Description

What if I told you that you could buy (1) a #2 online classifieds business that is a flat - LSD revenue grower and (2) a sticky, mission critical software business that is a 25-30% revenue grower together for 6x EBITDA and 5x earnings? Is that something you might be interested in? NYSE: CARS includes a classifieds business and the recently bought Dealer Inspire.

CARS bought DI for $165mm and the founding team is staying on. Dealer Inspire (DI) sells software to car dealers, including website design / maintenance, chat, and programmatic bidding on online video advertising slots. It’s not easy to change the website developer after implementation and this is a “COVID winner.” DI recently won a semi-exclusive deal with General Motors to run 800 dealership websites. The business does ~$100mm in revenue grows revenue at a 25-30% clip. At 6x revenue, Dealer Inspire is worth $600mm. CARS has a TEV of $1.2bn, so this would imply the core classifieds business is worth $600mm or 3x EBITDA.

CARS trades as if CARG will destroy CARS in the next few years. However, Cars.com is still growing traffic (75% mobile) and has 2/3 organic traffic. Cars.com gets ~15mm free, unique traffic per month because it ranks well on Google. Dealers can’t get this traffic at the same cost because their websites don’t rank as well on Google. Traffic that hits Cars.com represents valuable, high purchase intent folks. As long as CARS is growing or holding organic traffic constant, dealers will continue to list on the platform. Dealerships have to sell merely 1-2 incremental units per month at $1-2K GPU to breakeven on the $2K monthly fee for CARS. The average dealership lists 220 cars and gets about 6K unique visits per listing on CARS (23mm monthly unique visitors in aggregate). Dealerships just need a 0.03% conversion to make the $2K worthwhile…

Investors focus too much on CARG vs CARS and not enough on vertical affiliate penetration. Dealers spend $22bn on advertising, $8bn of which is still offline. The affiliate channel is <15% of online spend and <10% of total. Vertical affiliates attract consumers with high purchase intent and rank better on Google than individual dealers, especially given how fragmented the car dealership industry is. Affiliates can also pay higher CPC’s on FB / Google because they have far more listings than any individual dealer.

Listening to the CARG management team, one would think that CARG clearly has the winning hand. If CARG provided enormous value to dealers, then dealers would have seen clear and significant uplift in sales after adopting CARG. Management would boast about churned dealers returning where the change in unit volume. And the ROI for dealers would be clear, instead of an illustrative calculation in the investor decks. However, attribution is challenging because the consumer does not complete the purchase online. CARG has been at it for 14 years and aggressively undercutting on price. For most of this time, CARS was neglected as a non-core segment of Tegna. Yet CARS lives on.

I’m comfortable underwriting CARS with SOTP math because there is a history of private equity interest. 20+ PE bros looked at CARS in 2018 when the stock was at $20+ versus <$10 today. They walked away back then because the dealer churn was alarming. However, churn was temporarily elevated because of legacy affiliate contracts that date back to Tegna. CARS had affiliate deals with newspapers to sell CARS subscriptions. The newspapers got 40% of revenue. These deals were due to expire and the wholesale car dealers were not treated very well toward the end. CARS agreed to make one-time payments to end these affiliate agreements early so it could re-acquire those dealers directly. The wholesale dealers were included in the total dealer count and it looked like a lot of churn when the deals ended. However, the core direct dealer churn was far lower. CARS has an opportunity to recapture these dealers at far better unit economics today. Also 2019 EBITDA includes $38mm of affiliate payments and Q2 2020 was the last quarter with such payments. Direct dealer churn had stabilized in late 2019. In fact, CARS was growing dealers for 4 months excluding Dealer Inspire in late 2019. And then COVID hit. As long as COVID impact doesn’t last more than another year or two, PE interest should return to CARS as dealer churn stabilization shows up in the numbers once again. CARS is an attractive platform to start a dealer services roll-up. A PE takeout at 1.5-2x the current price in the next 2 years would be nice, but I would prefer that CARS stays public, get to the 4.5x target EBITDA leverage, and repurchase shares with excess cash flow. I’m estimating a 10x by 2025 under this scenario, see below for assumptions.

Catalyst

Either lever up and repurchase shares or PE takeout