#019 - Vroom

Vroom is primarily an online used car retailer. It’s seen terrific growth over the past few years but it’s still unprofitable and is competing in a competitive industry with many notable companies.

Vroom - (NASDAQ: VRM)

Vroom is primarily an online used car retailer. It’s seen terrific growth over the past few years but it’s still unprofitable and is competing in a competitive industry with many notable companies.

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Industry Overview

Used car retailers (mostly online ones) have grown in popularity over the past couple of years and most recently this past year with COVID-19. One of the most notable companies (both loved and hated by longs and shorts) is Carvana. There are a handful of used car retailers that focus on selling cars mainly through the internet. Carvana, Vroom, CarGurus, CarMax, and some others. All of these companies have slightly different strategies and I’ll be covering each of them over the course of the next month or two.

Why does this opportunity exist?

First, buying a new car is expensive and as soon as you drive it off the lot, the value of the car falls off a cliff. Some people are frugal and may prefer to buy a slightly used car and suffer through some potential headaches to save a couple grand.

Second, people generally don’t like car salesmen. The incentives are misaligned. Car salesmen want to sell you a vehicle that gives them the most commission. I’d argue most people don’t like to negotiate and further do not want to negotiate a car salesmen who negotiates for a living. Buying a used car online reduces the negotiating piece and consumers can compare prices across different websites.

Third, Amazon exists and is a household name. People like to buy things online from inside their homes. What if buying a car was that easy? This behavior won't change overnight, but COVID-19 sure did help. Most of these online retailers offer some guaranteed return policy where you can drive the car for a bit and return it if you don’t like it. This might be better than just a simple test drive at a dealership. I think it’ll take some time and honestly might never happen because cars are expensive and people want to see them in-person first, but the same could’ve been said for furniture, appliances, or other expensive purchases 5-10 years ago but look at where e-commerce has penetrated today.

Business Overview

Vroom sells used cars and offers additional products on top of selling used cars like financing, insurance, and other costs associated with selling a used car (see below for more). Vroom sources inventory from “auctions, consumers, rental car companies, OEMs and dealers.”

Vroom employs an asset-light/hybrid approach where it works with 3rd party companies for some of their operational areas. Vroom still has some of these operations in-house, hence the hybrid approach. Vroom works with partners for logistics, reconditioning facilities, customer financing, and customer support. From what I’ve read so far, this is a major difference between Vroom and other competitors like Carvana and CarMax.

Why work with partners? Vroom believes it “provides flexibility, agility and speed as we scale our business, without taking on the unnecessary risk and capital investment inherent in direct investment.” I can see working with some partners as being beneficial but if these partners also need to make a profit on their relationship with Vroom, I worry how much those costs might pile up over time for customers.

More on the financials for Vroom, for the fiscal year of 2020, E-commerce, Wholesale and Texas Direct Auto (TDA) represented 67.4%, 18.1%, and 14.5% of revenue, respectively. Vroom purchased TDA in 2015 and serves as an in-person dealership.

The image below gives a good overview of Vroom’s revenue and gross profit calculation. Vehicle gross profit in 2020 is down ~50% from 2018 levels, but what has been the result of COVID-19 on this segment? I’ll touch on this more in the financials section as well.

Vroom is a much smaller company than Carvana or CarMax and therefore doesn’t benefit from scale as much as investors might like but that also means Vroom has more future growth potential.

Total Addressable Market

In Vroom’s S-1, the used automotive market is the “largest consumer product category” with over $841 billion in sales from 40 million units in 2019. One of the most interesting aspects of the used car market is how fragmented it still is and how companies like Carvana and CarMax still represent such a tiny portion of the overall market.

There are lots of inefficiencies in trying to sell a car without using Vroom, CarMax, Carvana, or others. For smaller, cheaper, and less important products like a book, you can buy it from neighbors, go to a yard sale, or look online on places like Facebook Marketplace. Buying a book from a neighbor who might’ve had some white lies won’t be too damaging to your bank account. Books with a couple rips or smudges aren’t ruined and at most you’re losing $20.

Used cars are expensive, important, could be the difference between life or death (ok I might be exaggerating here but you get the point), and you need to trust the other party’s words in order to have faith in buying their vehicle. Buying an awful used car will cost you thousands or tens of thousands of dollars so you want to make sure you buy the right car from the right person.

Another interesting perspective I heard from a podcast is that what if Carvana, CarMax, and Vroom, can make the average consumer purchase a used car more often or reduce the friction of buying and selling used cars. This is a purely hypothetical example and I’m just trying to explain a point, but if the average person drives a car for 6 years before selling it, but the ease of use of buying and selling cars to these retailers makes the average person more likely to trade the car in after only 5 years. This increases the number of used car units sold per years, and could dramatically improve the size of this market. I think this scenario is only upside and shouldn’t serve as the main thesis or even your bull thesis.

Competitive Advantages

  • Scale

    As Vroom is able to expand its infrastructure to support selling more cars, its margins should improve as fixed costs are spread over a larger base of units and profitability will likely (and hopefully) follow. Once Vroom has the infrastructure in place, competitors may be unable to compete on prices or the selection of cars because of scale advantages.

  • Brand

    I think there’s a lot of trust that will need to be established over time. Used car retailers are trying to get rid of the slimy car salesman. I wonder how important branding will be to some of these competitors.

    It seems to me that Amazon’s focus on customer service early in it’s life helped to make the switch from buying in-person to buying online so much easier. If Vroom or another competitor can build the trust necessary to make that switch from going to a dealership to buying a car online, then that brand will likely be vital to its success and its competitive advantages.

    Word of mouth can also head spread a brand’s reputation since you won’t be buying a car on Vroom as often as you’d be buying toilet paper on Amazon.

Financials

I’ll primarily be focusing on the e-commerce business unit within Vroom when looking at the financials. I think e-commerce is the most attractive and interesting part of Vroom’s financial statements. I could list out every single line item that I find important or could be relevant but then this would take up the whole writeup. Also the product revenue has 100% gross margins.

2020

  • E-commerce vehicle revenue = ~ 884.6 million

  • E-commerce vehicle gross profit = ~ 30.0 million

  • E-commerce product gross profit = ~ 30.9 million

  • E-commerce units sold = 34,488

  • E-commerce total gross profit per unit sold = ~ $1,765

    • E-commerce vehicle gross profit per unit sold = ~ $869

    • E-commerce product gross profit per unit sold = ~ $896

  • E-commerce revenue growth = 55.7%

  • E-commerce total gross profit margin = 6.6%

  • E-commerce vehicle gross profit margin = 3.4%

2019

  • E-commerce vehicle revenue = ~ 577.0 million

  • E-commerce vehicle gross profit = ~ 21.0 million

  • E-commerce product gross profit = ~ 11.1 million

  • E-commerce units sold = 18,945

  • E-commerce total gross profit per unit sold = ~ $1,696

    • E-commerce vehicle gross profit per unit sold = ~ $1109

    • E-commerce product gross profit per unit sold = ~ $587

  • E-commerce revenue growth = 95.3%

  • E-commerce total gross profit margin = 5.5%

  • E-commerce vehicle gross profit margin = 3.6%

2018

  • E-commerce vehicle revenue = ~ 295.4 million

  • E-commerce vehicle gross profit = ~ 16.7 million

  • E-commerce product gross profit = ~ 5.8 million

  • E-commerce units sold = 10,006

  • E-commerce total gross profit per unit sold = ~ $2,241

    • E-commerce vehicle gross profit per unit sold = ~ $1,666

    • E-commerce product gross profit per unit sold = ~ $575

  • E-commerce total gross profit margin = 7.4%

  • E-commerce vehicle gross profit margin = 5.6%

While some of these metrics look terrible because it’s decreasing from 2018 through 2020, I think they need to be taken with some understanding that Vroom (like many other businesses) is investing for the future and is hoping to gain operational leverage once the scale and infrastructure is in place. Of course, if you don’t believe Vroom is a great business, then these metrics might support your case but I don’t think it’s as easy as black and white.

What’s Interesting

  • Tiny current market share?

    Like I touched on above, the e-commerce penetration in the used car industry is miniscule. Even if this industry never reaches more than 5% e-commerce penetration, that’s still a 5x increase from today. That’s easy to say but hard to do obviously but I think the potential could be there.

    While I think there will always be some consumers who won’t ever be comfortable buying a used car online, there will be some consumers who are more comfortable buying a car online rather than in-person. There’s more negatives about buying a car in-person than there ever was about buying toilet paper at the local grocery store. I think if the friction of buying a car online continues to be reduced, more people will be attracted to using one of these companies. It’s up to the investor to determine which company (if any) to invest in.

  • Somewhat counter-cyclical?

    Used car retailers aren’t totally recession proof but if you want exposure to the auto industry without a complete collapse when the economy isn’t doing too hot, then I think used car retailers could be an attractive investment. While on one end of the spectrum, buying and selling cars is a cyclical business, on the other end, buying and selling specifically used cars rather than new expensive cars will have much less of an impact due to a recession than the broader market. So maybe not entirely counter-cyclical, but somewhat counter-cyclical.

    Most people would agree that cars are a necessity. During a recession or when the overall economy is suffering, people turn to cheaper options. One cheaper option during a recession is to buy a used car over a new car. In a perfect world without debt or unprofitable companies, used car retailers will suffer during a recession but will fare better off than dealerships or other businesses selling new cars through the recessionary period. Dealerships or other companies selling only new cares will suffer more than these used car retailers and won’t perform as well through the recessionary period but will have a greater return to normalcy than used car retailers once people have more spending money again.

Future Questions

  • Asset-light versus asset-heavy?

    One of the big differences I’ve noticed from just my initial research this week is that Vroom talks a lot about it’s asset-light and hybrid infrastructure and business model, but Carvana seems to have a much more vertically integrated business. Each setup has its pros and cons, but is there a particular strategy that helps to win the major of this industry’s market share?

    Do these differences lead to a profound impact on future margins? What about growth or competitive advantage? If Carvana has better infrastructure and more fixed costs that are hard to implement or copy, does that mean Vroom or other competitors can’t offer nearly as good of a deal as Carvana can?

  • Market structure in 5 years?

    Does this market remain fragmented in a couple of years with some of these online retailers only capturing a hundred basis points of market share or do these businesses grow large enough to capture a meaningful portion of market share in say 5-10 years.

    Also does this market turn into a winner-take-all market? This industry is different from software industries, but Amazon has cornered a large portion of the e-commerce market because of the investments in infrastructure and the supply and demand is matched on Amazon. This isn’t a perfect apples to apples comparison or anything since Vroom isn’t a marketplace but rather a retailer. The investments in infrastructure though and being able to spread those costs over a large base of units may lead to a cost advantage for one or more of these companies.

Conclusion

I’m not sure where I stand on Vroom and the rest of this industry. There are many investors who think some of these companies are a total fraud or wildly overvalued. This is my first week of working through the used car retail industry and I’m looking forward to learning more and getting some feedback.

The companies I have in this sector so far are:

  • Carvana

  • AutoNation

  • CarGurus

  • Cars.com

  • Shift Technologies

  • CarMax

  • Auto1 Group

If there are any companies I’m missing or that I should add to this list please comment below, DM me on Twitter, or send me an email at StratusYoung@gmail.com. If you’ve enjoyed this research, please feel free to share it with friends or colleagues.


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