Vroom: Overvalued or Big Potential?
Upon listing publicly on the 9th June Vroom, an online marketplace for used car transactions, saw its share price soar, doubling in value over its stock market debut day and greatly exceeding its initial price. The IPO priced Vroom shares at $22 and enabled them to raise $470m, however on listing the price rocketed, gaining 117% hitting $48 by market close on the day of listing. Since the impressive debut demand has cooled slightly with shares down to $43 on market close on Friday although this remains significantly higher than the initial offer price. At $43 a share Vroom have a market capitalisation of just under $5bn, showing there is investor belief in the future of the used-car ecommerce market.
Vroom filed for an IPO in May following a stall in new listings as a result of COVID-19. Following a collapse in global stock markets in March the S&P500 entered a record bull run from April to June, posting its best 50 day return in history. As a result of this run the US benchmark index is now positive for the year although is yet to pass its February peak. There is said to be high demand for new listings and a high supply with San Francisco firm JMP Group referencing a ‘record backlog’ of firms seeking an IPO and Citi ECM group claiming demand as now as strong or stronger than it was before COVID-19.
This spike in demand has meant that Vroom is not the only firm to have seen its share price soar on listing, since the beginning of the month Warner Music and ZoomInfo (not to be confused with the video-conferencing platform Zoom) have also listed and seen impressive debuts. Warner Music were able to price at the top of their target range and ZoomInfo saw a 60% gain upon listing, these strong performances reflect increased confidence in the equity markets as the global economy attempts to recover. Vroom has previously been heavily backed by venture capital funding and major investors T Rowe Price and Bill Gates’ Cascade. However, despite strong revenue growth of 40% in 2019 to $1.2bn it continues to be a loss-making firm with net losses rising by 68% to $143m in 2019.
Vroom on listing, Source: Nasdaq
Vroom had initially targeted a share price of $17 with the aim of raising $319m at a market capitalisation of $1.92bn, a rise on the $1.5bn valuation it was given in a funding round in December 2019. This was later extended to a target of $20 a share, which was then exceeded on listing, with a share price of $22 that encouraged Vroom to list a greater number of shares and enabled the firm to raise $470m.
This increased share price of $22 was still viewed as a gross undervaluation by the market, with the price spiralling to $48 by the end of the trading day, a 117% rise, which made it the second-best debut this year (after Inari Medicals 124% rise in May). This inflated share price gave Vroom a market capitalisation of $5.5bn, significantly beyond the $1.5bn valuation given by investors only 7 months ago in December, which gives the implication the market is currently overvaluing the firm, as it is unlikely that its value could have truly grown by $4bn over such a short period.
The used car market is one of the largest consumer markets in the US with estimates valuing it at $840bn in 2019, placing it ahead of the $636bn new car market. The market is a highly fragmented one with over 40,000 active firms and lacks any dominant players with the largest firm in the industry CarMax only holding a 2% share of the market. Vroom’s ecommerce model places it in a good position to disrupt the market as it offers something that differentiates it from the traditional brick-and-mortar used car dealerships. The current ecommerce penetration in the used-car market is very low at only 0.9%, where most retail markets see penetration levels in the mid-teens. Whilst this ecommerce model differentiates Vroom it is also a source of doubt in the firm – many in the industry believe that its clientele remains reluctant to purchase cars without having physically seen and tested them.
However, in a post COVID-19 world this may no longer be the case with a shift in preferences towards contactless transactions. Surveys of the industry support the idea that the landscape is changing, with 61% of customers open to buying a car online (compared to only 32% before the virus). Another survey, taken by dealersocket, a software solutions firm focused on car industry, exhibits the frustration with the current situation – 81% of customers claimed to be dissatisfied with the industry, implying they would be open to change.
Vroom may be the firm to bring about this change with its business model reducing the friction often associated with the market as it enables the consumer to complete the transaction entirely remotely as Vroom provides vehicle delivery and pickup. Alongside a shifting landscape the industry is also enjoying a positive demand shock as consumers are now keen to avoid public transport and car-pooling to reduce transmission of the virus, moreover Vroom’s contactless transactions remove the risk of contracting the virus when attempting to purchase or sell a car, making them a highly attractive option for consumers in the current climate.
A traditional brick-and-mortar used car dealership, Florida. Source: Mike Small
Vroom are not entirely unique in their business model – comparisons are frequently drawn to Carvana, another ecommerce used car dealership. Carvana is currently the more established of the two - at $3.9m it generated triple the revenue of Vroom in 2019 and also recorded a lower loss of $115m. Whilst the two firms have many similarities in their business models Vroom’s asset-light approach is a major difference and offers a unique dimension to Vroom.
In 2019 Vroom owned only $7.8m in property, plant and equipment (PPE), outsourcing large parts of the business to third parties - out of 14 vehicle reconditioning centres used only one is owned by Vroom. This allows Vroom to pass on costs to third party operators, avoiding the fixed costs associated with being asset-heavy and the ability to be more financially flexible.
However, outsourcing may reduce the reliability and consistency of the service provided as well as the loss of potential profits on business lines outsourced. Further to this financing for buyers is done by partner lenders and even the customer service team is currently being run by a third party, which risks the quality of customer service in a fragmented industry where it is crucially important. This differs from Carvana who own all of their vehicle reconditioning centres and provide financing, giving them a much larger asset base, with a total PPE value of $667m in 2019. Whether or not the asset-light approach is the ideal one is debatable – however in keeping costs low it may be crucial in facilitating Vroom’s path to profitability.
Vroom has seen an impressive expansion in recent years, driven by the growth of its ecommerce division. Currently Vroom operates through 3 key lines, ecommerce, Texas Direct Auto (TDA) through which it operates its only company owned vehicle reconditioning centre and wholesale. The ecommerce business made up around 50% of revenue in 2019, although the wholesale business is a by-product of the ecommerce business, therefore masking the true contribution of ecommerce.
Over the past 4 years ecommerce revenue has grown by a multiple of 5 to hit $588m, this was helped by the enormous 145% growth between April 2019 and April 2020 that occurred as a result of an aggressive marketing campaign that saw a rise in visitors to the site by 130% to just under a million visitors. With an increasing number of customers moving online as a result of COVID-19 Vroom is primed to see further gains in customer base and users, allowing it to increase market share and move towards profitability. However, to continue this growth they are reliant on customers continuing to transition to the online marketplace, and their ability to retain these customers once traditional brick-and-mortar dealerships open again.
Whilst Vroom is in a high-growth phase it appears a long way from profitability, CFO Dave Jones has claimed they will become profitable when they sell 200,000 cars annually, this seems a far reach from the 19,000 sales seen in 2019. Although profitability may currently appear distant Vroom are in a good position to eventually generate a profit. Through their data driven approach they can adopt an optimal pricing strategy, and this approach enables them to differentiate from the vast majority of other players in the fragmented market. Moreover, with rental car companies enacting sell-offs of their fleets Vroom may be able to address supply-side issues that they have previously struggled with.
The exponential rise in the share price of Vroom gives it a market capitalisation way above that it had been valued at in funding rounds only 7 months prior and is double the value that it was initially given on launch. With this occurring at a time where investors have a strong appetite for new listings in an equity market bubble the share price appears to be highly inflated. However, whilst it may be overvalued right now Vroom have enjoyed rapid growth and if they can continue on this trend and take advantage of changes in the industry landscape, particularly the further ecommerce penetration of the market, then they are in a good position to become profitable and further gains in their share price can be expected as a result.