Description

TrueCar is an online automotive advertising platform with a unique model and a strong value proposition to both consumers and dealers.  The company is undergoing a tech re-platforming and subsequent product enhancements should substantially increase monetization.  Longer term, the company is well-positioned to offer an end-to-end digital retailing platform that is more akin to a vertical software model rather than an Internet advertising company.  The opportunity in the stock lies in the transition of the business to a more dealer-friendly but higher monetization model, as well as the fact that they are emerging from a temporary disruption to their largest affiliate traffic channel.

TrueCar is unique among the well-known automotive advertising platforms.  The majority of the players in online automotive advertising focus on the used car market and are effectively CPM models with commoditized offerings.  CarGurus for sure has a competitive advantage in SEO, and is materially cheaper, but the used auto online classifieds space is intensely competitive.  For some context, Cars.com and Autotrader.com were started in the late 90s and became a very profitable duopoly in online classifieds for autos.  The two companies also leveraged their brands and traffic to monetize nicely through OEM brand advertising.  Over time, players like Kelley Blue Book, Edmunds and Carfax, among others, also got into the online classifieds markets.  While these new entrants caused the market to become more competitive, competition to a major step up with the entrance of CarGurus a few years ago; CarGurus used its lack of brand advertising and operational background from TripAdvisor to excel in SEO while effectively giving the product away to dealers (they have since started raising price but are still well below the incumbents).  This strategy resulted in very fast growth in both traffic and inventory, and has created an enormous headwind for the legacy players in the market.  With consumers mainly starting their research via search engines, all the classifieds platforms advertising the same prices, and the increase in the number of platforms, this has become an increasingly competitive business.

TrueCar, on the other hand, is mainly focused on the new car market.  The platform is unique in that dealers allow them to tie into their DMS systems to access their inventory, and then dealers bid into the system with prices below MSRP and ask.  Rather than charging dealers based on page views, TrueCar charges (effectively; they also have subscription model option, but it is loosely tie to transactions) $300 per new car sold.  This business model is not only difficult to replicate, but it is compelling to both consumers and dealers.  From a consumer standpoint, they can find a uniquely low price on the vehicle of their choice without visiting multiple sites and dealerships and haggling.  From a dealer standpoint, they have a clear and attractive ROI at $300/transaction.  When you talk to auto dealers, most will say their ideal marketing cost per transaction is $300, the targeted range is $300-500, and that some of the legacy expensive sites like Cars.com can be north of $800 in some cases.  The clarity of TrueCar’s ROI / attribution is not something to be underestimated in terms of its attractiveness to dealers; when talking to dealers it is clear that marketing attribution remains a huge problem / area of guesswork across most channels, and that the cost-per-action model of TrueCar is a major perceived benefit.

The opportunity in TrueCar’s stock exists mainly because the company has been going through a mult-year transition.  Prior to 2015 the company was run by the founder Scott Painter and had very a very acrimonious relationship with auto dealers.  Their marketing strategy was effectively “hey consumer, those dirty car salesmen are screwing you”, and, no surprise, the dealers did not like it.  To illustrate this, the company was sued by several dealer organizations, and AutoNation dropped the platform in a very public dispute in 2015.  As a result, the company hired Chip Perry to be CEO at the end of 2015.  Chip ran Autotrader from its inception and grew it to be a ~$1.5b revenue business; he knows the industry inside and out, has a great operating history, and enjoys good relationships with the dealer community.  Since he’s been at TrueCar, Chips focus has been twofold: 1) repair dealer relationships, and 2) improve monetization.

On the first count, I think it is clear that Chip has done a wonderful job.  It’s also worth noting that this issue is still a major misconception re: TrueCar.  I think a lot of investors still think TrueCar is “getting put out of business by its customers”.  When talking to dealers, it’s clear how much of a positive impact Chip has had.  Chip changed the company’s business practices and instituted the Dealer Pledge (https://www.autoremarketing.com/retail/truecar-pledge-outlines-actions-address-dealer-concerns).  These efforts have resonated with dealers.  AutoNation has rejoined the platform, and franchise dealer count has grown from <10k to >12k over the past two years, and is still climbing.  The company has also been successful on the dealer front, most notable settling the California Dealers Association lawsuit (http://www.autonews.com/article/20171214/RETAIL07/171219814/truecar-california-dealers-association-settle-lawsuit) last December for what amounted to their existing (new under Chip) business practices (also interesting and instructive to note that through the lawsuit the company maintained relationships with ~50% of California’s franchise dealers).

Regarding Chip’s efforts at increasing monetization, the company has seen some traction, but the majority of the opportunity lies ahead of them.  First off, when I say increase monetization, I don’t mean what the company charges a dealer per transaction; the company fully intends to remain at that $300/transaction figure which I think is a strategically sound decision.  By “increasing monetization”, I mean the number of transactions coming through the company’s audience/engagement funnel.  This is what lies at the heart of another big misconception about TrueCar; it’s not a traffic story (despite a lot of bears focusing on that).  In fact, the company is purposefully not investing heavily in marketing / traffic until they complete their technology re-platforming that lies at the heart of their monetization efforts.  Once the tech re-platforming is complete and the subsequent product changes have been executed, not only with they have more profits to invest in traffic acquisition, but the unit economics will be significantly improved.  Looking at TrueCar’s funnel, at a high level it works in the following way: unique users are converted into registered users (provide info so they can get prices and inventory and be contacted by users), and then registered users are closed into transactions.  Historically, TrueCar has averaged ~8m monthly unique users, has had a conversion rate of ~5%, and then a close rate of ~20%.  What this means is that TrueCar’s “net funnel efficiency” has been around 1% (for every 100 visitors to the site, only 5 register and 1 of those and can be attributed to a transaction (given that they are tied into DMS systems they are able to compare their registered user logs to dealers transactions and that’s how they charge).  This 1% traffic monetization rate monetization rate stands in stark contrast to independent research by JD Power that shows that >50% of car buyers research on TrueCar.  I am definitely not suggesting that TrueCar’s monetization rate should be 50%, but if it went to 1.2%, they would have 20% more revenue at nearly 100% incremental margins.  Unfortunately for TrueCar, making changes to the product so that they can capitalize on this opportunity is not as easy as it sounds.  The TrueCar site was built inefficiently and in old programming languages.  This is why the company has been undergoing a tech re-platforming named Capsella.  Capsella is scheduled to be finished by the end of this year, and will give the company the flexibility to make significant changes to its core product.  The company has been able to do some things already that suggest these forthcoming changes will have very positive results.  In late 2016 / early 2017 the company made changes / added benefit messaging helping users understand the benefits of becoming registered users, and the result was a ramp in conversion from 5% to 6%.  While this does not sound like much, when you get all the way down to transactions it results in a 20% increase.  The company has not laid out the changes that they will make going forward, but has alluded to the fact that it will involve the how and the point at which users can register, as well as how dealers can contact users.  We believe both of these are powerful.  More registered users increase the company’s ability to match users to transactions, and better dealer contact management should result in better experiences overall; the company has great net promoter scores for registered users who end up transacting, but low for those who don’t because the immediate deluge of calls/emails from dealers turns them off.

There are also a few other positive developments at TrueCar.  The first being the resolution of the main issue of what drove the stock down ~50% over the last 12mos: traffic from their main affinity partner USAA.  The decline in traffic was due to site changes at USAA, which have since been resolved and the company has seen the trough and now a reacceleration in traffic in that channel.  Additionally, the company is growing several nascent opportunities such as used car, trade, and OEM.  While in the new car business the company has material competitive advantages in terms of their dealer network with DMS connectivity and unique low prices, the used car product is the same / similar to CARG/CARS/Autotrader, however they are priced lower than CARS/Autotrader and they benefit from the traffic already being generated by the new product.  The new TrueCar Trade product is similar – Chip built a similar product at Autotrader, so by definition it is not incredibly unique – but it’s still incremental high margin revenue that gets dragged along by the competitively advantaged new car traffic funnel.  Lastly, the company has some innovative new products to help OEMs get attractive returns on their incentive marketing spend (a big market) and those programs are generating nice revenue growth at high margins.  I expect the USAA traffic inflection and the incremental contribution from these new products to be nice tailwinds to the structural benefits of the Capsella re-platforming.

Lastly, I think that TrueCar is uniquely positioned to potentially become a compelling auto digital retailing platform.  I think that the only company out there that is really doing true digital retailing at scale is Carvana, but when you talk to franchise dealers, most recognize that this is where the market is headed (some citing Carvana’s success as evidence).  With their unique front-end lead generation engine, and with the addition of products like TrueCar Trade, TrueCar is in an interesting position to become a digital retailing platform for dealers.  I think it’s possible you could see them acquire a company like Roadster or Drive Motors to cement their ability to offer a full scale platform.  The upside from this would be a shift towards more of a vertical software model with a larger TAM, and perhaps an acquisition by someone like a CDK who seems very interested in buying growth in this area.

Regarding valuation, TrueCar trades at a teens multiple of next year’s consensus EBITDA estimate which has little to no assumption of improvement in net funnel efficiency.  For a growing, unique, asset-light business with expanding margins and ~20% of the market cap in cash that has showed downside on disappointing quarters / performance can drive the multiple to 10-12x, I think downside is somewhere in the 30% range.  Upside I think could be 100% or more with a return to the stock in the $20s (where it was before the USAA temporary issue).  I think this could be driven by improvements in net funnel efficiency that drive large positive EBITDA revisions (enhanced by a reacceleration in USAA traffic and increased contribution from used/trade/OEM) and multiple expansion back to ~20x (still well below an admittedly silly peak multiple).  The company does not need much improvement in net funnel efficiency to drive very large contributions to EBITDA.

Catalyst

1) Reacceleration in USAA traffic

2) Completion of Capsella

3) 2019 increases in net funnel efficiency