This is so simple it will seem simplistic, but it’s really just the math.
In 2018, Carvana’s revenue was almost $2 billion. But gross profit was only about $200m. That’s a 10% Gross Margin.
To make that $200m of profit, they spent well over $400m in Operating Expenses. That’s right, OpEx was actually more than 200% of Gross Profit.
Unless something fundamentally changes, Carvana will simply lose more and more money as they “scale.” That’s not what I call scaling. With SaaS, this is exactly the opposite.
Carvana’s battle: because gross margin is so low, they will have to (eventually) try to keep OpEx down to eke out a tiny profit.
SaaS’s battle: because GM is so high, they have to try to spend a ton on OpEx to take full advantage of the opportunity, otherwise they profit a ton now but leave money on the table for later.
Bear
PS - Valuation
I don’t see why a Carvana is valued at $10 billion. If you must invest in a company that will have a hard time making a net profit, check out Wayfair. They made $6.8b in revenue in 2018 (vs Carvana’s 2b), 1.6b in Gross Profit (vs Carvana’s 200m), and spent $2.1b on OpEx (still more than gross profit, but not nearly 200% of it). And they’re valued at about $14 billion.
That’s about $14 billion more than I would pay for Wayfair, but it’s weird how they have 8x the gross profit of Carvana and yet are just 40% more expensive. I think SaintCroix mentioned 51% of Carvana shares were held short. If that’s correct, I can see why!
Another point about Carvana, is I don’t see how their cost of acquiring cars will ever go down. They are buying used cars! From what I understand auctions are a big source of their inventory. Someone has to sit there and inspect the car and decide what to bid. And bid on it. And have it delivered. This will not scale either. In other words it will be very difficult to scale down OpEx for Carvana on the purchasing end.
Compare this to, say, Wal-Mart, who probably has ERP software sophisticated enough that it sends purchase orders to suppliers automatically with no human intervention, and inventory just shows up on their dock. Prices are negotiated/arranged beforehand for many purchase orders over, say, 6 months or a year.
Also, there is no stickiness for repeat business or recurring revenue.
There might be some brand loyalty if you had a good experience.
But I would guess that the consumer would have more brand loyalty to the car maker, the service center, or mechanic; thus diluting any loyalty to the website brand.
None of these are issues for SaaS model companies.
Carvana is probably a great company…but I don’t see how scaling up doesn’t provides it with the economies of scale of SaaS type companies or any software or media company.
Just this evening after the market closed, Carvana announced a new capital raise, selling 3.5 million common shares (with up to 525,000 more), along with $250M of notes expiring in 2023 paying a rate of 8.875% (pretty sure that is approaching, if not well into “junk” territory for a bond coupon in today’s environment, where the 5-year treasury yield is about 2.2% - https://www.treasury.gov/resource-center/data-chart-center/i…).
So make that $1.45 billion in total debt for Carvana, vs. $316 million total debt for Alteryx, a company generating essentially the same gross profit dollars at this point, but is an asset light, high margin business. Actually now $776 in long term debt at CVNA. Let’s say at 7% a year, that’s $62 million in interest expense, when their GP is run rating at $352 million. When their debt cuts into about half their GP, we’re going to see some big problems.
This is the difference between a high capital cost, low margin business and one that enjoys 90% gross margin and a differentiated product.
Carvana’s differentiation actually costs more and will be more expensive to maintain, because it means having the higher number of cars to sell to be the “default go to” for buying cars online.
We have the perfect real-time example here. Alteryx can grow and grow, and if they DO meet their TAM, extend into more product lines (as they said they will do eventually).
Meanwhile, Carvana will be strapped with debt loads they have to pay off and that’s when their growth will slow, when they simply have no funding for further growth. Then growth will come to a grinding halt because they can’t increase their inventory. They’ll have to find a way to increase their inventory turns, that will be the only way. If I were an investor in CVNA I’d be gone the second I started seeing seekingalpha articles talking about their debt load, if not before.
Funny thing about Carvana, apparently it was borne out of DriveTime, which was formerly Ugly Duckling. Ugly Duckling was one of the companies I was thinking of when saying how perilous the used car industry can be. Turns out it’s the same guy who ran Ugly Duckling now in charge of Carvana.
Garcia’s financial comeback started with Ugly Duckling, a rental car chain he bought for less than $1 million. After failing to turn the business around, Garcia merged it with a tiny finance company and built it as a seller and financer of used cars for people with poor credit histories. As the stock market roared in the 1990s, Garcia had Ugly Duckling raise $170 million by conducting an IPO and then issuing more shares.
Forbes first wrote about Garcia in 2001, as he was preparing to take Ugly Duckling private after its stock priced crashed from $25 to $2.50. Garcia ended up with full control of Ugly Duckling, buying the shares he didn’t own for $18 million. At the time, the company had annual revenues of $600 million. He hired Raymond Fidel, who eventually became CEO, and renamed the company DriveTime Automotive. Fidel also pleaded guilty to a felony charge connected to the Keating scandal.
Hopefully Garcia learned a thing or two with his Ugly Duckling experience. And hopefully that experience is not on how to milk shareholders even more this time.
4 years ago I bought a car and sold a car on Beepi which was the Carvana of the time. They were a disruptive company seeking to do the same thing that Carvana wants to do. They went bankrupt for various reason - some structurally related to the complexity of the car business and some related to mismanagement pitfalls of a start up. Maybe Carvana could be different. Additional competitors includes www.vroom.com
Hopefully Garcia learned a thing or two with his Ugly Duckling experience. And hopefully that experience is not on how to milk shareholders even more this time
Typically I wouldn’t weigh in here as I don’t own Carvana and don’t know all that much about them, your simple argument, while completely true is somewhat unfair. I mean this board is full of companies that aren’t earning money. I realize that the SAAS companies have huge gross margins but they are also very highly valued.
If you want a comparison, you should use the one that was mentioned when Carvana was brought to the board and that is Amazon. Another company that had extremely low gross margins… and I mean extremely low gross margins for years as they grew revenue 40% a year for about 2 decades. Their share price followed the sales growth and it was an incredible investment…with people saying it was crazy expensive very similar to your comments.
I know, this isn’t Amazon, but if they can grow revenues and eventually margins grow a little while OpEx grows slower, this story changes drastically… which is why the company is expensive today.
Not sure I buying in yet, but any industry that is a mom and pop today that can be expanded on the internet is one worth watching…
Just one man’s opinion.
Randy
No position here except a decent sized one in Amazon and a whole bunch of SAAS companies that seem to be getting very expensive.
Great discussion here. Interesting points on both sides.
I believe Carvana can be a good short-term investment. Let’s say over the next 12 to 24 months. But if you want to make the long-term comparison to Amazon then the Carvana business model of selling cars is flawed.
We’re gradually moving towards a subscription-based economy because of the buying habits/convenience that Millennials are looking for. Millennials are now the largest population group in the US. They’re somewhere around 75 million. That’s larger than the Baby Boomers.
The long-term play will be based on a car subscription service. Why buy a car online from Carvana when a customer can essentially “rent” a car on a month to month basis? Millennials are already using services like Amazon Prime Wardrobe, Stitch Fix, Birchbox, Blue Apron, etc. The next step will be big ticket items like autos.
Car subscription services are still in their true infancy stages but it’s coming. Luxury brands are leading the way by offering pilot programs. For example, Porsche only offers the program in Atlanta, GA. BMW offers the program in Nashville, TN. These players are testing these programs but over time they’ll start to figure out what works and what doesn’t with their subscription offerings, pricing, services, etc. Enterprise recently announced they are going to be entering the subscription space as well.
The subscription model offers convenience to customers. Right now, Carvana is a more convenient way of buying a car online. Three to five years from now a car subscription service will be a more convenient option.
Just think you could drive a four-wheel drive SUV in those snowy winter months and then switch to a convertible in the summer.
PS: I do not own CVNA but YTD the stock is up 105%. During that same time ZS up 95%. TTD up 70%. OKTA up 70%. Not bad company to be in.
If you want a comparison, you should use the one that was mentioned when Carvana was brought to the board and that is Amazon.
Randy,
I’m sure you mean well, but comparing any company to Amazon is more than a lowercase fool’s errand. Here are a few reasons why:
Amazon is the ultimate survivor-bias example. There may be 1,000 companies you think are “like it,” but how many of them will actually become it?
Amazon isn’t a retailer as much as it is a conglomerate. There are multiple businesses here. And the “retail” business may be far less valuable than its SaaS business, Amazon Web Services.
Picking the next Amazon from a list of retailers entails picking not just which has optionality, but which will execute on its optionality to a degree only a few companies in the world ever have.
Using Amazon as an example should be banned from reasonable conversation. It’s like saying, “Here’s a cartoonist…just like Walt Disney.” Or, “Here’s a lawyer, just like Barack Obama.” Never use the stand out exception to prove the rule.
Hi Paul,
Fair enough, but I didn’t mean to imply they were the same or even make the first comparison, the person who brought it to the board did. And my intent was not to say it would become another Amazon, it was to say that the business model they were trying to build was very similar. Nothing wrong with trying to emulate a business model that works is there?
Essentially, they are trying to grow revenues rapidly with small gross margins in the beginning with the intent of expanding them once they have reached huge economies of scale. Something Amazon did most effectively, along with Netflix and many others.
So, to be clear, my response to your post was that you were pointing out that Carvana’s business was totally flawed just by looking at a few simple numbers. I disagree, in fact, it can work and it isn’t even an uncommon business model.
Whether they are successful in the used car field is a much more difficult question and I don’t have an opinion of that as of yet (it seems very difficult). But if they are successful, their success will be built on the backs of a lot of articles just like yours explaining why it couldn’t possibly work.
Bear,
IMO Amazon is not a retailer. They are also not a conglomerate in any traditional sense of the word. What they are is a low cost provider of nearly friction free essential services via the design and implementation of purpose built infrastructure.
Amazon as a retailer examined all the friction points of shopping, starting with getting your stuff together to go shopping, getting to the place in which you conduct the transaction, comparison of products, purchasing, delivery, after purchase services, and on the seller’s side, inventory management, packaging, shipping, bookkeeping, and whatever else you can think of and they reduced the friction to at or near zero. They fine tuned it by using it, then leased excess capacity to those who wished to take advantage of it. The majority of product sold on Amazon is not Amazon owned inventory.
Then they did the same thing with software. What I mean by that is what is the primary inhibition for companies wanting to exploit the benefits of software? It’s the capital expense and on-going maintenance of the hardware environment required to utilize that software. Amazon, took all that friction away with AWS. They built and manage a computing infrastructure that few companies could afford on their own, and they lease it out at a relatively low cost.
What’s next? My guess it’s going to be “the last mile” delivery service. At present, that last mile is inordinately expensive and inefficient. But, it might also be the brick and mortar retail checkout line. Or both. But it will be the same strategy. Extremely well designed and purpose built bullet proof infrastructure that eliminates common friction that inhibits the flow of commerce.
