Vroom.com IPO Prospectus analysis — A company driving through the COVID-19 pandemic
The Sars-CoV-2 virus that causes the disease called COVID-19 has hit every single aspect of our lives with an unimaginable death toll across the world. While fighting the virus, we learned and became overnight experts in ‘flatten the curve’, R0, ventilator technology, log charts and ‘social distancing’ techniques in a matter of weeks.
The pandemic has also caused tremendous economic impact from record-level unemployment rates to negative oil prices to spike in government spending to curb the menace of the coronavirus.
As a result of social distancing measures, the work of many has moved to their homes (at least for the ones who can afford to). According to a FED survey conducted in April of 2020, the percentage of people working from home in the U.S. increased from 7% in October of 2019 to 53% in April in the first tectonic shift of ‘The Sharing Economy’ in which consumers are incentivized to have access over ownership of almost any imaginable asset or service through digital platforms — from clothes to cars and from working spaces to furniture.
The COVID-19 pandemic ripped us all — physically, emotionally and financially — and it forced us to change the mental models we use in our daily lives. Many aspects of the sharing economy will be strained for the foreseeable future, and companies in the space are facing difficult decisions that may involve changing their business models until there is a ‘new normal’:
“there simply was no good news to hear. Ultimately, I realized that hoping the world would return to normal within any predictable timeframe, so we could pick up where we left off on our path to profitability, was not a viable option”
Dara Khosrowshahi: https://apnews.com/d9544a3d6f4cdc0f55197ec4b9fccc03
Some argue that the ‘new normal’ will be a ‘Low Touch Economy’ designed to reduce — or potentially restrict altogether — human interactions between consumers and employees. One segment that highlights this trend in the pandemic is the auto industry, where driving is reportedly down 16% while public transportation off by 72% since January 2020 according to the Apple Mobility Trends report. Understandably, people are avoiding taking subways and buses to escape gatherings for fear of contamination of the Sars-CoV-2 virus and are instead riding their cars for (non)essential destinations.
In ‘IPO land’ — one that has been effectively closed since February with some exceptions — a new listing from a company that is driving on the mobility trend has emerged.
Vroom.com, a New York-based venture capital-backed e-commerce car retailer company founded in 2013, has filled its prospect with the SEC in the first major consumer-oriented tech startup since Casper went public in Feb/2020 — in what feels like another lifetime.
INDUSTRY & COMPANY OVERVIEW
The U.S. pre-owned vehicle is a mature market with projected annual sales of approximately 41 million units in 2019, representing compounding annual growth of 2.4% from the last six years, in line with GDP growth.
The most significant channels for used cars are car dealers (120,000+ Used Car Dealers in the U.S. according to IBISWorld), e-commerce platforms (E-commerce share of total auto & parts revenues is 3.9%, among the least penetrated categories) and peer-to-peer. The company reported in its S-1 that half of used cars transactions were peer-to-peer with the remaining distributed across dealers. The top 100 car dealers represented 9% of total used cars sold in 2019.
At the same time, over the last six years the average transaction price for used cars topped $20.6 thousand ($20,618 to be precise) last year, growing at over 3% per year with the increase explained by two factors: (i) average vehicle age is decreasing and (ii) shifting buying patterns from buying less non-luxury cars to SUV that are more expensive.
One of the major consumer preference factors to buy a pre-owned vehicle is the total cost of ownership. Used cars have on average a lower purchase price, lower insurance prices, potentially lower depreciation (cars tend to have higher depreciation rates in the first years of ownership) and the Internet has allowed consumers to retrieve a car’s ownership history and e-commerce platforms that enabled the discovery of sellers who don’t sell through a car dealership, two major pain points in the purchasing process.
In this highly fragmented market with thousands of regional car dealers and countless ecommerce sites, Vroom was founded four years after the 08–09 great financial crisis to “build the world’s premier platform to research, discover, buy and sell vehicles”. Over the last six years, the company has built functionalities in the website and bought a company to offer its vehicle reconditioning center (“Vroom VRC”) to differentiate itself.
The business model of a used car dealer starts with the sourcing of inventory: it actively engages in and purchases cars at vehicle auctions, with rental car companies that frequently renovate their fleet and with other car dealers. Just like a financial analyst compares past performance of a company against similar businesses to understand how well it is run, Vroom evaluates a basket of ‘most sellable’ used cars in the market. Some metrics include model, year and mileage of a car, inventory turnover of similar vehicles, and the data science models are primarily created to maximize its profit (or GPPU — Vehicle Gross Profit per Ecommerce Unit, which we will discuss in the finance section). In a 2016 blog post, Vroom claims that:
“More than 80% of the cars for sale on Vroom are less than three-years old. The remainder are vehicles that we’ve thoroughly checked out and are supremely confident will run and run for years to come.”
In the S-1 prospectus, the company updated the information disclosing that the average year of its inventory is five years and the majority of the inventory is priced at above $20,000.
Once a vehicle is identified and acquired but before it is listed for sale in its platform, Vroom leverages a network owned and third-party vehicle reconditioning centers to repair each car. As of March 2020, Vroom’s reconditioning capacity is 326 daily units, up from 235 vehicles in March 2019. As the company continues to expand its VRC capacity output and geography footprint, it can explore additional economies of scale with auto parts (bulk purchases) and shipping costs (lower distances to and from destinations) to increase its gross margins. Simultaneously, by increasing its ability to retrofit more vehicles, it can improve its ability to offer a larger inventory of vehicles for potential buyers to target new segments and new geographies.
A look at the map below shows how underpenetrated Vroom is in key markets in the Northwest, Northeast and the South. I counted a total of 14 VRC (the company doesn’t report the number in the prospectus), with only one owned in Houston, TX. Just like Amazon expanded its shipping abilities when it increased its owned distribution centers, I suspect Vroom is heading to the same direction.
Consumers can browse through the thousands of retrofitted cars and even choose among different financing options within the platform through Vroom’s partnership with Santander, Ally Financial and Chase (some of the largest auto lenders in the country).
Vroom’s flywheel is powered by the growth of its inventory and the perfection of the customer journey road, from website, to financing, to logistics and delivery. Over the last two years, the number of monthly units sold increased from 818 in January of 2018 to 2,880 in April of 2020, during the outbreak of the COVID-19 pandemic throughout the U.S. In the financial section below, we will analyze the impact of the increase in scale into Vroom’s margin.
Ecommerce, though, is only one of the three channels that Vroom.com uses to sell its vehicles. The other channels include (i) their retail store in Houston and (ii) via wholesale auction sales. Sales from the last nine quarters clearly demonstrate a shift of sales channels. In Q12018, wholesale units represented 42% of total sales, down to 30% in Q12020. In the meantime, ecommerce sales increased from 24% to 51% in the same period. Typically, wholesale have lower profit margins compared to ecommerce, and although Vroom has not provided many quarterly financial data points yet, we will cover how gross profit margins vary by channel.
Vroom.com has built its leadership team around nine people, three of which are women, including the head of retail. On Glassdoor, the company has a below average 60% CEO approval and only 38% of employees would recommend to a friend (I am aware that these sites are not scientific, but it can be a decent data point when looking at the broader picture). None of the nine leaders are with the company for more than 5 years including four who joined after 2018. This is normal for a startup company that faces ups and downs, from layoffs to founder departures.
Founders Marshall Chesrown, Kevin Westfall, Scott Chesrown and Allon Bloch have all left the company sometime in and after 2016 to start new entrepreneurial journeys, when I assume the company might have hit the break between series D (Dec/15) and E (Sep/16). For instance, read what Michael Farello, Managing Partner at L Catterton and board member at Vroom, said during vroom’s CEO replacement announcement on Jun/16:
“We are grateful to Allon, a visionary CEO who has transformed Vroom into the most compelling online car store in the world, generating more than $1 billion dollars in annual revenue. As the business continues to scale (…)”
At face value this seems like a regularly issued letter from investors congratulating a founder who grew an idea to a billion-dollar revenue business. However, the $1 billion revenue is essentially flat compared to the 2019 numbers, and while Vroom.com has not provided financial statements back to 2016 in this version of the prospectus, I’ll update this article if and when the company reissues it, but I assume that they hit reverse for about three years before posting the same billion dollar revenue.
When looking at the issue price of each round of equity financing, it is clear that Vroom repositioned itself after the CEO replacement in 2016. And although it has not faced down-rounds since its founding, the firm likely faced slower growth and changes in direction over the last couple of years given the slower uptick in issue price from Series E to Series F and Series G rounds.
The company formed a 7-member board of directors with a mix of investors (4), independent (2) and the CEO and elected the two only women on May 2020. Additionally, there are no major conflict of interest reported in the prospectus except that there is no ‘Related Person Transactions’ policy in place.
FINANCIALS & COMPARABLES
To check against Vroom’s performance, I’ll compare it to a basket of comparable public-traded companies including AutoNation (AN), CarMax, Carvana and CarGurus. While they share similarities with Vroom’s business model, they are concurrently equal in many senses and uniquely different in others. AutoNation has a much broader size and scope (it is a supplier, competitor and investor in Vroom), CarGurus primarily serves the industry through a marketplace for peer-to-peer activity and CarMax has a broad reach of retail operations. This comparison analysis will provide with a broad perspective of the used-vehicle industry and the performance according to different business models.
Because the auto industry is so mature and stable, companies fight to become operational efficient in every level and Vroom is no different. In fiscal year 2019, 80% of the revenue originated from retail operations (ecommerce plus retail), with the balance accounted for wholesale auctions and value-added services sold at their retail store. Gross margins decreased from 7.1% to 4.9% in FY 2018 and 2019, respectively.
A closer look at gross margins per sales channel (see table below) shed light on the reasons of the decline. Gross margins from ecommerce and retail are significantly higher than that of the wholesale business and the retail channels have experienced lower decreases in margin during the pandemic. As Vroom continues to prioritize its retail channels over wholesale for future growth, we can keep a closer eye on their margins.
Another way to analyze its gross margins is to observe the variable cost associated with the vehicles. Net of purchase price, reconditioning accounts for an increasing percentage of the total ecommerce variable expense (from ~60% in Jul/19 to ~70% in Dec/19) even with flat auto part expenses because shipping has materially decreased over the last couple of months as Vroom expands its VRC network.
Now, the comparison of Vroom’s Gross Margins with its competitors paint a dark frame. It is 1,000bps lower than that of the other traditional car retailers (CarMax, AutoNation and CarGurus) and orders of magnitude lower than that of Carvana, which post 90% gross profit margins because of its asset-light peer-to-peer marketplace model.
Among the five companies in our cohort, Vroom and Carvana have negative EBIT for their choice of prioritizing revenue growth and sustained investments over profit margins with the promise of future profitability.
While sacrificing profits over growth is a popular decision among tech companies, this is a particular difficult tradeoff to achieve in an industry that punishes incumbents with no differentiation. Vroom will continue to invest in sourcing and logistics to accelerate its ecommerce growth, and YoY sales growth validates that decision. Vroom grew in excess of 50% in Q1'20 compared Q1'19 and only Carvana grew at a faster speed over the previous quarters.
The journey for a company that files to become a public company, albeit intense, is only the outset of a rare trip. To put it in perspective, 2020 marks 16 years (!) since Google went public with 961 million in revenue in 2003 and last year it achieved over 161 billion in 2019.
For Vroom.com the 7-year road trip was bumpy with layoffs, founder departure and several rounds of financing until nailing the right business model and experience top line growth over the last couple of years. The COVID-19 pandemic is another rock on Vroom’s road and investors will keep a close eye on its ability to improve margins while continuing to experience growth in this highly competitive market.
PS: We tell our kids not to take candy from strangers so don’t take this article as financial advice.