, we think shorts may end up surprised by the strength of traffic growth by year end (which we believe will translate to renewed revenue growth in the future)

  • Improvement in the revenue trajectory will take time (need to win dealers back, marketing spend is weighted more to the fall than summer, etc), but all of our discussions with dealers suggest CARS has a highly competitive offering that should be able to at least maintain share in a growing space absent poor execution

  • Longer-term, revenue is mathematically set to accelerate as the affiliate agreements expire (both from price and also likely in terms of the volume uplift)

  • Independent of the pricing uplift, the mix shift to direct should be positive for consolidated revenue growth because wholesale revenues have consistently lagged

  • Outperformance on Margins: Mgmt is guiding investors towards medium-term margins of 34%-37%; these margins appear highly conservative

  • While some business investment is needed after TEGNA cut too deep to improve margins, we expect material margin improvement over time

  • We think the affiliate revenues are likely to come through at very high incremental margins (especially with the mathematical elimination of $9mm in costs)

  • Further, incremental margins should be very high given the 80%-90% incremental gross margins

  • Additionally, we think there may be potential for cost-cutting in terms of IT spend (as mentioned before)

  • Potential Catalyst - Earlier Affiliate Capture: We think it could make sense for mgmt to attempt to re-capture some portion of its affiliates earlier than 2019/2020

  • If CARS paid a modest premium to the NPV of the affiliate agreements, they could get direct control over these geographies and start improving results

  • Mgmt has also minimum performance requirements as a way to potentially get earlier control

  • Potential Catalyst - Tax Reform: CARS stands to benefit from tax reform to a greater degree than other businesses based on the following

  • The business is 100% domestic, and therefore should be more levered to lower US corporate tax rates than most public equities

  • In addition to benefiting from more tax savings, the tax savings should be more enduring for CARS than for most other public equities

  • Capital intensive businesses should see pricing pressure as tax rates decline (given that capital investment is priced to an after-tax ROIC)

  • CARS has no invested capital, but instead prices its products based on the ROI to the subscription buyer (tax rates should not negatively affect the economics)

  • Potential Catalyst - Sale of the Business: Chairman Scott Forbes has a track record of creating value in online marketplace businesses

  • Forbes was Chairman of Orbitz; while he was there, they re-accelerated growth and the business was sold in ~2yrs at a healthy premium

  • PE funds would likely find the future affiliate uplift and the potential to consolidate a still-somewhat fragmented industry attractive

  • Our historical analysis of spinoffs suggests that spinoffs are 5x as likely to be acquired as the avg public equity in the 5 years following the spin. The decision to spin CARS may have been made in order to maximize tax efficiency, with the plan to ultimately sell the business post-spin. If so, the decision to put Forbes in as Chairman (as well as putting a former senior M&A banker on the board) may have been done to set up for a sale

 

Risks:

  • Market Share: We believe the largest risk is the potential to lose share to existing competitors and new entrants

  • Competitors like Car Gurus have been willing to tolerate low margins (and even losses in some cases) in order to build market share.  However, we have heard that Car Gurus is raising prices ahead of a potential IPO, helping to restore rationality to industry pricing

  • Given the low barriers to entry and long-term likelihood of consolidation due to material synergies, we expect competition to remain fierce near-term

  • Traffic declined meaningfully in 2016, and Q1 showed organic revenue declines (largely due to a decline in dealer count driven by the traffic issues).  The traffic declines appear to be broadly attributable to the botched re-platforming from last year and inadequate relative mktg spend as TEGNA starved the business of investment (rather than from a worse competitive position)

  • Mitigant: The company gave guidance for positive traffic growth this year despite weak Q1 numbers as recently as May.  This suggests they are seeing positive momentum (and they have a better understanding of the easy Q4 comp)

  • Cyclicality: Auto sales are cyclical, and we appear to be operating above cycle in terms of auto sales

  • Mitigant: ~80% of business value comes from used car sales, which have historically been less cyclical

  • Mitigant: The subscription model and the mix shift towards digital have historically proved a buffer to an economic downturn

  • Dealers have said that cutting their digital advertising would be the last thing they would want to cut, and Cars has managed to hold firm on price in the past

  • As evidence, the business grew revenues 3% in 2009 and just 2% of dealers eliminated their CARS subscription (although the penetration opportunity was much greater in 2008-2009)

  • Long-Term Auto Risks: We could see a movement away from a dealership-driven auto market and/or a long-term reduction in individual buying demand

  • Autonomous driving and increased prevalence of ride-sharing fleets could reduce demand for Cars.com

  • Mitigant: These risks appear to be longer term than the investment time horizon (although they certainly could impact the exit multiple)

  • We would think Carsales faces similar risks from these long-term trends and it still trades at >20x earnings today

 

Returns:

 

We model a base case 3yr IRR of 38%

  • Our model assumes an exit price of 18.0x 2020 cash flows, which is an implied 16.0x 2021 cash flows with an exit in mid-2020

  • We are modeling sluggish underlying growth through 2020 ex-affiliate relationships to reflect the current state of the autos market

  • We do not assume tax reform takes place in our base case

 

We believe these returns are highly compelling and reflect a lack of understanding of CARS’ underlying financial profile.  We believe there is ample margin of safety (i.e. if marketing spend to re-ignite traffic growth needs to be higher).  Returns could be front-end weighted if investor discovery takes place more quickly and/or the business is acquired.

 

Disclaimers:

The views expressed herein are for informational purposes only, and are not intended to be, and should not be, relied upon as an investment recommendation in connection with any investment decision for any purpose or for legal, accounting or tax advice.  This information does not constitute an offer to sell, or the solicitation of an offer to buy, any security.  Any forward-looking financial information (“Forward-Looking Information”), including but not limited to, IRRs, EBITDA, cash flow, margins and revenues are presented for the purpose of providing insight into our investment objectives.  The Forward-Looking Information is not a prediction, projection or guarantee of future performance and is based upon assumptions regarding future events and situations that may prove not to be accurate or may not materialize.

The author makes no representation as to the accuracy or correctness of the information contained herein and expressly disclaims any liability to any person from relying on such information.  The information and views contained herein are provided as of the date this summary was posted and present the views of an investment firm that currently holds a long position in the company’s securities.  The author has no obligation to update any of the information provided herein.  The author reserves the right, in light of, among other factors, its ongoing evaluation of the company’s financial condition, business, operations and prospects, the market price of the company’s stock, conditions in the securities markets generally, general economic and industry conditions, its business objectives and other relevant factors, at any time, to decide to purchase, sell, or engage in any other transaction involving, the company’s securities as it deems appropriate.   Past performance is neither indicative nor a guarantee of future results.  There can be no assurance that an investment in the company will be profitable or that the assumptions regarding future events and situations will materialize or prove correct. 

 

 

 

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.

Catalyst

Potentially include: investor discovery, revenue re-acceleration, outperformance on margins, earlier affiliate re-capture, tax reform, and/or sale

    sort by    

    Description

     

    Situation Background:

    Cars.com ("CARS") is one of the leading digital marketplaces for buying and selling cars (~82% used / ~18% new).

    CARS is a high-margin internet asset that should experience secular growth as dealer advertising budgets shift to digital.  Revenues are generated primarily by subscription advertising revenues from approximately 21,000 franchise and independent car dealers (80% of revenues).  The dealers pay to list their inventory online; there is a base pricing package and various upselling options for premium placement.  The rest of revenues come from website display advertisements (18% of revenue) that are primarily sold to OEMs and other small adjacencies (2% of revenue) 

     

    Cars was spun out of TEGNA on May 18th; TEGNA primarily owns TV broadcast assets, which typically have very different holder bases than internet assets.  Our historical analysis of spinoffs suggests that selling pressure tends to be more acute in situations where the spinoff is a much different business than the parent.  Another factor is that research analysts covering the parent do not generally publish on the spin if it is in a sector that the analyst does not cover.  In this instance, we have not yet seen anything published by analysts covering the parent (the only firm who has published is an obscure firm named Barrington).  We also believe that misleadingly high headline multiples on consensus combined with general concerns around the auto market have weighed on the stock.

     

    Thesis:

     

    We believe Cars.com is one of the most compelling spin-offs we have seen over the past few years

     

    Misunderstood Valuation: We believe CARS is materially cheaper than it appears at first glance

    1. Income Statement Projections: We estimate $12.5mm of public co costs and $12.8mm of increased spend on marketing/sales are partially offset by $8.3mm of revenue growth

    2. Non-Cash Revenue: We remove the $25.2mm of non-cash revenue that is amortizing into the income statement as a result of the contract with affiliates

    3. Affiliate Arrangements: We believe the most misunderstood portion of the CARS thesis is the potential uplift from the expiration of affiliate contracts

    1. Cost Cutting: While 2017 will see increased public company costs (~$12.5mm), we believe there are opportunities to reduce IT spend

    1. Cash Tax Shield: CARS will receive a significant tax benefit from intangible amortization stemming from Gannett's purchase of Cars.com

     

    Comps:

     

    Private Transaction Comps: AutoTrader US is the best private transaction comp to CARS (the two companies are the largest players in the marketplace)

     

    Prior Sales Process: We think the prior sales process (where Gannett purchased the other 73% of Cars.com at an implied $2.5bn valuation) is the most relevant transaction comp

     

    Public Comps: Cars.com does not have any great public comparables, so we look to a mixture of online auto marketplaces & other digital marketplaces to triangulate

     

    Catalysts:

     

    Risks:

     

    Returns:

     

    We model a base case 3yr IRR of 38%

     

    We believe these returns are highly compelling and reflect a lack of understanding of CARS’ underlying financial profile.  We believe there is ample margin of safety (i.e. if marketing spend to re-ignite traffic growth needs to be higher).  Returns could be front-end weighted if investor discovery takes place more quickly and/or the business is acquired.

     

    Disclaimers:

    The views expressed herein are for informational purposes only, and are not intended to be, and should not be, relied upon as an investment recommendation in connection with any investment decision for any purpose or for legal, accounting or tax advice.  This information does not constitute an offer to sell, or the solicitation of an offer to buy, any security.  Any forward-looking financial information (“Forward-Looking Information”), including but not limited to, IRRs, EBITDA, cash flow, margins and revenues are presented for the purpose of providing insight into our investment objectives.  The Forward-Looking Information is not a prediction, projection or guarantee of future performance and is based upon assumptions regarding future events and situations that may prove not to be accurate or may not materialize.

    The author makes no representation as to the accuracy or correctness of the information contained herein and expressly disclaims any liability to any person from relying on such information.  The information and views contained herein are provided as of the date this summary was posted and present the views of an investment firm that currently holds a long position in the company’s securities.  The author has no obligation to update any of the information provided herein.  The author reserves the right, in light of, among other factors, its ongoing evaluation of the company’s financial condition, business, operations and prospects, the market price of the company’s stock, conditions in the securities markets generally, general economic and industry conditions, its business objectives and other relevant factors, at any time, to decide to purchase, sell, or engage in any other transaction involving, the company’s securities as it deems appropriate.   Past performance is neither indicative nor a guarantee of future results.  There can be no assurance that an investment in the company will be profitable or that the assumptions regarding future events and situations will materialize or prove correct. 

     

     

     

    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.

    Catalyst

    Potentially include: investor discovery, revenue re-acceleration, outperformance on margins, earlier affiliate re-capture, tax reform, and/or sale

    Messages


    SubjectIncremental Marketing Spend from Affiliate Market Recapture
    Entry07/21/2017 09:15 AM
    MemberBismarck

    Thanks for the writeup mip, it is informative as all of your posts are. 

    I am having trouble reconciling your estimates on go-forward margins post affiliate market recapture to my own diligence and thoughts. $10mm of incremental marketing spend seems too low, could you possibly walk me through your thoughts here? It was my intuition that contracts brought back would come with at least Cars.com level marketing spend requirements (if we are giving them credit for improving the markets covered by the affiliates post recapture, shouldn't marketing spend be higher than Cars.com average?). Also, have you done any diligence with respect to better estimating the efficiency boost post affiliate recapture? The affiliates shown in the Cars.com presentation may be skewed due to their size and geographies. 

    I agree that Cars should trade at a discount to comps (if we want to even call them that) though I am not certain what that discount should be. What gives you confidence the floor is at a 30% discount? Cars has not demonstrated it can pull out economics from existing dealers by way of price increases (and actually it is not apparent here whether these are true price increases or a dealer is being upsold to a larger contract -- though the latter is still a positive). It also has not demonstrated it can cut marketing spend and keep similar value for dealers. They have a large chunk of their dealer TAM already; most growth has been from distribution gains. How do you get comfortable with a 5-10% estimated top-line growth rate at this margin structure (let's ignore the affiliates for now) with no effective pricing power to the platform? It seems rather difficult to operate such a platform in the U.S, I'd be curious if anyone has done an analysis as to structural dealership returns on capital in varying geographies. Maybe the stock is too cheap on a FCF basis already that I make a moot point. 

    How can we get a better feel for the risk that CarGurus presents? I have heard as well that pricing has come up on CarGurus, but the base is so much lower this probably does not matter. Dealers act relativelty rationally from our diligence and measure direct lead ROIs. If CarGurus is happy taking a lower margin than Cars.com and has at least as good of a platform, why shouldn't they win in the terminal case? I have heard that even with its utter dominance (>70% market share and 70% ebitda margins), Auto Trader UK has started to cut pricing due to CarGurus. 

    Thank you. 


    SubjectRe: Incremental EBITDA
    Entry07/21/2017 05:09 PM
    Membermip14

    On the first question, our research suggests the math you lay out is not like-for-like in terms of sales force.  A lot of the overall sales force is not "feet on the street" as there is an entire regional management network already built out, which will be leveraged as they expand into the affiliate markets. We think is causing an issue with your denominator.  Additionally, the existing direct sales force is also selling the national advertising revenue, so we think the numerator is incorrect (total retail revenue is greater than $460mm vs. the $333mm number you mentioned).  Our estimates on the incremental sales force reflect conversations with those who are very familiar with the exact affiliate markets and the number of people that would generally be required to sell into those markets.  We have consistently received similar estimates, with the two most credible sources estimating $15mm and $17mm.  We have been told there will also be incremental marketing spend up front to build the brand in affiliate markets, taking our best total cost estimate to $25mm-$30mm.  This is before deducting the revenue share to affiliates that is currently paid through the income statement even though it is sold by the national accounts ($8mm-$9mm).  While our estimates could be wrong, we feel comfortable on the consistency of the feedback we received and the credibility of their estimates.

    In terms of your second question, it is hard to say.  The first portion of the revenue uplift is just math (going from 60% to 100% is a 67% revenue uplift).  In terms of the penetration opportunity, the company has a slide showing a substantial uplift in year 1 (especially when you realize ~80% of revenues come from franchise dealers) and every industry participant we have spoken to has confirmed there is a substantial uplift in penetration possible (we assume 20% although we were given a number of higher estimates over a 3yr time frame).  We had not previously looked at the precise dealer split between direct and affiliate markets, but one thing to keep in mind is that a number of the affiliate markets are in large cities.  It may be that the density of the cities leads to higher revenue per dealer in general.  I will see if I can get a better answer to explain the math you point out but feel comfortable with the magnitude of uplift we utilize.

    Finally, we agree that Google and Facebook are taking some share.  The dealers with the savviest tracking tools tend to believe the Facebook ROI is currently the best with the marketplaces fairly similar to Google.  We expect the marketplaces will continue to lose a modest amount of share but think that consumers prefer to shop directly on marketplaces rather than on a specific dealer's website.  As such, we think there will be continued upward momentum supporting marketplace advertising despite a modest amount of share loss to Google and Facebook.  This could potentially reverse if the market becomes more like the OTAs (particularly if the space becomes more consolidated).  Hope this helps.


    SubjectRe: Margins
    Entry07/21/2017 05:10 PM
    Membermip14

    We think management wanted to highlight the need for business investment in marketing post-spin while re-setting expectations lower.  Their stock units were based on trading prices post-spin, giving the team every incentive to be conservative.  Management has been extremely cagey in describing the affiliate uplift, referencing things such as "costs might arrive before revenues" and noting that the affiliate time period could be perceived as 'beyond mid-term" since full profits don't really flow through until 2021.  We regularly see this type of mis-leading conservative guidance with spin-offs (such as with the incremental margins at TopBuild in our prior pitch) and believe this is a similar situation.


    SubjectRe: SEO questions
    Entry07/21/2017 05:10 PM
    Membermip14

    The company has talked about their SEO being in the mid-30s as a percentage of traffic at the highs.  At the investor day, the CEO stated that "it used to be higher into the 30%s" but now is "about a quarter of traffic."  This math is broadly consistent with your 25% number.  We don't think search is more important than the company is quoting.  One thing that is nice is that public data from SimilarWeb shows that 50%+ of traffic is direct, providing a durable traffic stream outside of Google.  

    In terms of Google raising their cost per click faster than CARS can raise price, it is possible that this could pressure margins but we are not overly concerned.  CARS has very high incremental margins on growth and paid traffic is a relatively modest portion of overall traffic (<25%, likely <20%).  It seems paid search cost inflation will likely be less meaningful than the incremental margin impact of revenue growth, but we would note that increased marketing costs are a big portion of why the company is guiding to lower mid-term margins (we believe a good amount of this could go towards paid traffic).  We also think there is ample margin of safety in the creation price.

    In terms of dealer consolidation, we think users like to search on marketplaces to compare prices.  The dealers would obviously like to avoid this and Google will certainly show them a bunch of metrics to try to convince them Google spend is their best ROI, but we think consumers have a strong desire to comparison shop to get the best deal (rather than clicking onto one dealer's website).  We think the sophisticated dealers recognize this and believe they have been some of the leaders in terms of the transition to more spending on marketplaces.  


    SubjectRe: Incremental Marketing Spend from Affiliate Market Recapture
    Entry07/21/2017 05:11 PM
    Membermip14

    In terms of your questions on incremental marketing spend, we are confident in our numbers of ~$10mm on top of the sales force expansion.  A lot of the brand-building type of advertising is already being done at a national level (and supporting the affiliate markets there).  We understand that the affiliates are making remarkably high margins on their existing revenue stream as a result of this (estimates vary but line up with our numbers), which CARS is effectively inheriting by replacing the affiliate sales force with its own. 

    In terms of exit multiple, we think the margin of safety seems quite large if we believe we are buying this at a 14%-15% CF yield when we see the market trading around a ~5% CF yield.  We don’t believe our exit multiple is underwriting 5%-10% top line growth as we think our exit is broadly consistent with the market multiple in the current environment (for high margin, consistent cash flows with capital-light growth).  If the exit multiple ends up lower than expected, we believe returns still look very attractive (given our base case IRR is so high). 

    In terms of the CarGurus risk, we think the pricing gap is narrowing materially.  We think dealers understand there is value in being on multiple marketplaces and think most dealers will end up on both CarGurus and Cars (if they are not there already).  We believe CarGurus has been exerting downward pressure on the ability for Cars and AutoTrader to raise price, which is why the 5% price increases of the past have not taken place in recent years.  It appears (although we are less close to the situation) that AutoTrader UK may now have to deal with a similar dynamic.  Ultimately, we think CarGurus pricing will continue to move towards peers.  There is also the possibility of industry consolidation (as in other digital marketplaces) to help keep pricing rational.  We agree that CarGurus presents a risk to the future margin profile but think a lot of the pain has been taken over the past few years & in the forward guidance.   


    SubjectRe: Short Thesis
    Entry07/22/2017 08:02 PM
    Memberrobberbaron

    The competitive environment is pretty rough; Cargurus and AutoTrader are formidable and will eat into CARS' top-line growth. It's not THAT cheap if they can't hit numbers. Add onto that the usual peak SAAR stuff that people have been calling a top on for a while now, and the SI becomes more understandable.


    SubjectRe: Re: Re: Short Thesis
    Entry07/24/2017 10:16 AM
    Memberrhubarb

    I haven't spent time on this one, but what comes to mind is 1) reliance on Google 2) lot's of competition 

    just google "buy a new car" and look at all the results...


    SubjectRe: Overstock Entry
    Entry08/03/2017 12:06 PM
    Memberskierholic

    Just did a quick look at the website.

    The website looked very poorly designed and inventory seems to be lacking. I am going to hazard a guess that the listings are mostly scrapped from the Internet and they probably signed up a few dealers by promising them to list their inventory for free. They either have chosen the cargurus model (free listings + pay per lead) or offered low price + trial listing packages.

    they are not likely to do any serious damage...


    SubjectTraffic
    Entry08/03/2017 12:37 PM
    Memberskierholic

    thanks for another very interesting idea!

    Just want to get your thoughts on a few things:

    1. How much tail wind do you think the sector will gain from the conversion from print to digital. NADA put out a number saying that 34% of the marketing spend is on digital today. Seems low compared to where UK, Germany and Australia are (60 - 80%). I am not sure if there is any nuances in the US that makes it different. Afterall, Internet was invented in the US some 30 years ago and the online marketing spend penetration is still so low today.

    2. I am still trying to get comfortable with cargurus. My concern is that Cargurus is offering a better experience for the consumers as it ranks the search results based on how good the deal is to the consumer and it also labels the search results with monikers such as "great deal" and "good deal" very clearly. Cars.com doesnt do it because they dont want to piss off their dealers who really hates the inventory judging thing (unwilling to cannibalise themselves). While cars.com have added a soft version of the price transparency tool, it is not the same. And do you know how cars.com ranks its search results? is it influenced by how much the dealers pay them? While I agree that cargurus might be relaxing on the pricing side, can cars.com provide a better user experience?

    3. Cargurus is able to generate a huge amount of traffic because they are excellent with SEM & SEO. Any evidence that cars.com can do the same after they replatformed their IT system? Afterall more traffic means more leads = lower cost per lead

    4. Would you consider long Cars.com and short Truecar? Because of the big valuation gap (EV /REV @ TRUE is 5.6x while EV / REV @ CARS is 2.7x) despite cars.com being a better business than truecar (for now at least). You sort of take out the industry cycle risk also with this.

    Thanks!


    SubjectRe: Traffic
    Entry08/04/2017 12:47 PM
    MemberMencken

    I thought this was kinda neat -- the platform architecture rewrite does seem to have really sped up their software updates / new product offering rollouts. Two weeks ago I was looking at the site, and the Price Comparison Tool was just a static scatterplot with anonymous price listings vs. mileages. This morning I did the same search, and the Price Comparison Tool scatterplot is now dynamic (i.e. allows me to click through each of the "dots" to see the vehicle description page and the sale listing) and there is a CarGurus-like "good/fair/crummy deal" bar next to the scatterplot.

    Anyways, this is a round-about way of saying product innovation gaps have a way of closing w the right management focus & willingness to endure (traffic) pain. Time shall tell if the traffic gap closes, but ComScore data provides a live look into that sort of thing.

    As a side note, please be gentle when mocking me for looking at a Mini.