Amazon 2.0

[mschmit]

2) Those big box retailers will also be bad investments

Like Costco…and HD?

Cars.
Very different and hard to dominate compare to Amazon shipping a box from a warehouse.
First there are new, used and for sale by owner.
Cars have to be serviced…so some people will WANT to buy from a place that has service.
New cars (and some used ones) have to be prepped and cleaned before people are going to take delivery. Dealers already exist to do this…so they will resist all this…or be part of it and take a cut.
Some people like to take test drives…hard to do on the Internet.
Sure some people are just looking for a 5 year old Honda for KBB value and can search and slice and dice on the internet to find it. Others are buying their first car and most expensive thing they ever bought and want to “kick the tires” on a few cars, first.

There are already many online car buying and auction sites. I’ve sold two cars that way.

Mike

[TMFSaintCroix]

if you can invest in much higher gross margin, stronger hold on the customer and recurring revenue businesses with very high headroom to grow - like MDB, AYX, TWLO, SHOP, SQ and such, why would you want to invest into lower margin, no hold in the customer, one time business type of markets like car and home shopping?

That’s a great question. I got a 4-part answer:

for the amazing revenue growth

Carvana

2015: $130,392,000

2016: $365,148,000

2017: $858,870,000

2018: $1,955,467,000

(Yes, the company almost skipped the $1 billion sales mark entirely, jumping from $859 million to almost $2 billion in revenues in a year. It will be interesting to see if they skip $2 billion in sales and $3 billion in sales and their next annual number is $4 billion in sales. I say yes!).

for the sheer size of the TAM

It’s not just that Carvana is growing revenue at such a quick rate. After all, you can grow geometrically off a tiny base. Start-ups and drug companies do that all the time. What’s impressive is this fast-paced growth is happening in the context of a massive operation. Most of our favorite SaaS stocks haven’t hit $1 billion in sales yet. Carvana not only hit it, they almost skipped over it. They will get to $10 billion in sales before Alteryx gets to $1 billion in sales. Bet you a beer. And I’ll make the same bet with Zillow. That’s a 2-beer virtual beer bet.

because of the negativity

I like negativity on my investments (sometimes). Not too much negativity, it harshes the vibe. I particularly hate negativity when those negative nellies have a point and they cause doubt in me and my investments and I sell out and then I miss out on all those fantastic gains. That is horrible negativity. But negativity when I am right and I know I’m right? That is awesome. Why is it awesome? Because it causes a massive short interest, all of which translates into future buyers if I am indeed right. Also all this negativity keeps the multiple low, really low, super-low. And there’s room for expansion as understanding shifts and more people come on board. Right now, Carvana has a P/S of 4.

because it’s been a fantastic investment so far

Here’s a 2-year chart, Carvana vs. Twilio

https://finance.yahoo.com/quote/TWLO/chart?p=TWLO#eyJpbnRlcn…

Carvana: 535% growth
Twilio: 461% growth

ZScaler hasn’t been around for two years, but they lose out, too…

Carvana: 224% growth
ZScaler: 138% growth

Look, we hold a lot of SaaS companies. 11% of our port is in Shopify. That’s almost twice as high as Carvana, which has 6%. I’m not saying that Carvana is a better investment than SHOP. I don’t actually have an opinion on it. We’ve held SHOP longer and just let that winner run. But what I am suggesting is that a low-margin, high revenue, high-growth business can be a fantastic investment.

[12x]

St Croix, my only suggestion is to watch the debt with Carvana because so many used car dealers have gone bust due to the debt load. Perhaps they are issuing enough equity too. But it’s expensive to build inventory of cars where margins are razor thin not to mention the infrastructure to sell it… but maybe their inventory turnover is sufficient.

Carvana does seem to have a new model in this new era of buying cars online without haggling with the dealer. And convenient when they are offering their best cost up front. And is inventory regional? It actually wouldn’t be easy to replicate what Carvana has done if they can successfully scale it.

You’re right. There is a world outside of SaaS and I have been going that direction too. I don’t see any reason to completely dissolve of SaaS, and besides, it seems each segment within SaaS. For example I don’t see why the tide ZScaler is in, which is cloud based security, should ride and fall along with Coupa which is procurement software. Totally unrelated industries though they may both follow the business cycle but one of the appeals in SaaS id they are supposed to be saving companies money, a necessity in all economies.

[12x]

I just checked, and with all those billions carvana is doing, their gross profit is actually comparable or lower than AYX depending on what quarter you measure. Which brings to the point sales is not everything. Sales does not pay the bills. Arrow Electronics is a $30 billion/year revenue company but is only worth 5billion. Their gross margin is only a little over 10%

So with Carvana they are selling an expensive car, tying up their money in an expensive car, to sell it at a razor thin margin. Not an ideal business model. Not only do you have razor thin margins, you have a ton of money tied up to sell that stuff at razor thin margins, that you have to pay for up front! At least with Costco or other retailers they may have net 30 or longer, they may sell the inventory before they even have to pay for it.

To pay up front and then have to sit on it and sell at razor thin profit is not an ideal business model. Which is why these auto dealers that grow so fast often go bankrupt.

[TMFSaintCroix]

The real estate market is prime for disruption

yes

The days of real estate agents driving people around looking at houses with nothing but a description in the newspaper are over.

yes

However the real estate agent market is very, very fragmented. There is no “gorilla” in that space. Why would there be online?

I put this in my earlier post, but it’s worth repeating. This is the CEO of Keller Williams, a traditional realtor.

“I feel like I have no choice now,” Keller said. “I can’t allow Opendoor or Zillow to go out and be the only play in the iBuyer space and then begin to dictate terms and build brand around ‘they buy houses’.”

That’s a realtor who is now making offers on people’s houses. That’s a dramatic change in a business model. I can smell the flop sweat from here. “I feel like I have no choice now.” Why does he feel that way? Because consumers obviously are loving the iBuyer phenomenon. Keller even names names. He tells us the names of the companies who are scaring him, and their names are Opendoor and Zillow.

Opendoor is the rule-breaker in the iBuyer space. They invented it. They are the first mover. (They are also private and we can’t invest in them).

Last year, Zillow jumped in.

I was never interested in Zillow, because they never had the revenue growth. And they were unprofitable. And I didn’t much care for their business of “collecting eyeballs” and selling advertising space. It seemed to me a niche market. I just figured David Gardner was wrong about this one.

But here’s the thing I missed. Zillow now has a huge database of real estate information they have built up over their 14-year history. And now they are starting to monetize all of this knowledge. Their light business model is allowing them to shift quickly into adjacent businesses. All of a sudden, they’re providing mortgages (look out, LendingTree). But of course the big one is the iBuyer phenomenon.

Redfin is a viable alternative for this.

I disagree, but maybe you’re right. Definitely a gorilla game going on. Zillow, Opendoor, Offerpad, Redfin, Keller Williams. It’s worth googling iBuyer and reading up on it. I just discovered this site, pretty interesting…

https://www.mikedp.com/opendoor-ibuyer-business-model

[12x]

St Croix you bring sone interesting topics to the table but my concern is not all revenue is equal. For example carvana now has over $400 million in long term debt. Which is fine for now. They could have years of growth with equity issuance and debt. But once I hear articles about concerns over carvana’s debt, I’d probably sell. Consider that to Alteryx, which just recently had $12 million in debt. And both of these companies are generating about the same gross profit. One is in a scalable business one requires a huge amount of investment for the same gross profit growth.

Zillow is becoming more interesting. But I’d rather not buy a company that buys houses and resells them. Unless they are working with a bank that gives unlimited credit line and they’re actually good at what they do. TBD. Still requires debt though. Is Keller Williams good big to compete? Highly unlikely. Even open door. VC can only take you so far.

Historically these cash buyers will only buy at a huge discount but if Zillow is giving full price easily, and able to make a slim margin on it, that’s a huge game changer.

Again the revenue as a result is only pass through, but the gross profit could be interesting. Still something that could become a mess in a down real estate market.

Another reason assets light companies are ideal… but anything can happen within a few years.

[TMFSaintCroix]

Zillow is becoming more interesting. But I’d rather not buy a company that buys houses and resells them.

I’m enjoying this site:

https://www.mikedp.com/opendoor-ibuyer-business-model

Click on that video on the left. Will iBuying Become Mainstream. Very interesting.

And this is worth a read: Zillow’s billion dollar seller lead opportunity

https://www.mikedp.com/articles/2018/11/12/zillows-billion-d…

If you’re thinking about Zillow doing iBuying and you’re not thinking about seller leads, you’re thinking about it the wrong way…

The value of the seller leads is almost 30 times the profit from flipping houses…

Zillow doesn’t need to actually buy and sell a lot of houses for this model to generate significant profits for the company in a national rollout.

The other interesting thing is that while the iBuyers have forced Keller Williams to start making offers for houses, the reverse is happening, too.

Opendoor’s pivot to agents

https://www.mikedp.com/articles/2018/11/4/opendoors-pivot-to…

[sunriseal]

The important point here is that neither Zillow or Carvana have the same ability to scale as the SAAS companies that we are looking at here. A software company has a one-time big cost to create a sellable package, followed by much lower support costs. The scale leads to very high margins if the product sells well.

The margin on Zillow and Carvana isn’t going to increase substantially as they grow. They’ll continue to be heavily capital-intensive with inventory and carrying costs. And neither one has a unique product.

Having said that, both are probably good investments, just not in the same class as some of the others discussed here.

[tamhas]

A software company has a one-time big cost to create a sellable package, followed by much lower support costs.

Actually, companies often create core products and bring them to market, but then continue to invest heavily in development creating new companion products, adding functionality to existing products, and adjusting to the needs of individual customers. When I first opened doors as a ISV for an ERP software vendor the package I got was about 250 KLOC. 10 years later, my suite was 1.7 MLOC, including replacing the original 250 KLOC so that my product was independent of theirs.

[etagordon]

Reading this link made me think of a passage I recently read in a book called The Black Swan, by Nassim Nicholas Taleb. He wrote a section talking about how to accumulate wealth. He said it is obviously better to build something once and sell millions of copies, than having to build the same thing over and over again. His example is an author who writes a book one time and then sells millions of copies compared with say a plumber who learns his skills and then has to repeat his effort time and time again.

So Carvana has to build physical structure for the cars. Even if show rooms are few, the inventory has to be stored somewhere. If you live within 100 miles of a showroom, Carvana will deliver the car of your choice to your front door. If after an hour of driving you don’t like it they will take it back. If after six days of driving you don’t like it a truck will return and take the car back. Sounds like a lot of moving pieces. But they have the ability to purchase your trade-in cheaply. (and of course your car has to be made showroom ready.) Lots of moving pieces, people and capital investment.

Cars are becoming more and more similar. With quality going higher and higher, cars are becoming a commodity. two years ago I bought a car via e-bay. I shopped Carvanna and visited local dealerships to test drive the cars I was interested in. In the end, I saved thousands of dollars buying a car off e-bay. I thought the Carvana process terrific, but in the end, my wallet won. My car was a Hyundai Genesis and was then and still is under new car warranty. Now, for a car not under warranty, perhaps the results would have been different.

As I understand it, Carvanna makes money three ways: selling the car, making a loan, and buying inventory (think trade-ins) cheaply.

So, having said all this, I am still thinking build once and selling millions of copies, as in software, has to produce higher margins than buying and selling individual cars, regardless of projected revenue growth.

Gordon

[bjurasz]

Interesting stuff about Zillow and Redfin. I tend to agree real estate is ripe for disruption, in some way. Just not sure how yet. However a friend of mine has been an agent with ExP World Holdings (ticker symbol EXPI) for a few years now and swears by it. They basically run their entire organization via Cloud based apps. No physical presence, etc. They are growing fast, which makes me want to consider them as a purchase. But from what I can tell their disruption is on the agent model itself and not necessarily on the customer-facing side (i.e. no reduction in fees). Not sold on this idea yet but intrigued by all three names here.

[TMFSaintCroix]

The important point here is that neither Zillow or Carvana have the same ability to scale as the SAAS companies that we are looking at here.

That’s wrong. Not only are Zillow and Carvana scaling their business, but they are doing so far more rapidly than SAAS companies.

A software company has a one-time big cost to create a sellable package, followed by much lower support costs. The scale leads to very high margins if the product sells well.

I see, you’re talking about scaling to profitability. You’re right. I absolutely agree that software companies have higher margins than retailers. That’s a no-brainer. I just disagree that retailers are bad investments. No, they’re not. If you’re buying the right retailer, they can be fantastic investments.

Here is a big negative when it comes to tech stocks: the market is limited. The more limited it is, the weaker the tech stock. I tried to invest in optical stocks for years and years, because I thought the technology was important. But a major problem with these stocks was that the market was so limited. How many potential customers did JDS Uniphase have? Basically they were limited to companies who were building out telephone infrastructure. Since the customers were so limited, all of those tech stocks were bad investments.

I’m not a techie, which means I’m really weak at analyzing how cool or important a technology is. I would suggest the more you have to explain or translate a technological innovation to people, the more dangerous that investment is. If it’s difficult to understand, that means the customer/decider pool is more and more limited.

Peter Lynch used to joke, “I don’t even know how electricity works.”

One of the powerful benefits of SaaS is that you don’t have to first convince the chief technology officer to buy your stuff. That’s what a “land and expand” strategy is. You can convince anybody in the business to try your service. And then as it catches on within the business, the uppity ups may decide to make a company-wide purchase.

Smart tech companies try to expand their market by making their technology easy for non-techies to understand. That’s why internet companies have been fantastic investments. They are tech stocks that are easily understood by many. I don’t know how Google works, but I understand Google. I don’t know how Carvana works, but I understand Carvana.

The potential market for a Google or a Carvana or a Zillow or an Amazon is far greater than the potential market for an Alteryx or a Twilio. Don’t kid yourself about TAM, it’s very important.

The margin on Zillow and Carvana isn’t going to increase substantially as they grow. They’ll continue to be heavily capital-intensive with inventory and carrying costs. And neither one has a unique product.

All this is true. Nonetheless, retailers can (and do) scale, and get very big. And internet retailers scale far more quickly than off-line retailers. And there are powerful networking effects at play. If Carvana has more car options than anybody else, that’s where you go to shop for a car. If Zillow is the company with all the housing data, that’s where you go to find your next house.

I feel like I was having these arguments 20 years ago!

[12x]

That’s wrong. Not only are Zillow and Carvana scaling their business, but they are doing so far more rapidly than SAAS companies.

Just look at the balance sheets and income statements of AYX and CVNA. We are seeing this play out in real time. CVNA now has $526 million in long term debt. $1.2 billion in total debt. AYX? $316 million in total debt. I don’t know why you’re so concerned over selling $2 billion, or $3 billion, and focusing on top line, when AYX is making more gross profit on a much smaller revenue number. So who is really scaling their business faster when AYX is making more gross profit? Who cares what sales are quite frankly! It’s not what matters.

Yes, CVNA has a large tam. By that definition you should also be buying Beyond Meat, because it too has a larger TAM than AYX. CVNA’s gross profit does not even cover their SG&A expense. They are a long way to profitability and they’re going to take a lot of debt to get there. Then that interest on the debt is going to be a bigger portion of the cost of selling a car.

AYX will be able to generate $1 worth of profit at a fraction of the cost of CVNA. All business is, is making the most profit possible with the smallest investment possible. The economics of AYX are much, much better than CVNA’s. I would never focus on just TAM but the economics of that TAM. Who cares if CVNA gets to $10 billion in sales when they can’t even cover basic operating expenses let alone show a profit. As I said before, Arrow Electronics, $25 billion year revenue business, worth $5 billion. Sales is not everything.

The reason JDSU is not a good business is because it’s a mature business catering to a few telco companies, and extremely competitive due to the concentrated customer base. It has been that way for years. CVNA, likewise is in a very competitive business selling cars, the same cars you can get at any other dealer. There is absolutely no differentiation in products. Other than “they have a bigger selection”, meaning a bunch of money tied up in inventory. That they make next to nothing on. There is no scaling up of buying used cars as a CVNA the same way WMT was able to buy in bulk from manufacturers.

It’s fine if you want to buy CVNA but in no way shape or form does it mean it’s better than AYX because it’s a bigger TAM market. Especially when one is growing dramatically and the other is not.

[12x]

His example is an author who writes a book one time and then sells millions of copies compared with say a plumber who learns his skills and then has to repeat his effort time and time again.

This is an example of someone who actually tries business finds out. I found this out through two side businesses. 1) reselling vintage furniture, and 2) creating metal products with CNC equipment.

With reselling vintage furniture, finding the furniture at a price you could actually make money on is next to impossible. Sitting around at auction houses bidding against a bunch of other dealers not to mention people who wanted to buy it for themselves does is not an ideal method for acquiring product to sell. Nor is camping around in front of estate sales. Then the cost of selling it. And sitting on all the inventory until it sells. Only to repeat the process once you do sell it. All your money goes to inventory that sits there. That you possibly have to pay someone to refinish to actually sell it. This was always a hobby for my interest in furniture because I didn’t make a dime on it and I competed with other people doing the same or not making much.

With CNC manufacturing, getting inventory is just as easy as calling a steel supplier on the phone. Raw materials are only a small portion of the expense. I can buy sheet metal and let it sit there until it’s used with no problem, the raw materials are only 1/5 the cost of the sale. Cash flow is much better. Profit is much higher, and easier. There is differentiation between product so you can charge more. You can scale by actually making product and sell it at a price you could actually afford to employ people to make it for you. The only cost is the machinery and repairing it. Which can add up but it’s no worse than having all your money tied up in furniture inventory. Software companies have it even easier. They have no machinery they have to buy. Total cost is up front developing the software.

All business is is making the maximum profit with the smallest investment possible. Carvana is in a terribule industry for that to happen.

I just bought Taleb’s books again and reading Fooled by Randomness right now. Read two of them years ago but can’t even remember that example. Some things can just get glanced over without much thought at the time because they don’t mean anything to you.

[sunriseal]

I feel like I was having these arguments 20 years ago!

Ha. I’ll admit that somewhere in the Fool archives from 20 years ago, there’s a post where I said something like Amazon is just a bookstore, Walmart will eat their lunch!

The point is that for Carvana to sell a car, they need to go to an auction and buy it at a small discount to retail. To sell another car, they need to go out and buy another one at a small discount to retail. Merchandise isn’t going to cost substantially less with quantity. Same with Zillow.

Both companies have substantial competition that limits their asking prices. Carvana is competing against Carmax, AutoNation, Avis, and every new car/used car dealer lot in the area. Zillow’s pricing is limited by competitive values too.

A software company has roughly the same development cost whether they sell one copy or a hundred. The companies that we are looking at here are the ones that have already developed a marketable niche product that is somewhat differentiated from their competition. Profit margins will soar once enough copies are sold to cover costs. We’re buying (and selling) stocks here in the hope that they’ll reach that level quickly.

Does that make Carvana and Zillow bad investments? I hope not because I own some Zillow and Carmax, a Carvana competitor. I hope that both continue to give me good returns at relatively low risk, but I don’t consider either one part of my Saul’s Superstar portfolio.

[tamhas]

Same with Zillow.

Except that Zillow doesn’t need to take title, so there is none of that inventory expense. And, if at all successful, they probably don’t have to work very hard at finding properties since sellers will bring the property to them.

[12x]

An interesting metric for carvana is their gross profit per car went from $2000 to $2400 in just one quarter. Not sure what caused that. If it’s scale we’re talking about

[NajdorfSicilian]

I disagree, but maybe you’re right. Definitely a gorilla game going on. Zillow, Opendoor, Offerpad, Redfin, Keller Williams. It’s worth googling iBuyer and reading up on it.

Why would you think Zillow would be the winner? Any of these big RE agencies have the same data from the past 15+ years. Now they’re taking on buyer credit risk in the mortgage space as well. Most of us remember what it looked like for the non-bank and shadow-banking sector when they entered that space in 2005-07 it looked really great until it blew up right in their face.

It doesn’t make any conceivable sense to me that home buying by realtors/online lenders/data gatherers will be a gorilla game because you are going to sell to whichever of them offers you the most money. It is nothing like Amazon’s flywheel which improved results for buyers and seller by making it easier to shop there and had tech that was years ahead of their competition. RE sales are public information unlike Amazon’s internals.

I mean, Wal-mart, just passed Staples in online sales a couple years ago for crying out loud.

If I’m selling my home I’ll download the best 6-10 apps to find the iBuyer willing to pay the most in addition to my local B+M agent[s]. Nobody will care about Zillow unless they have the highest prices.

And if they always have the highest prices, that’s a recipe for disaster worse than any upcoming mortgage crash.

Not that Z can’t be successful and make money.

On a diff note, I do find a horrifying % number of Gen Zers don’t even have driver’s licenses both in the city and suburbs where I live. Ignore that trend to your detriment.

[etagordon]

regarding re-selling homes. It seems to me that the company that will do will is the one that will let you represent your own home for 2 percent, but yet show it in multiple listing services. Selling my home to a Zillow or some such, does not make my wallet tingle. What does make me smile, is selling the house at full price and not paying the realtor 5 - 6 percent.

Gordon,
Who has sold every house he has owned FSBO

[brittlerock]

I don’t think you actually understand Amazon’s business model. They are not a retailer. Let me clarify, yes, they sell a ton of stuff at retail prices to the general public off their web site, so they look a lot like a retailer, but that’s not the core of their business. Not to my way of seeing things anyway.

IMO what Amazon does, in fact, what they invented was to examine the most common activity on the planet (with the possible exception of sex), the exchange of goods for monetary consideration, and took note of all the primary frictions to this activity. Amazon created an infrastructure that reduced or eliminated as much friction as possible. They used the infrastructure to fuel their own business, but they also, in effect leased out excess capacity to anyone (with a few constraints) that wanted to take advantage of it.

They did exactly the same thing with AWS.

And BTW, you can buy a car on Amazon, Carvana so far as I can see has no moat.

And buying a house will never be as simple as buying a book. Aside from the fact that virtually every home sale requires financing, there’s all the stuff around title insurance (can’t get financing without it), recording, possible liens, tax status, etc. There’s just a whole lot of contingencies around real estate sales that add tons of friction (and expense) to the transaction. I don’t see this ever expanding to the scale of Amazon, but there is leverage in reducing the selling costs associated with brokerage fees. I’m not sure how/if Zillow is attacking that, but there’s an opening.