Description

Value with a soft catalyst. Motorpoint is a UK used car retailer run by an excellent CEO who owns 10% of the company. The stock trades at 10x P/E or 4x our three year estimate despite having net cash, and we think the company is likely to launch a substantial buyback at some point. This opportunity exists because the stock trades £100k/day and Motorpoint launched a new strategy last year to invest to grow market share, in online sales, and roll out more stores, which will result in depressed profits in the short term. Investors have not bought into the strategy, with the stock halving since its peak last year. Despite this, management recently decided to further accelerate investments as they think the strategy is working and key competitors are struggling.

Situation Overview

Motorpoint has been written up on VIC several times before, so this writeup will focus on the company’s significant change in strategy over the last 12 months and how investors are underappreciating the higher market share and profits that the company’s increased investment in marketing and tech will bring. 

As a brief background, Motorpoint is a UK used car retailer selling vehicles under four years old. The company is run by CEO Mark Carpenter, who owns 10% of the business and has high integrity, excellent customer focus, and a strong focus on long term value creation. Under Carpenter, Motorpoint sells cars at below market prices, provides good customer service, turns stock quickly, and has grown from 9 stores at their IPO in 2016 to 17 today. Unit economics are very strong with IRRs on new stores and ROEs typically between 50%-75%. Meanwhile 40% of retail sales are already made online or on the phone. 

Despite these attractive economics, the company historically only opened one store per year as the Chairman Mark Morris preferred to focus on shorter term profits, thinking this would support the stock. That attitude changed over the last twelve months with Morris exiting and new Chairman John Walden freeing Carpenter to move forwards with a plan to open 3-4 stores per year and invest heavily in IT and marketing to grow the online retail business to over 50% share by FY25.

Over the last few years, a significant competitive risk also emerged with pure-online retailers like Cazoo, Cinch, and Carzam making unprecedented investments in marketing to funnel customers towards buying cars entirely online.

Unfortunately for the newcomers, the dominance of Autotrader in the UK and the country’s geographic density makes a purely online business less advantageous than in the US. Meanwhile, investor perception of rapidly growing but loss making companies has deteriorated drastically. As a result, Carzam ran out of funding and shut down while Cazoo has seen its share price decline 90% and may also run out of funding over the next year. 

On the other hand, Motorpoint reported its highest ever earnings of 19p/shr for the fiscal year ending in March despite facing enormous marketing campaigns, a record breaking decline in car supply, and Covid restrictions. While rising used car prices certainly helped, the point is the company weathered the storm with relative ease. 

With its competitors now fighting for survival, Carpenter told investors in June that Motorpoint plans to accelerate its investments. The company laid out various new metrics they claimed show the new strategy is working and that they should invest quicker. While we agree with this conclusion, we do not think the case has been laid out well. Investors clearly have not bought into short term profits being suppressed even further, with the stock having halved from its peak last year. One VIC comment recently summarized the market’s reaction well: “the revenue picture does looks solid, the NPS is phenomenal, the management seems very strong for a business of this size BUT the shareholder is being asked to be awfully patient if the company is reinvesting so aggressively that it's going to see PBT shrink over the last 7 years (assuming FY23 ests are right)”.

Below, we try to lay out in detail the types of calculations we believe Carpenter and his team have done. We:

• Split the UK nearly-new vehicle market into 66 catchment areas with 1.7mm vehicle sales per year.

• Estimate it costs ~£8mm in brand marketing to acquire each 1% market share within these areas.

• Estimate each 1% higher share increases profits at existing branches by £5mm, for a payback period of 1.5 years just on existing stores.

• Show how higher share also makes more catchment areas viable, thereby opening up a much bigger opportunity. At 15% share Motorpoint’s economics would be viable in 47 areas holding 74 stores and generating £82mm in net income or 93p/shr.

We think Carpenter is frustrated that the stock price is below pre-Covid levels despite the company being worth substantially more. As the owner of 10% of the company, he is willing to take the pain of a short term decline in profits and stock price as he has confidence in where the strategy will put the business in three years. We think it is likely he will relaunch a buyback at some point to take advantage of the stock price.

Motorpoint’s New Strategy

Motorpoint’s targets for FY25 were laid out in their June ‘21 deck, but the key points are:

• Initially doubling marketing as a % of sales from 0.7% to 1.4%, plateauing to 1.2% over three years.

• Increase in tech investments by 3-4x.

• Increase store opening from 1 per year to 3-4.

• Double revenues from FY20 levels to £2bn.

• Increase online sales as % of retail to over 50%. (⅓ of ‘online’ is currently via the call-center).

• Increase PBT margins from 1.5-2% to 2-3% despite added investment spend.

This is how we believe management thinks about the UK market:

There are typically 8mm used cars and vans sold in the UK each year, of which 1.7mm are in Motorpoint’s target market of under 4 year old vehicles. Using data from the Society of Motor Manufacturers and Traders, these sales can be mapped to specific postcodes and brought together to create catchment areas. We split the UK into 68 of these catchment areas using British counties as a starting point then adding or subtracting postcodes so that it takes roughly one hour to drive across an area. That means a Motorpoint branch placed in the middle would be within a 30mins drive of the entire catchment.

All of Motorpoint’s existing branches fit within the 34 largest areas:

We estimated sales at individual stores by comparing their respective inventory levels. That allowed us to calculate Motorpoint’s market share in each area, which corresponds fairly closely to shares management laid out in their recent presentation for cohorts of stores.

A Motorpoint branch usually needs to sell 3,000 vehicles per year for the economics to be attractive. With 10% market share at maturity that implies a catchment area must contain at least 30,000 sales per year, although the table above shows that the company has some stores in areas selling as few as 20,000 cars. That is probably because not every sale is within 30mins of a branch and around 10% of sales are of vans, which aren’t included in the area numbers above. 

Cost to Acquire 1% Market Share

Our ball-park estimate is that it will cost Motorpoint £8mm in brand marketing spend for each 1% market share gain within 30mins of its stores. 

To begin to estimate this, we note that Cazoo had spent £105mm on marketing since inception to the end of 2021. Its management say two-thirds of this (£70mm) was on brand marketing, which we sense checked by estimating the costs of all their major sponsorships, tv & radio ads, and out-of-home advertising.

Cazoo claimed in April that it has 80%+ prompted brand awareness, but a survey by Car Dealer magazine earlier this year put the number at 60%, which is the number we’re assuming. Since Cazoo only launched three years ago, all of this awareness is a result of the marketing spend in intervening years.

We do not know how this converts to unprompted brand awareness, but a rule of thumb is one-third, or 20% in this case. For context, Motorpoint claimed in their recent presentation that they had 13% unprompted awareness within 30mins of their branches. So 20% for Cazoo across the whole of the UK seems about right since anecdotally far more people know of Cazoo than Motorpoint.

That means gaining 1% of unprompted brand awareness costs £3.5mm. (£70mm / 20% = £3.5mm).

A table in Motorpoint's FY22 presentation shows that on average 13% brand awareness translates to 7.7% market share for a 0.6x conversion. We knocked 30% off to cut it to 0.45x since incremental conversion should be harder. 

That means gaining 1% market share costs £7.8mm. (£3.5mm / 0.45x = £7.8mm).

This estimate is obviously imprecise, but can be sense-checked. A one year sponsorship of the mid-level Premier League club Aston Villa cost Cazoo £6mm. TV ads on ITV cost ~£22k during peak evening shows or £3.5k during Good Morning Britain. With an £8mm budget, a company could run one ad during peak time and two or three ads during the morning shows for 365 days per year, assuming a 25-30% discount for a bulk purchase.

We also do not know how long the awareness from brand marketing lasts for, but it seems to be several years since Cazoo launched three years ago and expects to benefit from its past investments for some time (otherwise its economics would be truly catastrophic, which is also good for Motorpoint). Motorpoint’s investments will also be more complex than a one year up front investment for a 1% share gain. In reality, the company will be investing on a continuous basis and we expect it will try to gain more like 5% market share.

Nevertheless, this estimate of £8mm in brand marketing to gain 1% share within 30mins of branches gives us something to work with when comparing against the profits gained from these investments.

Value of Market Share Acquired

In FY22 Motorpoint generated £17mm in net income from 17 stores. That was despite an £11mm increase in marketing and IT spend to fuel growth. We add back half of that to estimate net income at existing stores of £21mm (scenario #1), which is still at the bottom end of management’s 2-3% PBT guidance in FY25.

These stores have an average 7.7% market share within 30mins, and that share typically increases as the stores mature and get repeat purchases. Management’s ‘official’ target is to achieve 10% share at maturity, although many stores are already above those levels. We estimate the existing stores will generate net income of at least £30mm at maturity (scenario #2), which implies a 2.3% PBT margin and is again at the low end of the 2-3% target.

For each 1% market share gain, profits at existing stores increase disproportionately because some costs are fixed. We estimate that each 1% increase in share increases PBT by £5.1mm. (8,169 vehicles x £16,795 ASP x 3.7% incremental PBT margin = £5.1mm.)

That means the £7.8mm in brand marketing to achieve that 1% share gain has a payback period of around 1.5 years just from gains at existing stores.

Perhaps the bigger gain is that higher share makes it possible for Motorpoint to open stores in more catchment areas. Even at 10% market share, we estimate that branches are viable in 34 catchment areas selling 1.24mm vehicles. That could support 39 stores and generate £46mm in net income at maturity (scenario #3). But at 15% share, 47 areas and 74 stores become viable because Motorpoint can go into catchment areas with under 20,000 vehicle sales and still sell 3,000 vehicles at a new store. Some of the bigger areas can then also support two or three stores. We therefore see a mature net income of £82mm or 93p/shr in this scenario (#4). For context, Arnold Clark is the biggest player in the industry and has over 200 dealerships, although it sells cars outside the 1-4 year old range.

Scenario #4 is the real opportunity that the new strategy opens up for the next decade. We think what matters most for the value of Motorpoint in the long run is whether it can ultimately earn 50-75% returns on 20, 40, or 75 stores. By spending on marketing and tech to gain share and open three or four stores per year instead of one, Motorpoint is earning a payback of 1.5 years on existing stores while opening up the longer term opportunity on top.

While these numbers are obviously imprecise, we believe these are the types of calculations management made when forming their strategy and are continuing to make as they see the first year’s results and decide to further accelerate their investments.

Valuation

We estimate that Motorpoint will earn around £40mm in net income in FY25. This assumes revenues of £2.3bn (above the target of £2bn) and a PBT margin of 2.2% (at the low end of the 2-3% target). Note that the table above showing £46mm in net income in scenario #3 holds the company’s wholesale business flat to highlight the change in the retail business as Motorpoint invests, but in reality we expect it to also increase rapidly, which is why our £40mm estimate looks punchy.

We put the stock on 20x P/E and think accumulated earnings will be around £80mm over the three years, of which roughly half will go into inventories, leaving £40mm in excess cash for an £840mm valuation. That equates to £9.4/shr when divided by 89mm shares. The stock trades at £1.95/shr today.

20x P/E is significantly higher than what the 11x-17x the stock has generally traded at since its IPO in 2016, but for context Carmax has averaged 20x over the last decade and we think Motorpoint is in a better competitive position. This is not appreciated by the market, which we believe should start to change as the strategy plays out. A multiple in line with the stock’s historic range would still result in substantial upside. 

While the stock could decline in the short term with falling used car prices, car supply shortages, or a ‘cost of living crisis’ in the UK, we think an investor at today’s share price has a very low risk of a permanent loss over three years. Even if we are completely wrong and net income is still at £17mm in three years and the stock trades in line with traditional franchise dealers at 7x, it is still worth £1.91/shr after adding three years of accumulated earnings. That is in line with today’s price.

Buyback

On the other hand, we think the upside could actually be higher. Motorpoint spent £23mm buying back stock in the two years pre-Covid, equivalent to 70% of net income. The CEO thinks the company is in a better position today and is clearly frustrated that the stock is lower. We therefore would not be surprised to see the company relaunching its buyback at some point.

The £40mm in excess cash we expect the company to generate over the next three years could purchase 20mm shares at today’s prices and shrink the share count by 22%. The actual execution of the buyback should also act as a catalyst. Motorpoint trades an average of just under 50k shares per day, which over three years equates to 37.5mm shares. The company will therefore generate enough cash to buy up to half the trading volume at today’s prices, or more likely a smaller amount at higher prices. Indeed, the company was regularly buying 50k shares per day at £3/shr prior to Covid, demonstrating that they are willing to buy aggressively.

Catalyst

Buyback

Growing earnings