TRUECAR INC TRUE S
August 22, 2014 - 5:28pm EST by
reid3235
2014 2015
Price: 20.90 EPS ($0.06) $0.10
Shares Out. (in M): 86 P/E NM 218x
Market Cap (in $M): 1,806 P/FCF NM 223x
Net Debt (in $M): -112 EBIT -37 -38
TEV ($): 1,694 TEV/EBIT NM NM
Borrow Cost: NA

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  • Auto software
  • Network effects
  • Internet
  • Lead generation
  • Recent IPO

Description

Background
TrueCar is a consumer focused online car-buying service that provides consumers with no-haggle prices on new and used vehicles through its relationship with ~7,700 dealers.  Essentially, it is a lead generation vehicle (pardon the pun) used by car dealerships and operated through both the company's TrueCar.com website and TrueCar-powered car searches with "affinity group marketing partners" such as USAA, Consumer Reports, AAA, American Express and PenFed.  Consumers who search for cars through these portals are able to build the exact cars they want and shown a "good" price based on market data TrueCar has collected from its dealer partners; then, after entering personally identifying information, they are emailed price quotes from partner dealerships.  In most instances, TrueCar is paid $299 by partner dealers if one of its quotes leads to a new car sale ($399 for a used car).  Its lead-gen model violates franchise laws in some states, which requires TrueCar to charge dealer partners in these states on a monthly subscription basis (although monthly subscription rates are raised/rebated so the effective revenue to TrueCar roughly equates to the $299/$399 unit-based pricing model).  For leads generated through one of its partner sites, TrueCar rebates the site a portion (~$80-$85 for most partners and ~$100-$110 for USAA) of the revenue it receives on each sale.
 
Quick Thesis
  • At 221x '14 adjusted EBITDA, excluding the stock comp that represents a low-teens % of sales (and 66x consensus '15 adj. EBITDA assumptions that I think are materially too high), the stock is incredibly expensive for a service that already captures 3.4% of all new car transactions in the U.S. and, according to the company, ~15% of the sales of its 7,700 dealer partners, and I believe it operates primarily as a mechanism for shifting marketing expense from dealers to TrueCar, leaving TrueCar with limited structural earnings power, as it must spend to keep acquiring new customers who hold onto their cars for an average of ~70 months (i.e., repeat business is relatively insignificant).
  • Customer reviews are lousy, the market is competitive (edmunds.com, autotrader.com, cars.com, kbb.com, Costco, and a bevy of others offer similar services), its dealer customers are agnostic about their lead sources (i.e., most are on multiple platforms), and many dealers are aggressively rolling out or updating their internet sales channels to reduce reliance on expensive third-party lead gen sources, especially given that increased pricing transparency has reduced new car margins.
  • Given that dealers must pay TrueCar $299/$399 for each transaction, consumers are, by definition, paying more for cars than they'd have to pay if they simply walked into the dealership and haggled.  That being said, every dealer with whom I spoke said the average gross sales price on TrueCar transactions is marginally less than the average gross sales price on walk-in sales.  The consequence of this dynamic should be obvious; if/as TrueCar grows its share of car sales, dealer gross margins will decline unless they raise prices to TrueCar customers, which will create an even larger air pocket between TrueCar prices and walk-in prices that are not subject to $299/$399 fees to TrueCar.
Key Issues
The evidence suggests TrueCar is simply a pass-through vehicle for dealer marketing dollars, and its customer acquisition cost is not declining.  Dealers spend a fortune on leads through various forms of media (e.g., television, radio print, display, etc.).  TrueCar brings dealers leads, but it spends a lot of money in order to attract car buyers.  If you simply divide TrueCar's Sales & Marketing expense by the number of units sold in a given quarter, it appears that it spending $223 for each unit sold through its platform in Q2, and the cost appears to be rising (if four quarters in a row makes a trend) or, at the very least, not declining, while monetization per unit has remained in the $280-$310 range.

  1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14
Total units sold 59,455 48,413 54,228 60,587 72,871 96,614 116,503 113,931 125,980 149,527
Sales & Marketing expense $27,205 $16,607 $11,290 $15,225 $13,783 $15,626 $21,878 $23,893 $75,180 $33,292
S&M expense / unit sold $457.57 $343.03 $208.20 $251.29 $189.14 $161.74 $187.79 $209.71 $220.41 $222.65

TrueCar's marketing partner relationships are the gem of the business, as the leads come through its partners' sites, and TrueCar just kicks back a portion of any sales commissions to its partners. I believe the $75+ kick-back to marketing partner-generated leads only captures part of the economic leakage, however.  USAA is, by far, the largest partner, representing 43% of total unit sales (and 58% of all partner sales) in FY13, and in May, TrueCar extended its relationship with USAA through 2020.  We don't know the exact terms of the renewal -- although suffice it to say that USAA had/has significant leverage over TrueCar given its share of sales -- but the company reported in its 2Q filings to have provided USAA with 1.46M warrants exercisable in $7.95/$15.00 tranches.  As a 22% shareholder of TrueCar, USAA likely has incentive to stick around as a partner, especially given that it has received ~5M in warrants over the years, but given the dilutive effects, TrueCar has clearly been paying more for USAA leads than the reported expense.  

Given the risk of losing marketing partner relationships and as an effort to grow its brand and share of revenue per lead (i.e., keep all the economics), TrueCar has been heavily advertising to move consumers to its owned site, TrueCar.com.  (I'm sure U.S.-based people on this site have seen their ubiquitious TV ads.)  I believe this effort is proving to be quite expensive.  If I back the assumed average expense of ~$90 per marketing lead out of the company's sales & marketing expense line, the company spent $442 per converted lead from TrueCar.com in 2Q versus $420 in 2Q13.  While this approach is admittedly quite crude and likely commingles some marketing partner advertising expense with TrueCar.com marketing expenses, even allowing for some error, the math doesn't seem to work; and given the mediocre reviews and average length of time between new car purchases, I struggle to understand how the company will gain enough scale to make this business sufficiently economic to justify what is nearly a $2B market cap.  As an aside, a DC-area dealer with whom I spoke who was a customer primarily because his region had significant overlap with military/USAA customers (the latter of which he admittedly described as quite valuable), described TrueCar.com leads as "total garbage" and said the TrueCar salespeople with whom he "argues every month" over lead costs (because he's a subscription customer) have admitted as much to him.

TrueCar's relationship with dealers is tenuous at best, and most of the dozen-ish dealers with whom I spoke view the company as "one of many" lead gen sources.  CEO Scott Painter is a serial entrepreneur who has founded 37 companies, and his track record is very spotty.  In 2011, TrueCar leveraged its connection to the dealership management systems of its dealer customers (a requirement for dealers on its platform) to pull sales transaction data and power a marketing campaign telling consumers how much they could undercut dealer pricing (i.e., how low they'd go).  This, along with various state investigations into whether TrueCar was acting as an illegal broker, caused its dealer network to shrink by 1/3 and vehicle sales through TrueCar.com to fall 80% through the first three months of 2012.  Painter admitted his mistake, blamed his own "arrogance" for the issues, and changed the platform to comply with state laws (i.e., the move to a subscription-based model in certain states) and provide less specific pricing data, which now tells the consumer what a "good" deal is versus the "best" deal. 

Still, only one of the dealers with whom I spoke was using only TrueCar for lead gen purposes, and the general sentiment was TrueCar leads were moderately economic for dealers. Interestingly, probably half of the dealers said there were internal efforts underway to reduce reliance on third-party lead gen sources and bone up their own internet lead gen capabilities. Another common theme was the claim that TrueCar had or was overcharging dealers and/or claiming fees for leads generated by non-referred clients, as apparently TrueCar's billing system matches leads from its database with sales from dealers' DMSs based only on the customer's first and last name, rather than on unique identifying data. One particularly disgruntled former customer told me he "found a 20-30% margin of error on their invoices between customers we already had and other 'computer glitches' on their end."

TrueCar's growth might be its own undoing.  As I mentioned, dealers uniformly told me the sales price on a TrueCar-initiated sale was, on average, slightly lower than an off-the-street sale, which suggests the gross profit dollars reaped on a TrueCar sale are at least $300 lower (and probably $500-$700 lower, on average).  While this in some way validates the business model from a consumer standpoint, as/if TrueCar grows as a % of a dealer's sales, the dealer will necessarily have to raise his TrueCar pricing to compensate for the lower sales price and $299 fee and depressed, at which point TrueCar ceases to provide particularly good pricing.  Given that TrueCar already accounts for ~15% of the transactions occurring at the 7,700 dealers in its network and the company views its optimal coverage as 11,000-12,000 dealers, I suspect we are not far away from the point at which the TrueCar "deal" is not a deal at all -- and the company's reviews would suggest many consumers have already figured it out.  

Another angle to this argument is, according to NADA, dealers spend an average of $604 marketing new cars, so TrueCar is only economic to the extent that a TrueCar sale (and its accompanying $299 fee) is not priced dramatically lower than the dealer's average non-TrueCar-iniated sale and/or TrueCar generates significantly greater sales velocity to dealers, the latter of which does not appear to be the case per my conversations with dealers.

The company is also involved in the used car market, and although I've seen sell side estimates suggesting mix of up to 20%, the data suggest it's actually closer to 10%.  In general, the model does not seem to lend itself well to used car sales given the additional variables involved in comparing used cars (e.g., mileage, condition, etc.).  TrueCar has also talked about adding ancillary services such as financing, but, when asked about it, dealership owners told me in no uncertain terms that the company would face severe backlash if it also attempted to eat into their financing business/profits.

Valuation
The stock is absurdly valued.  On consensus #s (which I believe are too high), it trades at 221x FY14 adj. EBITDA and 66x FY15 adj. EBITDA, which is likely due in part to a low-float-induced short squeeze.
 
Just to sanity check myself, I assume TrueCar captures 10% of the 16M annual U.S. new vehicle market, which implies they grow their dealer base by roughly 50% (to their optimal 11-12K) and capture 30% of all sales at these dealers.  I also assume they lower their CAC to $175 from my calculated $223.  In this scenario, which I consider the uber bull case, the stock is trading at 14x adj. EBITDA, with the additional caveat that stock-based comp will likely run ~13% of sales this year, so ongoing dilution should be significant.
 
Annual U.S. vehicle sales ('000s) 16,000  
TrueCar Share 11% I'll add another 1% to account for used car mix in TrueCar
Annual TrueCar leads 1,600  
Value per lead $310 $299 new / $399 used, so around $310 blended at a 10:1 ratio
Revenue $545,600  
Gross margin 92%  
Gross profit $499,244  
     
Sales & marketing expense per lead $175 $223 in 2Q
Sales & marketing expense $308,000  
     
Cash opex $70,000 Currently ~$60M
Adj. EBITDA $121,224  
     
EV
$1,694
$20.90 stock price / 86.4M diluted shares outstanding / $111.8M net cash
EV / EBITDA 14.0x  
 
 
 
 



















I think a more realistic estimate would be something like 7% total new car penetration (add another 1% for used cars) with a $190 average cost per lead, which, holding all other variables constant, puts the stock at 34x adj. EBITDA in this several-years-out scenario, which works out to $8-9 at the 12x adj. EBITDA that I consider a more reasonable multiple.
 
It's also worth pointing out that, the day after releasing its 2Q earnings report, this company issued a press release I can't recall having ever seen in which it said it was "correcting erroneous media reports misstating that the Company failed to meet analyst consensus EPS estimates" and in which it argued that its non-GAAP EPS was in-line ($0.02) and it's GAAP EPS ($0.22) beat consensus by a penny.  In my experience, companies that respond/react to Wall Street drivel are great short candidates.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • IPO unlock (mid-November)
  • Increased visibility into the company's inability to generate significant sales & marketing leverage
Risks
  • Limited free float at least until IPO unlock creates high borrow cost and/or squeeze (although think we're already there on the latter)
  • Company is able to build its brand/mindshare such that it's able to materially reduce CAC
  • Ancillary products gain traction and don't piss off dealer customers
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