Description

Autoweb is a turnaround situation. Its closest public peer is Truecar. Both firms identify consumers that are researching new cars on-line,  and sell these “consumer leads” to auto dealers to help them sell new vehicles. The table below shows that both Autoweb and Truecar reported  about $15 million in EBITDA in 2016. In the next two years EBITDA rose 120% at Truecar, while Autoweb blew-up. Mediocre management allowed profits to plummet so that Autoweb will lose about $13 million in EBITDA in 2018. As a result Truecar today has a market of $765 million, which is 17x times the market cap at Autoweb. The good news is that a new management team at Autoweb has a strategy in-place,  that if successful, will lead the company to record profits and a $12- $13 stock price.

Autoweb competes for a share of auto dealers  and OEMs overall marketing expenditures within the online and offline media marketing channels.  The auto industry spends over $15 Billion/year on marketing so Autoweb with $120 million in sales is a tiny factor in this industry. On-line competitors include Truecar, CARS.com, Edmunds.com, KBB.com, Autotrader.com, Cargurus.com,  and the Google Search engine. Off-line media competitors include newspapers, radio, TV, direct mail and billboards.

Autoweb’s Competitive Advantage:

Retail Auto dealerships purchase $5 Billion annually of web based leads that put them in touch with consumers that are shopping for a new car. The average price of a new car lead is about $24, but some leads are of higher quality than others. At TrueCar only 8% of leads result in a new car purchase within the next 90 days.  At Autoweb 17% of leads result in a new car purchase over the next 90 days. Thus auto dealers spend $300-$350 on leads with Truecar to generate a new car sale. Autoweb can generate a new car sale for a dealer by providing them with half the number of leads compared to Truecar. Thus Autoweb can save retail auto dealers up to 50% in spending on leads compared to Truecar. With such a competitive advantage it is remarkable that Autoweb has performed so poorly in the past few years.  

Explaining Why Autoweb Profits Collapsed in Two Years (2016-2018)

In the past two years Autoweb’s sales fell by $35 million.  Gross margin dollars fell by $41 million and EBITDA declined by $28 million.

The collapse in gross margin dollars was driven by a shift in the mix of product sales from high margin “retail leads” with  an estimated 50% GM to lower margin “OEM leads” with a 17% GM. The former incompetent management team incentivized the sales-force to maximize the number of leads sold, not the gross margin dollars generated. This encouraged the sales-force to sell lower gross margin leads to the auto OEMs and ignore the more profitable auto dealers.  The table below shows that retail leads are priced at $20 per lead, a 67% price premium to OEM leads. On a gross margin dollar basis Autoweb earns 400% more selling a retail vs an OEM lead. Nevertheless, the former management team had the wrong incentives for the sales-force. Revenue from retail leads fell to 19% of revenue in 2017 compared to direct competitor Truecar where 87% of sales go to the retail auto dealers at much higher gross margins.

Cost of goods also rose materially in the past two years,  even  while sales were declining.  Consumers changed their shopping habits from browsing on their desktop computers to using their smartphones. This is a problem since Autoweb never upgraded their websites to be mobile centric.  Consumers would visit a desktop oriented Autoweb website on their small smartphone screen. Autoweb wanted consumers to fill in a form with information such as the make and model of the vehicle they are interested in plus the consumers name and email address.  Filling in the form became difficult when the form does not conform to the smartphones smaller screen size. Many consumers would abandon Autoweb’s landing page which resulted in media costs, aka cost of goods, rising.

Autoweb has a simple business model.  A sales-force obtains monthly purchase orders from retail auto dealers and OEMs to deliver “digital leads.” Autoweb then uses search engine marketing (SEM) to connect with consumers that are researching new vehicles on the internet.  A consumer will be directed to an Autoweb landing page and asked to fill out information about themselves and the vehicle they are interested in purchasing. If the consumer clicks an X on the browser to abandon the “lead form, ” a second page will appear underneath  that can redirect consumers to other websites like Edmunds.

Autoweb sells the filled-out forms called “leads” for $10-$26 each.  The “clicks” or redirected traffic on the second landing page earns about $1 per click.  The 2017 mix of sales at Autoweb was 76% rev from leads and 24% from clicks. The cost to generate one lead or one click is about the same. Thus the key to profitability is to sell the lead at the highest price,  which is usually paid by retail auto dealers. The problem at Autoweb during 2016-2018 has been the negative mix shift to products with much lower prices and lower gross margins.

New CEO:

Jared Rowe joined Autoweb as its new President & CEO on April 12, 2018 He is an excellent choice to lead Autoweb, given his twenty years working in digital marketing in the auto industry.  Ironically, Mr. Rowe worked at Autoweb in 1998-1999. Thereafter, he was on the FordDirect team that grew sales from zero to $100 million/year. He was also the President of Kelley Blue Book (KBB), a direct competitor,  where sales and EBITDA nearly doubled during his three year tenure. Mr. Rowe has spent his first year at Autoweb identifying the problems, establishing a turnaround plan, and hiring a new executive team to implement the plan.

This Turnaround Has Alot Of Upside:

The Autoweb that Mr. Rowe inherited was a mess, but he took the CEO job because he saw a big opportunity where he had the skill-set to achieve a successful turnaround.

So let’s look at the Autoweb upside scenarios:

Scenario: #1   Margin recovery

The company is losing money right now, but in 2015 a badly managed Autoweb reported $16 million in EBITDA.  The most direct public peer Truecar is valued at 14x 2019 EBITDA,  and Cars.com trades at 11x 2019 EBITDA.  In a profit recovery to $16 million EBITDA at a 10x EBITDA Multiple, Autoweb  would be value at $160 million or $12.31/share, plus $1 cash/share. That’s a potential return of 250%.

Scenario: #2    Higher Realized Prices

Truecar and Autoweb each help auto dealers sell about 1 million new cars every year with the use of their digital leads. Truecar charges dealers $300-$350 for every new car they help the dealer sell.  Autoweb only generates about $120 per new vehicle they sell. A larger mix of “retail leads” could allow Autoweb to realize $160 in revenue per new vehicle sold. I will assume that 75% of the extra

$40 million in annual retail sales drops down to EBITDA. Thus we arrive at a potential turnaround with  $17 million in EBITDA {($13M loss) reported in 2018 + $30M EBITDA added from retail leads)}.  Place a 10x EBITDA multiple on this profit and you have a $170 million enterprise value or $13/share.

Scenario: #3  Market Share Gains

Autoweb is a tiny player in the USA auto industry. Their $120 million in sales is only 2% of the $5 Billion+ spent on digital marketing to sell 16+ million new cars nation-wide every year. Cars.com generates $650 million sales/year with Truecar reporting $350 million sales/year. A higher caliber management team has the opportunity to introduce improved products that drive market share gains and record profits for Autoweb.  Cars.com reports over $200 million annually in EBITDA so you can see how profitable Autoweb could be. Nevertheless, we think Autoweb is a great investment based on Scenario #1 or #2.

Clearly,  the new CEO Jared Rowe thinks there is a lot of upside. He negotiated a compensation plan that emphasizes stock options far more than cash compensation.  He was awarded 1 million stock options at a strike price of $2.36/share in April 2018. Today, the Autoweb turnaround has progressed nearly one year and you can still buy shares at a similar level to Jared Rowe’s stock option strike price.

We have entered the second phase of the turnaround in 2019. We do believe it is possible that Autoweb could be at a $15 million EBITDA run-rate during 2020.  By comparison sell-side analysts are still forecasting that EBITDA in 2020 at Autoweb will be negative. Below is an explanation of what is likely to take place during each phase of the turnaround.

Phase One – 2018

Identify the problems at Autoweb that have led to the companies miserable performance.

Develop a strategic plan to lead the company to a recovery.

Hire a new senior management team to implement the strategy.

Phase Two – 2019

Drive a margin recovery by selling “retail leads” to auto dealers at higher price points with higher gross margins.

Double sales for “advertising clicks” (25% of rev) by selling clicks at $2-$3 versus $0.81 today.  Higher priced clicks occur when Autoweb is able to forward traffic to auto related web sites vs web sites not involved in the sale of new cars.

Improve distribution  by changing the sales-force incentive compensation plan to encourage them to open accounts at additional auto dealers.  Raise the conversion rate at the sales-force by allowing them to customize contract pricing terms with each dealer. Boost the average revenue earned per dealership  by targeting the largest auto dealers as customers.

The top 150 dealers in the United States sell 25% of all new vehicles, but few of these “Big Dealers”  are Autoweb customers. These “Big Dealers” purchase about $1 Billion of leads annually, but the prior management team failed to target this attractive customer segment.

Phase Three – 2020

Upgrade Autoweb’s  “lead products” to be mobile centric.

Mobile centric forms could boost EBITDA by $15 million in the year they are introduced. Media costs could fall by $10 million as fewer consumers abandon landing pages that are easy to fill out on a smartphone. As more lead forms are completed Autoweb could sell $10 million of additional  leads to the auto dealers at a 50% Gross Margin.

Further improve margins by reducing media acquisition costs which will reduce cost of goods.

A larger percent of consumers will fill out the mobile friendly forms, resulting in  higher sales of leads.

Launch better products for auto dealers  to help Autoweb keep up with the on-going  digital marketing innovation in the auto industry.

Insider Buying:

Three insiders have purchased shares in Autoweb in the past six months. The new CEO Jared Rowe was one of the buyers. He purchased $50,000 of shares at $3.64/share. The other two buyers were board members.

Attractive Valuation:

New Senior Management Team:

Jared Rowe has been very busy hiring a new management team during his first year at Autoweb.

In the past six months new hires has taken place in the following positions:

Chief Operating Officer, Chief Technology Officer, Chief Financial Officer, VP of Strategy, VP of Human Resources.  A number of the recent hires worked with the CEO Jared Rowe in the past which is usually a good sign. Employees that follow a former boss to a new workplace must think highly about them.  

RISKS:

New Car Sales Have Peaked On A Cyclical Basis:

New car sales in the United Stated have been growing since 2008,  and unit sales may have peaked in 2018. New car sales in 2019 are forecast to decline by 200,000 units to 16.8 million. In a shrinking market there will be auto dealers  spending less money in marketing. An even worse situation would be a recession where consumer spending on capital goods such as car and SUVs can decline by over 10% in a year.

Rising Interest Rates Increase The Cost Of Cars:

Nearly half of consumers finance the purchase of their car and do not pay upfront for the vehicle.  

Thus rising interest rates will make a car more expensive. The higher interest rates in 2019 could very well be the cause of the decline in new car purchases year to date in 2019.

New Car Sales Have Peaked On A Secular Basis:

Uber and Lyft may convince consumers to discontinue purchasing new cars.  This is a more serious risk for Autoweb as it would result in a secular decline in marketing dollars spent by auto dealers and their OEMs.

Competitors May Launch More Innovative Products:

At the January 2019 (NADA) National Automotive Dealers Association Convention a host of new marketing products were introduced by private companies. We already know that Autoweb’s current technology is sub-par.  Autoweb has plans to improve its products, but most likely this does not take place till 2020. There is plenty of opportunity for smart programmers to create better software products to sell new cars. Competitors spend much more money on R&D than Autoweb, so I am concerned that they could launch better products that hurt Autoweb.  Autoweb has hired a new chief technology officer, but it will take time to upgrade the firm’s technology capabilities.

Catalyst

Quarterly Earnings should improve seguentially during 2019.