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Greenfield's Point of View - May 2021

Automotive is Spawning Unlevel Playing Fields

My most influential professor was Patrick Noonan, who taught Strategic Decision Analysis during my last semester at business school. In addition to instilling ruthless rigor in the classroom and showing very little tolerance for students who were unprepared, he introduced me to a number of concepts and frameworks that I still use today. And for that, I am eternally grateful.

During class, we read a seminal book on game theory called Thinking Strategically by Dixit & Nalebuff. One of the important takeaways from the book was how important it was to know the rules of the game you’re playing before you start the first move. Luck particularly favors those who set the rules of the game. Just ask the chumps who play poker in Las Vegas with the pros.

I get a chance to speak with money managers every week who are keen to better understand the automotive space, whether their thesis is short or long-term in nature. I also get to interact with the owners of many car dealerships. It seems like just about every industry participant is scratching their heads to understand some of the company valuations we’re seeing in the market right now. It feels that we’re on an uneven playing field, both in retail automotive as well as in the wholesale auction space. Let me explain.

For online retailers vs. physical dealerships, we see a stark difference in valuations. CarMax is trading at a market capitalization of $21.7 billion, which equates to about 1.0x their 2020 “net sales and operating revenues” of $20.3 billion. Carvana, on the other hand, is trading at a market capitalization of $49.2 billion, which represents about 8.8x their total revenue of $5.6 billion. Compare both of these to AutoNation, the largest dealership in the USA, which trades at a market capitalization of $8.3 billion, or 0.4x 2020 total revenue of $20.4 billion.

In the wholesale auction space, KAR Global is trading at a market capitalization of $1.9 billion, vs. ACV Auctions at $5.2 billion. KAR trades at 0.9x 2020 revenue of $2.2 billion, while ACV trades at 25x 2020 revenue of $208 million.

Now, I’ll be the first one to recognize that market values are based on a number of drivers, including revenue growth rate, gross margins, and most importantly, the future outlook of the company.

But it’s got to be awfully frustrating right now to be sitting in the boardrooms of some of the public companies, trying to figure out how the market is rewarding these relatively new “disruptor” companies who are being held to a different standard of “growth at all costs” and not being held to the same standard of accountability around profitability.

As I was taught back in business school, the surest way to win a game is to set the rules. The auto industry seems to have a whole new set of rules being established by newer industry entrants, and it’s going to be interesting to watch how this plays out over the next 5 to 10 years.

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