Description

Please refer to Hastan’s excellent 9/21 write-up for good background information. Given the collapse in share price, we now see AG1 trading well below the value of its wholesale business and cash and thought an updated write-up was timely for VIC.

Company Description – Auto1 was founded in 2012 in Germany by Christian Bertermann (former VP of product at Groupon) and Hakan Koc (former chief product officer at Home24), and became the leading platform for buying and selling used cars online in continental Europe. Auto1 has two platforms: Auto1.com (sale of used cars to dealers) and Autohero.com (sale to retail customers). The company purchases majority of its used cars via their local consumer branded websites “we buy your car.com” and 400+ retail locations in addition to sourcing from dealers through its remarketing efforts.

Auto1’s merchant business (88% of revenue) sold ~550k cars in 2021. Auto1 launched its retail business – Auto Hero in 2018 and is expecting to sell~40k units in ’21.  

Investment Thesis – I think Auto1 is a BUY. I believe they can earn EPS of €3.74 in 2027. Our target price is €36. with the majority of upside driven by the Auto Hero business. I am estimating a revenue CAGR of 29% and EBIT margin improving to 5.5%.

The most important factor here is whether Auto1 can execute its plan to build the “Carvana of Europe”. If Auto Hero can get to 750k+ and a normal margin of ~8% by 2027, then we are already looking at €3 of earnings from Auto Hero alone (€30 at 10x), before considering the Auto1 business and the synergies between the two. On the other hand, Auto1’s legacy merchant business by itself accounts for close to 100% of stock value today (€11) on 15x 2023E normal earning of €0.6, plus there is another 3.70 in net cash/share. As such, we believe Auto Hero carries a negative value today.

I think Auto1 has a credible story because of (1) EU has a huge and underpenetrated used car market, offers plenty of room for growth; (2) Auto1 is best positioned to take advantage of the opportunity, mainly because of its merchant business and sourcing advantage; (3) Auto Hero can reach ~8% operating margin.

However, there are significant risk with (1) Execution; (2) It might take longer for management to reach target operating margin; (3) There might be difficulty converting customers from “we buy your car” websites to Autohero.com; (4) Lower online penetration in Europe.

Investment merits

(1) Auto1 has a huge addressable TAM and there’s plenty of room for growth

Auto Hero has a retail TAM of ~13M vehicles per year across continental Europe. Auto1’s 750k unit target only implies a market share of ~6%, much lower than the 2M+ target that Carvana has set out.

Auto1.com –Wholesale auction has relatively low penetration in Europe, running at only 5% (vs. US penetration of ~30%+ and UK penetration of ~20%). If we assume that EU can reach the same level of auction market penetration as US, we are looking at a ~9M units TAM. Auto1’s 2030 target of 1.75M units implies ~20% market share which is more than reasonable for a market with strong network effect and concentrated players.

(2) Auto1 is best positioned to take advantage of the opportunity

European market is much more fragmented than the US with no scaled players. There are 200k+ dealers in continental Europe vs. 43k+ in the US; only one dealer (Emil Frey, based in Switzerland) has more than 300k units transacted per year. None of the traditional dealerships have enough scale to compete. The only notable competitors are the online / omnichannel players: CarNext, Aramis, and Cazoo.

Among the group of competitors, Auto1 has the established inventory sourcing channel, one of the most comprehensive set of vehicle data, and a strong infrastructure network. Auto1 is best positioned to consolidate the used car retailing market, and I believe the market is large enough for multiple winners.

·         Inventory sourcing advantage: Auto1 is the only online player that has a strong inventory sourcing capability from consumers. By acquiring from consumers, companies on average makes 100-300 more per vehicle. In addition, the high brand awareness of Auto1’s local sourcing sites (“we buy your car”) give Auto1 ample selection to grow its Auto Hero business. Nearly every single one of our expert survey respondents have identified this inventory sourcing network as hard to replicate.

·         Proprietary data across EU: Auto1 has built a strong database of used vehicle pricing data over the past decade, this large dataset should allow Auto1 to price vehicles more efficiently and capture more profit from cross-border transactions.

·         Infrastructure network: Having a strong infrastructure network is important to lower cost and ensure superior customer experience. Auto1 is in the process of moving a large part of its infrastructure network in house.

o Reconditioning centers: Adoption of in-house reconditioning centers drives significant cost savings (close to 50% for Auto1). Constellation Automotive Group has the best footprint of reconditioning centers from its wholesale auction business; Auto1 / Aramis / Cazoo are in similar situation where they have limited reconditioning centers and are in the process of ramping up in the next few years.

o Transportation network: Due to its large C2B volume, Auto1 operates a strong transportation network of 250+ logistics partners, and is one of the largest customers of the European logistic industry. Auto1 is in the process of moving its last mile delivery in house but its scale should enable Auto1 to get more favorable pricing from its transportation partners.

o Physical locations: Auto1 has 400+ store locations which is further enhanced its inventory sourcing ability, while Constellation Automotive Group has 45 locations, Aramis has ~50 store locations in continental Europe.

Although Auto Hero’s 750k units implies a 50%+ 5Y unit CAGR, it’s possible due to Auto1’s strong existing inventory sourcing channel. Auto1 currently sources ~600k units (2021E) from consumers; while 2.4M+ vehicles go through Auto1’s online pricing algorithm. Auto Hero already have access to enough inventories to meet its 750k target with improvement in their pricing algorithm.

In addition, if we use Carvana’s growth rate to approximate what Auto1 will be able to do, Auto1 should reach more than 750k units by 2027.

(3) Auto Hero can reach ~8% operating margin

Most of the margin improvement comes from the higher mix of higher margin Auto Hero business and increasing operating leverage. As Auto1’s merchant solution is close to its target gross margin and the majority of 2027 earnings will be driven by Auto Hero business. I will focus on how I think Auto Hero can get to 8% operating margin.

Improve GPU from ~300 per unit now to 2,500+: We should be comfortable assuming Auto Hero can get to 2,500+ GPU in 2027 from ~300 today through moving reconditioning in-house, improving pricing algorithm, and increased financing services attached.

·         Financing income is the biggest line item in the GPU bridge. CarMax and Carvana have used car financing service attach rate of ~70%, significantly above US average. While EU auto financing penetration is only 5-10% lower than that of US, Auto Hero should be able to get to 50%+ financing penetration, which implies ~800 GPU per vehicle.

·         Another key area of improvement is vehicle GP. Through moving refurbishment in house, pricing algorithm improvement, and cross broader transactions, Auto Hero should be able to improve vehicle margin from 2% today to ~12%.

·         In addition, most of EU traditional dealerships have 2,000+ GPU per unit

Improving operating margin to 8%:

Auto Hero should approach the margin level of its US peers as it scales:

·         Similar economics in EU vs. US. EU traditional dealerships had an average profit margin of 1.5-2% versus the US average of ~2% (2019)

·         EU offers better opportunity. EU market is more fragmented with less large competitor, which should enable better economics for the scaled players

·         US peers: Carmax runs at 8% operating margin while Carvana has a target margin of 7-13%

·         Lots of operating leverage. Carvana’s SG&A trajectory showed tremendous amount of operating leverage in the business

Thus, Auto Hero will most likely get to similar level of margin relative to its US peers.

Investment Risks

(1) Execution risk

Auto1 has laid out an aggressive roadmap with ~50%+ unit CAGR in its Auto Hero business. However, we have some margin of safety from:

·         Management’s strong execution from its Auto1 merchant business;

·         Auto1’s inventory sourcing advantage and improving conversion will offer more than enough vehicle for its Auto Hero business;

·         Auto1’s merchant business already account for ~50% of the stock value today

(2)   It might take longer for management to reach target operating margin

While we acknowledge that there is significant operating leverage in the business, it’s unclear what is the scale needed for an online used car retailer to reach 8%+ operating margin. For example, Carvana, with an estimated 2021E retail units of 430k, still haven’t reached its target margin yet.

In addition, with more players come into the market, it might make sense for Auto1 to delay its margin target and invest more in marketing spending to capture more mind share. A delay in reaching margin target might result in Auto1 taking additional debt to finance its growth.

(3)   There might be difficulty converting customers from “we buy your car” websites to Autohero.com

Auto1 effectively operates 2 different brands in each country, 10+ local “we buy your car” websites for consumers to sell vehicles, and Autohero.com. Auto1 needs to consolidate those at some point. However, our conversation with a board member confirmed that Auto1 is actively trying to solve this issue.

(4)   European customers might be slower to adopt vehicle buying online

European online vehicle sale penetration is ~5 years behind that of US. A lower-than-expected online adoption will impact Auto Hero’s growth rate. However, purchasing vehicle online should provide a superior consumer experience. New players entering the EU market should help educate consumers better.

Catalyst

- Growth stock carnage subsides

- Autohero ramps quicker than expected

- Execute the GPU bridge on retail side