Auto1 Group: We are TAM Sceptics

30 Sep 2021

Auto1 Group: We are TAM Sceptics

SHORT @ €--

Recommendation: Short (Initiation of Coverage)

Price:

€--

3m ADV:

$20m

Price Target:

€--

Market Cap:

€6.5bn

Forecast Return:

~50%

Ticker:

AG1 GY

Investment Thesis
Overhyped used car dealer. Shares overpriced on market belief it will be a scalable digital platform, and is a ‘de facto’ winner.
Increase in capital-intensity likely, which could pressure returns and balance sheet. Long-term economics, in our opinion, could be less attractive than expected.
Intense competition likely due to low barriers to entry and massive private capital flows into the space.
Some risk to near-term earnings expectations given marketing and cost investments and European used car environment.

Shorting growth companies can be challenging, but we see the loss-making position of Auto1 and the capital cycle in the space as supportive of the Short idea. In food delivery (JustEat) and, to some extent, in online grocery (Ocado), we have seen how aggressive private capital can damage returns and investor perception. In addition to the competition points, we are unconvinced that the economic profile of the business model will support the current valuation.

The idea is actionable for clients today because it is liquid, there is low short interest, potentially significant downside, and possible near-term catalysts. Risks on the short include the strong top-line growth and tailwind of structural shift of car retailing into online channels. We do not note any major red flags on accounting or governance.

What is Auto1?

Auto1 is an online car buying and selling platform, listed in Germany, with a market cap of €6.5bn.

This year they will trade ~600k cars across Europe, primarily buying from consumers (~400 drop-off and inspection centres), reselling to dealers in their merchant division (wirkaufendeinauto.de and auto1.com) and retailing to consumers online in the smaller, but fast growing, Autohero business (~40k cars in FY’21e).

FY’21e revenue guidance is ~€4-4.4bn revenue, with an EBITDA loss of -2.5-3% of sales. The business currently operates at a ~9% gross margin and will spend ~5% of sales in marketing this year.

Long-term, Auto1 targets 2-2.5m cars sold p.a., a 10% share of the European used car market, and a mid-to high-single-digit adjusted EBITDA margin.

Auto1 may have been one of 2021’s hottest IPO, hailed as a ‘decacorn’ (a tech start-up with >$10bn valuation). ~€1bn was raised, alongside secondary placings, the stock popped ~50% on debut, but is now trading well below the IPO price of €38. The size of the TAM (>€700bn addressable market in European used cars, finance, and ancillary services), alongside Auto1’s first-mover and first-scaler advantage on the continent, created huge demand for shares in the newly-listed company.

Prior to IPO, the business model pivoted to increasingly emphasise the Autohero consumer retail platform, which offered faster growth opportunities beyond the core remarketing channels.

After the sugar rush of the IPO faded, the stock market has become increasingly concerned about competition, EBITDA losses, and funding needs, resulting in a declining share price. A waived lock-up led to a further 9.7m (4.6%) shares placed in June, with further sales from early backers in the last two months, below the IPO price.

Exhibit 1: Overview of Auto1 and Autohero Business Model and Operations

Source: Auto1 Investor Materials

New car sales drive used car sales because any delivery of a new car elicits multiple used car transactions. A new car buyer usually sells an old ~3 to 4-year-old car, which is bought by someone who also sells an older car of ~7 to 8 years, and that old car is then sold on or scrapped. Lower new car sales in Europe may therefore cause lower transaction density, although this could be compensated by the pricing environment (lower supply of used car leads to higher prices). These changes are beginning to express in Auto1’s earnings guidance with the recent trading update indicating volumes at the lower end of expectations, compensated for in higher revenue and sound gross profit per unit. At the last update, Auto1 upgraded revenue guidance, but downgraded EBITDA margin guidance on higher investments into Autohero brand building.

Everyone Wants to be the Next Carvana
The traditional auto retail channels (networks of physical dealerships with forecourts and local customers) is being disrupted by entrants such as Auto1 who are aiming to revolutionise the buying and selling of used cars, primarily by introducing effective digital channels that support high volumes, efficient pricing, and consumer choice. The traditional car dealerships have a poor reputation for customer service, low price transparency, and low margin business models.
Auto1 targets 3 to 10-year-old car inventory, where they believe an advantage in sourcing is available (large, established, merchant-remarketing channels). A network of drop-off points provides sourcing and can be differentiated with branding and size. Auto1 runs large sites on industrial estates with drive-in inspection halls and parking for 20-40 cars on site. In contrast, a typical Webuyanycar (Constellation Group) drop-off point in the UK is a simple tent or container on a parking lot. Alternatively, inventory can be acquired wholesale in auctions where 1 to 3-year-old volumes are widely available and leasing companies are moving downstream to capture margin by selling end-of-lease vehicles. Aramis Group (recent French IPO) appear to be more focussed on the younger end of the market, dealing pre-registered cars with the dealership affiliates; the link to manufacturer, Stellantis is important for their strategy. Aramis also operates outlet garages in France, Belgium and the UK. NextCar is the retail channel for Leaseplan to sell ex-lease vehicles to retailers, and Autoselect is linked to a large leasing company (Arval/BNP). Traditional dealers such as Arnold Clark are pushing harder into the online channels.

In the US, Carvana has emerged as the big winner, with aggressive and efficient execution into the massive and fragmented US car market. Carvana sold ~200k cars in H1’21, growing +96%. In the long-term, Carvana targets 15-19% gross margin, and 8-13.5% EBITDA margins.

As the anointed king, Carvana has a market cap of $56bn, around 20x that of the rivals; Vroom and Cargurus. Everyone in the space wants to be ‘the next Carvana’. It is still highly uncertain as to whether Auto1 can emerge as the ‘European Carvana’, and despite amazing execution by Carvana in the US, the profitability of that business model is, as yet, unproven.

Scalable Digital Platform Unlikely
We believe the idea that Auto1 is a scalable digital platform that will have high long-term returns and unbroken growth in the coming years drove the IPO process and supports the current valuation. However, Auto1 may simply be a very good, and big, used car dealer. The stock is priced for success in Europe, but the long-term economics are still unclear. Car retailing is traditionally an unexciting and low single-digit-margin business. Whilst the advantages of scalability, simplicity, consumer experience, data-driven selling, and inventory liquidity, are clear for the digital platform model, at its core, this is the buying and selling of used cars and we have our doubts about the €6.5bn market cap for a loss-making business.

We believe reality may not match hope and hype because investors are pricing into the shares that;

1. Auto1 is a winner in Europe;

2. Long-term margins will be mid to high-single-digit at scale; and

3. Capital intensity will remain low.

As we discuss in this note, investors could discount these factors, leading to a lower potential valuation. The physical footprint of the business will become large, and it is an inventory-carrying business model.

Factors driving capital-intensity and physical operations include:

Inventory-carrying: Auto1 carried €280m group inventory at H1’21. The inventory turn in the Merchant division is rapid at ~15 days (the company aims to sell 70% of cars in 7 days), which reduces car price risks. However, competition may drive more risk-taking on inventory as more options need to be offered to attract customers, and the growth in Autohero will drive levels significantly higher, because it has 80-85 days inventory. As discussed later in this note, we expect a build of >€1bn inventory. At the IPO, the company guided that 85% (medium-term) can be primarily funded through securitisation programs (non-recourse financing).
Production centres: On 10th September, the company confirmed the strategic decision to open in-house production centres for the purpose of reconditioning used cars. The first site at Hemau, Bavaria, has capacity for 16k vehicles per year. 50k total capacity is being signed as per H1’21 report, with 150-200k projected to be in the next six months. Beyond this, 500k+ is being screened across nine markets. The company guides to €80m capex for production centres, or €670/unit on 120k capacity (Source: IR call). At ~500k capacity, total capex requirements could reach >~€300m. Reconditioning used cars should be accretive to the business model, providing quality assurances and representing further vertical integration. However, it is not a differentiated digital business, and is simply what used car dealers have been doing for decades.
Glass trucks: Auto1 had only 42 trucks on the road at H1’21, and will grow this fleet to 143 at year-end. Glass trucks have a dual purpose; providing a delivery service to delight customers, and marketing benefits on brand awareness. 267 have been ordered, expected to be on the road by 2022. We estimate Auto1 will run 50-60 trucks on average in FY’21e, doing delivery on 25% of Autohero volumes (~10,000 cars). This means one glass truck does on average ~180 deliveries p.a. At a 25% delivery rate, for every 100,000 of additional auto volume at Autohero, we estimate Auto1 will need another ~100-150 trucks, which will drive capital-intensity and logistics costs higher. Using glass trucks benefits brand recognition and customer service, which means logistics may come in-house despite the potential cost disadvantages relative to outsourcing.
Collection and inspection network: Auto1 has >400 drop-off locations for sourcing cars from consumers looking to sell their used car. The company guides for limited growth in this network, given they already established European coverage, but there is some capital and fixed cost associated with this footprint. Collection centres and production facilities generate lease liabilities. Auto1 has ~€20m of annual lease payments, which are excluded in their guidance of adjusted EBITDA. This is another -0.5% of operating margin cost, in addition to the current financial guidance of EBITDA losses in the range of -2.5-3% for FY’21e. As the physical assets grow, so will lease costs.
Finance book: One element of the growth story is the potential to add financing to the used car sale, adding addressable market and gross profit per car (GPU). Auto1’s ambitions are clear, with financing already offered in Germany. At H1’21, the loan portfolio was only ~€15m (Source: IR call), covering ~1,000 cars at a 40% attach rate in Autohero. This could become substantial, driving higher gross profit per unit through financing income, but also driving balance sheet size, and turning Auto1 into a bank. The target is a 50% attach rate across Europe (Source: IR), and consensus estimates are at ~140k units in Autohero in FY’23e. This translates into a loan book of up to ~€1bn at current ASPs. Whilst much of this growth can be debt-funded, or in potential banking partnerships, an equity component may be needed and it is unclear whether investors would pay the same price/book multiple for a bank, as a digital auto retail platform. We do note Carvana’s success in providing pre-qualified loans regardless of credit score.

Intense Competition?
Recent noise from competitors such as Cinch and Cazoo, have pointed to European expansion. However, as of our recent call with IR, Auto1 suggested competition was not yet visible. We expect increasing competition as challengers have access to cheap capital and are pursuing aggressive growth plans.

In Europe, Constellation (Webuyanycar, BCA, Cinch) had been taken private at a £1.9bn valuation by TDR Capital in 2019, before raising £1bn in May’21. Constellation reports trading >1.5 million cars (mainly in the BCA auction business) and £12bn GMV. Cinch has powered growth annualising 45,000 cars eight months after launch with +45% month-on-month growth. Press reports earlier this year pegged Cinch at £5bn standalone valuation. Whilst these valuations are clearly demanding, they are used to anchor fundraising to accelerate growth and represent a clear competitive challenge to Auto1.
Cazoo is trading with a $7bn valuation after joining the AJAX SPAC, and targets $1bn revenue in FY’21e. It listed in the US after raising $1.6bn at a £5bn valuation. Cazoo acquired Cluno, a subscription business in Germany.

Exhibit 2: Cazoo and Cinch Target Europe

Source: Cazoo Investor Materials

In food delivery, we have seen JustEat pressured in Europe despite first-mover advantage, and profitability in core European markets. Doordash is reported to be looking at European expansion, and Delivery Hero is returning to Germany. Uber and Deliveroo continue expanding, and the pressure of marketing and logistics investments has severely damaged JET’s European profitability outlook. We believe auto retailing could become similarly competitive.

It would also be naïve to assume that US platforms continue to ignore European markets, and investors cannot neglect the threat of US-players expanding. It is too early to judge how many brands (American or European) the European market can support, whilst core consumer brand equity is not yet established. Consumers may have loyalty more to an OEM than a dealer, and the used car purchase is a decision that happens only every 4-5 years.

Exhibit 3: The Marketing Battle Begins

Source: Source: Google images

Brands need to sit on the mental shelf at the time a customer needs to sell and/or buy a car. A fantastic experience must be delivered at the point of sale, and winners will need heavy local marketing spend. A full selection of cars must be offered, so the provider can sell the dream car out of inventory, otherwise the buyer goes elsewhere, and this could lead to higher inventory requirements in the business models and higher competition in sourcing. Branding and Marketing spend (see Exhibit 3) will only get business so far if their core offer and customer experience is not truly differentiated.

The European used car platform market could therefore surprise negatively on profitability in the near-term and there is risk of business failures, with well-funded digital players all claiming to ‘reinvent’ or ‘revolutionise’ the way cars are bought and sold. A wall of capital, meanwhile, is being thrown into the space and the battle is underway.

Auto1 has raised cumulatively >€1.3bn in equity and debt since 2016, burning ~€500m of cash pre-IPO. They are now faced with the dual challenge of competition and the expectations of shareholders in the listed entity. Cazoo and Cinch conducted the large raises outlined above, but CarNext also raised €400m to accelerate growth.
Cazoo outline plans to lose >£300m EBITDA on the way to profitability in 2024e, whilst they generated negative GPU (gross profit per unit) in FY’20 and guide for only 8% gross margins in FY’22e.
Autohero/Auto1 may find it challenging to match these ambitions. For example, expectations are for reducing losses next year; consensus EBITDA for FY’22e is ‘€103m, followed by -€74m in FY’23e. We believe it is possible Auto1 could lose more EBITDA next year, relative to consensus. Revenue growth may be insufficient to offset escalating costs in personnel, marketing, and logistics, alongside the cash spending on increased inventory and capex.
According to IR, consensus has the company troughing at net cash of €400-500m, implying only ~€200-300m of cumulative losses from now to break-even.

Capital Needs Could Explode
As described above, the business combines physical-footprint, and increasing capital-intensity. By 2025, we estimate the potential capital spending needs of the business could grow as follows;

Inventory Build of €1-1.5bn: The merchant channel has rapid inventory turn around 15 days, but Autohero carries higher inventory (IR guide of 80-85 days) to offer choice and availability to consumers. The majority of inventory can be securitised with non-recourse debt facilities and the company can raise >80% via senior and mezzanine Notes. However, investors should be aware of relative increased capital-intensity- and inventory-risk as the business grows, and the equity component will still need funding from cash-flows.

Exhibit 4: Gross Inventory Could Grow to >€1.5bn

Source: Auto1 filings, The Analyst Estimates

Capital Expenditure of >€400m: Auto1 started life as a business with very low fixed-asset intensity. Capex only reached a total of €20m in the first five years (FY’16-FY’20). In the IPO prospectus the company outlined €110m capex for building Autohero (€30m for 250 branded transporters and the rest for refurbishment centres). However, the company is now screening ~500k production capacity, compared to ~120k for the capex guidance. More glass trucks are needed for further growth and marketing and we identify another potential ~€300m of capex spending for Auto1 to achieve growth ambitions.
Cumulative net losses in the P&L of >€0.5bn: Consensus forecasts cumulative EBITDA loss of only ~€200m through to break-even in FY’24e. We believe it could be larger, and the company has already increased guidance on the EBITDA loss for FY’21e.
Potential growth in financing book of €2-2.5bn: We already discussed the potential to add financing products to the used car sale. A 50% attach rate is targeted across Europe (Source: IR), and consensus estimates are at ~140k units in Autohero in FY’23e. This translates into a loan book of up to ~€1bn at current ASPs near-term. Beyond that, Auto1’s ambitions suggest growth in Autohero revenue towards ~€5bn, which would generate ~€2-2.5bn financing size.

Exhibit 5: Capital Needs Could Become Material

Source: Auto1 filings, The Analyst estimates

Dependent on profitability developments, the rate of growth in Autohero, and financing products, we estimate Auto1 may increase capital employed in the business by ~€3-5bn between now and 2025 (gross inventory position of €1-1.5bn, gross loan book of €2-2.5bn, €0.4m of capital expenditure, and €0.5-1bn cumulative net losses).

Auto1 has ~€750m net cash on the balance sheet, after the €1bn raise at IPO. 80%+ of inventory could be securitised and we assume only a 20% equity component in auto loan financing. With up to ~€400m capex, and a larger-than-consensus cumulative net loss of >~€0.5bn, this leaves a potential shortfall of up to ~€1bn.

Who will Pay?
Another large primary equity raise might be challenging for Auto1 (dependent on share price, EBITDA performance, and the competitive environment). Pre-IPO investors have been disposing of stock, and Softbank no longer have board representation. The supervisory board therefore has a more Germanic centre of gravity represented by Chairman Gerhard Cromme (ex-Siemens and ThyssenKrupp) and Gerd Hausler (ex-Munich Re and Bayerische Landesbank). Whilst venture capital is still well represented in the shareholder base and at board level, after the IPO, there is a potential conflict between the near-term capital spending needs of the company in a fiercely competitive growth environment, and the requirement of European equity shareholders to see positive EBITDA developments and smaller cash burn.

Money may not be guaranteed from Softbank and our call with Auto1 IR described some issues between the two companies in 2018. Softbank had bought out some early shareholders and wanted to rapidly increase vehicle buying with an aggressive expansion mentality. When dieselgate occurred the European markets were flooded with diesel cars and Auto1 bought large volumes. Subsequently, an oversupply of diesel cars pushed down pricing and gross margins in 2018 and Auto1 reported a 160bp gross margin development.

Although Auto1 claims to be comfortably funded through to profitability and positive cash-flows, the question of who pays may become important in the event of higher investment needs, slower growth, or additional costs.

Warning Signs
Business model pivot pre-IPO: The Autohero brand was established in 2017 and rolled out across European markets. In 2020, Autohero only sold ~10k cars, or ~2% of group volumes. Without the attractive potential growth of the consumer-facing digital retail offering, we believe it would have been much harder for Auto1 to achieve the high valuation it did in the IPO. Therefore, we are slightly cautious that investment in the Autohero brand only accelerated in Q4’20. €200m of IPO proceeds were intended to market the Autohero brand and €110m for capital expenditures in Autohero operations. The issue for investors today is that the IPO was sold on the promise of success in Autohero, but that business was not well established at the time and carries significant risk. Competitors such as Cinch and Cazoo appear to be running businesses primarily anchored to the consumer-facing platform in the first instance, and then raising money on the back of that success to grow further. With Auto1 it may have occurred the other wayaround.

Exhibit 6 Push Into Autohero Pre-IPO

Source: IPO prospectus

Tech claims may be overblown: Auto1 describes itself as ‘first and foremost as a technology company’. However, tech spending is merely ~€20m pa, which is only ~5% of the company’s opex. Challenges of scale, marketing, and logistics are significant for the business, but the pure technology challenge may not be as demanding as presented. Essentially, online used car dealers need a decent website, an app, an inventory-management system, and strong data analytics. These tech functions can all be replicated, and are likely, in our view, to look similar at competitors, which means it will be hard to differentiate the business model competitively solely on tech platform offer.

Exhibit 7: Low Tech Expense Relative to Claims

Source: IPO Prospectus

SB Management and SB Northstar: The backing of Softbank, pre-IPO, was likely seen as a strong bull case on the stock because Softbank have deep pockets, and a track record of backing successful tech start-ups which subsequently achieve high valuations. Between 2018-Feb’21, Auto1 had three consecutive Softbank board representations; Akshay Naheta (2018-Mar-20), Spencer Collins (Mar-20 – Sep-20), and Anthony Doeh (Sep-20 – Feb-21). Softbank put in €460m in 2018, valuing the company at €2.9bn (20% stake), at which point Naheta joined the board. Naheta is CEO of SB Management and runs SB Northstar, the investment arm of Softbank. Whilst Softbank has made some successful large tech investments, we do note that SB Management attracted negative publicity relating to their large $1bn investment in fraudulent German-payment processor Wirecard. A complex funding deal in THG PLC is also underway.

Conclusion

We add Auto1 to our Short list with a price target ~50% below the current share price. There is risk of higher losses in the coming years, and escalating capital requirements for the business to achieve ambitions as competition increases.

We believe the business could achieve profitability in FY’25e but valuing a loss-making entity before then is challenging. Assuming the business can reach €15bn revenue at some point later this decade, and produce a 5% EBITDA margin with ~1% of sales in depreciation and lease costs there is a roadmap to ~€0.6bn of EBITDA and ~€0.4bn net income and cash-flow. At best the stock is fully valued today at €6.5bn market cap.

A low margin and capital-intensive business in a fragmented and competitive market may trade on a low equity multiple despite the growth potential. We forecast ~€200m EBITDA in FY’25e, with cash burn greater than expected before then, and some risk of further funding needs. At 20x EV/EBITDA (undiscounted) and adding the cash burn we reach a price target around €16, or half the current share price.