I recently had a call with a Family Office that manages over $1 billion dollars of assets, who wanted my perspective on the future of the automotive industry. Their management style was one of a passive investor, and they were seeking to calibrate their “investment thesis” against my point of view. Needless to say, we had an interesting discussion. This got me to thinking that I should commit my personal perspective on the future of the automotive industry and formulate a thesis around which areas are likely to benefit investors most.
We would likely come to general agreement that the industry is about to endure a period of dramatic change. It might be harder to agree on sorting out which sectors and specific companies are going to benefit over the coming years.
The auto industry is starting to see more clearly a number of transformative elements on the horizon. Evolving consumer shopping preferences. Autonomy. Electrification. Connected Cars. Vehicle ownership. The evolution of the advertising ecosystem. Potential SaaS disruptors.
Some of these areas are going to be affected more strongly and more immediately than others. But we’d be wise to keep an eye on all of these evolving trends.
The Physical Dealership Market
In this month’s issue of the Intel Report, we hear from Brodie Cobb and George Karolis about what continues to be an exceptionally strong physical dealers “buy/sell” market, fueled by a low interest rate environment, dealers who weathered Covid, and strong stock prices of the public dealer groups.
Paul Sims tells us that we’re witnessing a “Buyer:Seller” ratio of 17:2.
Similar to many asset categories, the multiples being paid for physical dealerships are as high as they’ve ever been. I find myself having a hard time reconciling such a buoyant physical dealership market with the sheer number of uncertainties brewing in the industry.
Transparency: Good for Consumers...
We could all agree that transparency online has been great for consumers, but not so great for dealer profit margins. The NADA Data book clearly shows that dealership “front end” gross margins have been eroding for years, much of which is fueled by the fact that consumers are now better equipped with access to widespread pricing information, including invoice pricing and the ability to quickly and efficiently cross-shop across every vehicle for sale in America.
It seems likely that transparency is coming to other dealer profit centers, such as financing, F&I products, trade-ins and even parts and service. If consumer transparency on the front-end of the car deal has been any indication, dealers may soon start to experience margin compression across these other dealer profit centers.
Beyond COVID-19, it’s fair to say that 2020 was the year of the special purpose acquisition corporation (SPAC), and many electric vehicle manufacturers took the opportunity to go public, including Fisker, Nikola, Canoo, Lordstown Motors, and Hyliion.
Signs indicate that the EV Wave is accelerating include:
GM recently announced their goal to eliminate gas and diesel vehicles by 2035.
The Biden Administration announced the transition of the government fleet to 100% EVs.
Norway's electric car sales hit a new record in 2020, with battery electric vehicles (BEV) making up 54.3% of all new cars sold, a global record, up from 42.4% in 2019 and from a mere 1% of the overall market a decade ago.
2020 seeing numerous electric vehicle (EV) manufacturers take the opportunity to go public, notably via SPACs, creating billions of dollars of new market capitalization.
With Tesla’s market cap at $750 billion, Elon Musk is now wrestling with Jeff Bezos to claim the mantle of richest person in the world
Many of the legacy OEMs have indicated they are aggressively increasing their bets on EVs. GM boosted its planned spending on electric and autonomous vehicles by 35 percent to $27 billion through 2025. Volkswagen committed $41.5 billion through 2025 just for battery-powered vehicles. Ford is spending $11.5 billion on EVs and hybrids through 2022. Hyundai and Kia are planning to spend a combined $43 billion through 2025 on EVs, purpose-built vehicles and other new technology.
So, why should we care?
EVs have many fewer parts to fail and have much longer service intervals than internal combustion engine (ICE) vehicles. The Parts & Service section of a dealers’ P&L delivers only 12% of total revenue, but close to 50% of total gross profit. If both Parts and Service start to dry up due to the reliability of EVs, how are dealers going to backfill these profit centers?
Who Owns the Consumer?
We are starting to see evidence of growing tension between the OEM and the dealership, in terms of who owns the consumer relationship.
It was recently announced that for the all-electric Hummer, General Motors will allocate inventory based solely on customer orders and will encourage dealers to stick to standardized pricing. The automaker even asserts the right to limit GMC dealers' interactions with Hummer buyers.
OEMs increasingly want to influence the websites and digital retailing tools that their dealers can use. And, as vehicles become more “connected”, the OEM will have more opportunity to interact directly with the consumer. Vehicles will increasingly have the ability to “unlock” features and performance via “over the air” updates, which will put strain on whether these updates should be marketed and triggered by the dealer or by the OEM.
From a convenience perspective, as a greater percentage of purchases (and servicing of vehicles) are delivered to the consumer’s driveway, dealers will have fewer opportunities to forge a one-to-one relationship with their customers, and thus fewer opportunities to build trust and loyalty.
Health of the Vendor Universe
If the profitability of the dealer body becomes strained, then what about the ecosystem of advertising and SaaS products that rely on a healthy dealer body?
The barriers to building software have lowered dramatically, and it’s now extremely easy to launch a technology company. As a result, we’re seeing more and more new software companies emerge solving narrower and narrower “pain points” in the industry.
The automotive space has always fostered a healthy amount of innovation. Just walk around the convention floor at NADA each year to get a sense of the sheer volume of technology companies that support dealers and OEMs.
I love to see innovation in the space, but many of these new companies emerging with weaker value propositions may never make it. While the number of automotive technology startups increases, so will their failure rate.
The Consumer Financial Protection Bureau (CFPB), the watchdog created after the 2008 financial meltdown and largely muzzled in the Trump era, will get new traction under the Biden Administration.
The CFPB is likely to take a tough line against industry giants it finds engaging in abusive practices. While the agency will focus first on enforcing legal protections for distressed renters, student borrowers and others facing growing debt that its previous leadership had been lax about imposing during the pandemic, it may eventually fix its gaze on dealership financing and insurance profit centers.
Where to Make Investment Bets
Given all of the above, which companies and segments of the industry are likely to benefit over the next five years? There are two areas in particular that are of interest to me right now, that I’m keeping my eyes on.
Thesis 1: Saving Costs
As mentioned above, I believe that the margin compression that dealers have experienced on the “front end” of the deal will begin to be felt across their other profit centers. As a result, I’m a big fan of companies that are helping to alleviate margin compression by helping dealers spend money more judiciously.
For example, technologies that help dealers run their operations more efficiently (selling or servicing cars with fewer employees) should be well received by dealers.
Business Process Outsourcing (BPO) is the contracting of non-primary business activities and functions to a third-party provider. BPO services include payroll, human resources (HR), accounting and customer/call center relations. We should see more technology-enabled services that help dealers do more with fewer resources.
Thesis 2: Data
Back in 2008, I helped Manheim open an office in Dubai. Every time I visited the city, I was amazed at the amount of construction going on. At the time, the city was consuming a large percentage of the world’s construction cranes and scaffolding. I understand that billionaires were made from those who foresaw the demand and satisfied the inputs necessary to support growth.
Mark Twain said, “When everyone is looking for gold, it’s a good time to be in the pick and shovel business.”
There’s a similar “gold rush” going on right now with online consumer experiences. There are a multitude of various digital retailing experiences dealers can choose from, but I believe that the data powering these tools is where real wealth can be made.
In October 2020, heavy equipment auction juggernaut Ritchie Brothers acquired a company called Rouse Services for $250 million that was valued for the data that came from their POS software. Rouse’s data allows Richie Brothers to understand supply/demand, rental utilization rates and pricing.
I believe that wealth will be created in the data inputs needed to power accurate and comprehensive consumer shopping experiences.
While huge fortunes will be made in electrification (both OEMs and battery or charging technologies that “win”), in connected cars (and the data that can be harvested from them), in autonomy, and with flexible ownership/subscription models, entrepreneurs and investors would be wise to keep an eye on the two areas that I outline above.
In any case, I think we’ll see more change in the next 10 years than we’ve seen in the industry in the past 100.
On to this issue of the Intel Report.
This month, we have three guest contributors.
First off, I’m very excited to welcome Mike Rother to the Automotive Ventures team, as he comes aboard to run AV Strategy, our consulting arm. Mike shares with us his perspective on auto industry needs in the near future.
Second, I’m thrilled to have back both Brodie Cobb and George Karolis from Presidio Group, who will help bring clarity to the strength of the physical dealership buy/sell market.
Finally, I’m very appreciative to have a contribution from Paul Sims, an old industry friend and colleague, who shares with us his perspective on dealership consolidation.
Please check out my two weekly shows on CBT News: The “Friday Five”, where I recap the week’s automotive technology M&A deals, and “Founders Focus”, where I interview entrepreneurs for an intimate conversation about their journeys and the great companies they’ve built.
At Automotive Ventures, we are focusing a lot of our efforts on identifying and helping early-stage companies that have great founding teams, are attacking large total addressable markets (TAM), and have a unique, defensible solution and go-to-market approach. We hope to do our part to both strengthen the automotive technology early-stage ecosystem and help to provide entrepreneurs and their companies a better chance of not only surviving but thriving.
We also spend a lot of our time consulting with clients who are either looking to acquire or invest in companies in the automotive technology space. If you have needs in this area, please don’t hesitate to reach out to us.