In this second article of our “companies to watch” series, we discuss the recent IPO of Carvana (CVNA US). Who is Carvana, why did it’s IPO bomb and is it now a buy?
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At AtlasTrend, we aim to keep our members and investors informed and up to date on all our portfolio companies. We also continually monitor our investment universe for new opportunities for our Trend Funds including newly listed companies.
Although these companies may not currently meet our investment criteria for reasons such as valuation, we keep a constant eye on them in case circumstances change and we decide to add them to one of our Trend Funds. These are our companies to watch and in the second article of our new series, we discuss the recent IPO of Carvana (CVNA US).
Carvana is a online marketplace for the sale and purchase of used cars. Its point of differentation from its competitors is that it develops multi-level glass-and-steel buildings that are described as automated car vending machines, where customers can choose to pick up their purchased vehicle or have their vehicle delivered. The company offers free, next-day delivery to local residents in nearly two dozen U.S. markets.
Carvana raised US$225 million in its initial public offering (“IPO”) at US$15 per share in April 2017 giving it an initial market value of almost US$2 billion. At the time of writing, the shares are trading at US$11.35 per share or down almost -25% after trading to as low as US$8.72 in early May. It probably did not help that an analyst placed a US$10 price target on the company a week after its listing. With the current U.S. markets at all-time highs and a healthy IPO market, why did the IPO bomb?
Warning signs were there at the time of the IPO
In the last 4 years, private investors have invested into a number of online car re-sellers and marketplaces such as Carvana, Beepi and Shift Technologies. In fact, Carvana had raised US$460 million in private financing prior to its recent IPO with investors believing that like many other retail categories, these online car marketplaces could up-end the need for traditional used car dealerships. The investment thesis was partly based on the success of companies such as carsales.com (CAR AU) and Auto Trader Group (AUTO LN).
However, in late 2016, Beepi laid off 180 of its employees and closed most of its operations as it struggled to pay its creditors. To date, Shift Technologies has raised US$74 million in private financing and is likely to tap venture capitalists again later this year to fund its growth.
Carvana has lost money since its inception in 2012 including US$93.1 million in 2016 on US$365.1 million in revenue, which nearly tripled its revenue from 2015 according to its IPO prospectus. In the prospectus, Carvana also stated that it expects these losses to continue in the near term. Its IPO valuation equated to a price to current sales multiple of 5.4x, reasonable compared to already listed companies such as carsales.com at 8.6x and Auto Trader Group at 14.5x but these peers are highly profitable, cash generative and dividend paying.
So why have these start up online marketplaces struggled in the U.S. where others have succeeded in other parts of the world?
Certainly, competition is a significant factor from both traditional dealership groups such as Carmax (KMX US) to other online marketplaces such as privately owned AutoTrader.com, which shelved plans to IPO in 2013 and of course, Amazon.com which also sells cars online.
Further depending on the business model, online marketplaces for cars can require extensive funding especially if investments are required in physical assets such as Carvana’s car vending machines. Unlike other online product categories, which are generally smaller, deliverying cars can also be expensive and requires significant economies of scale before profitability can be reached. In this regard, Carvana’s IPO makes sense – the capital it raised along with the US$600 million that Ally Financial invested to fund its retail operations over the next year will allow Carvana to grow quickly to achieve those economies of scale.
In contrast, asset light businesses like pure online marketplaces that match buyers with sellers do not require as much capital expenditure or incur as much overhead costs. Auto Trader Group and carsales.com are good examples of this business model as is TrueCar (TRUE US), an online service that matches car buyers with dealers. Since it listed in 2014, shares in TrueCar have risen 92% and is forecasted to be profitable by 2018.
Is it now a buy?
We were not fans at the time of IPO and even with the stock 30% cheaper, we do not like the long-term prospects for such an asset heavy online business model that has a long path to sustainable profitability amidst rising competition.
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