The Grand Experiment Continues (aka: This Might Take A Bit Longer To Resolve)
McKinsey & Company notes that digital commerce adoption has accelerated ten years forward in just 90 days’ time; it’s remarkable how quickly e-commerce has replaced physical channels in three months, rising from 17% of US ecommerce penetration in Q4’19 to 33% in Q1’20.
“We’ve seen two years’ worth of digital transformation in two months,” Microsoft CEO Satya Nadella said on their recent quarterly earnings call.
In parallel to consumers transacting digitally, companies have learned to embrace “work from home” and find operational efficiencies (doing more with fewer resources). Google recently announced that many of its employees could continue working from home until at least July 2021. During Facebook’s Q2 earnings call, Mark Zuckerberg said there’s no timetable for bringing workers back to the company’s offices.
Speculation is that this trend will burst the atmospherically high commercial real estate prices on the west coast. I’ll be surprised if commercial real estate prices don’t correct across many major metro markets. Between the reduction in work forces and permanent work from home policies, companies just won’t need the same amount of office space going forward.
There will be long-term implications on company cost structures – automotive dealers and auction companies are reporting their most profitable months ever and rethinking how to be more productive with less expense. These trends will most definitely benefit the profitability of companies post COVID.
Strong Interest from Financial Players in the Auto Space
Numerous recent conversations with Private Equity (PE), Venture Capital (VC) funds, and Corporate VC teams have all had the same theme: trying to anticipate how the pandemic will impact both consumer shopping patterns and dealership operations long-term, and make investment bets accordingly. I sense that over the remainder of the year we will witness an acceleration of investments and acquisitions in the automotive space. On the flip side, I am speaking to an increasing number of innovative companies that are interested in raising money.
How’s the Economy?
U.S. gross domestic product (GDP) fell 9.5% in the second quarter, wiping out nearly 5 years worth of growth in the economy. GDP fell at a 32.9% annualized pace, the steepest drop in records dating to 1947. This figure is a bit misleading for two reasons:
All the contraction occurred in April and output then rose sharply in May and June.
GDP growth figures are routinely annualized. If it declined at the same rate for a full year, that would equal 32.9%, but it almost certainly won't.
At time of publication, federal stimulus has expired, and Congress seems to be at an impasse. This means that 25 million Americans are set to lose the $600 a week each in federal unemployment benefits that has helped the jobless to pay their bills, and has helped to cushion the economy. Many people view the payments as a lifeline, and analysts say the $15 billion a week in federal spending has provided vital support to an economy staggering from the effects of the pandemic. Critics say the money, paid on top of regular state jobless benefits, discourages some Americans from returning to work. A University of Chicago study found 68% of unemployed workers who are eligible for benefits receive more in jobless payments than lost earnings.
Personal incomes actually jumped during Q2. One-time stimulus payouts and unemployment benefits lifted incomes, boosted saving rates and helped keep households afloat. Real disposable personal income — which accounts for taxes and inflation — increased at a 44.9% annual pace.
Personal savings rose to $4.7T annualized in the second quarter, up $3.5T from the fourth quarter of 2019. The personal saving rate hit 26%. This means the hit to people’s incomes from job losses was more than offset by government stimulus payments, thereby preserving personal spending power.
Coupled with this, a federal moratorium that had protected an estimated 12 million renters from eviction for four months is expiring.
Between 2006 and 2014, about 10 million Americans lost their homes to the foreclosure crisis. Today, of the 110 million Americans living in rental households, 20 percent (or 20 million) are at risk being evicted between now and September.
Both of the items above are sure to be a drag on consumer confidence, consumer spending, and the economy. Roughly one-third of U.S. households have not made their full housing payments for July. In New York City, one-quarter of all renters haven’t paid their landlords since March.
No matter how the rest of the year plays out, unemployment is expected to stay above 10% into 2021. Companies don't expect to return to pre-pandemic employment levels this year — or next; the typical firm does not expect to regain their pre-COVID employment levels until sometime after the end of 2021.
While the economy is expected to grow in the third quarter — possibly at a record pace — a surge in virus infections that started in mid-June appears to be slowing the recovery in some states. Federal Reserve Chairman Jerome Powell said the U.S. economy faces a long road to recovery that will require greater public vigilance to prevent the spread of the coronavirus pandemic and more spending from Congress and the White House.
Why is the Stock Market So Strong?
As the economy suffered through its worst contraction in 70 years, and the number of new coronavirus cases continued to spike to record levels, the stock market closed out its strongest quarter in more than two decades.
Equity markets were on a roller coaster ride, three months that saw the fastest 30 percent decline in stock prices in history, followed by the fastest 50-day increase on record.
The public markets are being buoyed by the huge amount of liquidity that the Federal Reserve has injected into the financial system. That has pushed interest rates to record lows, turning money market funds, bonds and other fixed-income instruments into low-returning investments. The S&P 500 Index has a dividend yield of 1.9%, compared with 0.7% for 10-year Treasury notes. Unusually, an investor can now make more in current income from stocks than from high-quality fixed-income securities while also participating in any future appreciation in share prices.
Also note that 28% of the S&P 500 Index is now in the “Information Technology” sector, and that the big four tech companies — Amazon, Apple, Facebook and Google — announced record earnings (combined realizing $28.6 billion in profits in Q2’20), all reporting better-than-expected revenue and earnings results for Q2. The combined market cap of the four companies was about $5 trillion at time of publishing, most at new all-time highs.
But beyond the big tech companies, things look a little bleaker. For Q2, the S&P 500 is reporting a year-over- year decline in earnings of -44.0% and a year-over-year decline in revenues of -10.5%. But companies are beating their conservative estimates, which is supporting stock prices.
As of date of publishing, 63% of the companies in the S&P 500 have reported results for Q2 2020. The percentage of companies reporting actual earnings per share (EPS) above estimates (84%) marks the highest percentage of S&P 500 companies reporting a positive EPS surprise since 2008. The magnitude of positive earnings surprises is also the highest reported since 2008.
The Auto Industry Has Stayed Very Resilient
I’ve spoken with many dealers who were surprised to have record-making profit months in May, June and now July. Profits have been from a combination of better than expected volume of sales and service, but more so from the deep cuts they made in their cost structures as COVID first set in.
Like companies across many industries, dealers are examining their staffing models and figuring out how to conduct business with lower compensation expense. And many dealers have been finding other ways to squeeze out unnecessary costs such as renegotiating contracts with vendors. Lower interest rates have cut mortgage expense and floorplan expense, which are significant for most dealers.
Two critical and unknown questions are whether consumer demand for new and used cars will continue to stay strong, and equally importantly, whether the increase in buying vehicles online persists, or is a temporary reaction to the coronavirus. Dealers have also found creative ways to make vehicle service and maintenance more convenient for customers to boost their fixed operations. Pick-up and delivery have become more common.
Annual new vehicle sales pace (SAAR) in July was forecast to be 13.3M, down from 16.9M in 2019. The industry's recovery is slow but remains on track with a third straight month of improvement.
There are about 20% fewer vehicles advertised in dealer inventory today than were there at the beginning of the pandemic, which may mostly be attributed to limited supply. Additionally contributing to industry volatility, the number of automotive loans classified “in hardship” continues to increase, and are now 18 times higher than just a year ago.
Whether large or small, urban or rural, we expect dealers will emerge from the pandemic stronger and more profitable than ever before.
Electric Vehicles are Hot
Last month, Tesla's market cap grew larger than rival Toyota as the world's most valuable carmaker.
Electric carmaker Rivian raised an additional $2.5B bringing the electric vehicle maker's total amount raised to more than $5B in just over a year.
Nikola has a market cap of $11B. It went public on June 4th, priced at about $34. The stock hit $93.99 on June 9th. At time of publication, Nikola’s stock price is $30.00.
In mid-July, Nikola filed a registration with the SEC to sell an additional 23.89 million shares at $11.50 to holders of warrants, which were acquired as part of Nikola’s IPO.
The company is still at least one year away from producing its first vehicle. Its revenue for 2020 will be zero. All it has on its books are some non-binding orders for vehicles that don’t yet exist. Tesla had already delivered cars by the time its market cap was the size of Nikola’s.
Electric car maker Fisker raised $50M, and reached an agreement to merge with Spartan Energy Acquisition Corp., a Special Purpose Acquisition Company (SPAC) sponsored by an affiliate of Apollo Global Management. As a result, Fisker will become a public company with a valuation of $2.9B. The transaction is expected to close in the fourth quarter. Fisker said this will provide the funding it needs to bring its first product, the all-electric Fisker Ocean SUV, to production in late 2022.
What About the OEMs?
The “old guard” OEMs don’t seem to be faring quite as well as the dealers.
General Motors posted a $758M Q2 net loss mostly due to factory shutdowns in its home U.S. market. The company said its U.S. plants are cranking into overdrive to replenish thinly stocked dealership lots, a sign that its bottom line could rebound in coming quarters as the company tries to make up for weeks of lost production this spring from the pandemic. GM said nearly all its U.S. factories are running at pre-pandemic levels.
FCA lost $1.24B globally in Q2. North American vehicle shipments sank 62%, as FCA restarted auto production in May after a two-month hiatus in the region. But North American operations avoided a loss even as net revenue fell 53% to $9.71B. North America managed to report a $46.1M profit, down 98% from a year earlier.
Ford reported Q2 income of $1.1B despite a pandemic that idled its North American plants for roughly half the reporting period. The surprise profit came largely from a $3.5B gain on its investment in Argo AI, the company that is developing a self-driving vehicle system. Volkswagen Group closed on a deal with Ford for a stake in Argo last month and CFO Tim Stone said the startup is now valued at $7.5B.
Ford lost $1.9B in the quarter from operations, as revenue fell 50% to $19.4B. Still, the operating loss was much less than the $5B Ford had forecast earlier in the year.
Health of Financial Players
When I think of acquisitions and investments into the technology ecosystem, I usually divide the players into “Financial” vs. “Strategic” (although often this line is blurred, specifically with the “Corporate VC” activities of strategic players, and the fact that the Limited Partners (LPs) of automotive-focused VC and PE funds are increasing participated in by CVCs).
During the first six months of 2020, private equity deal value in the US was down nearly 20% from the first half of last year. Exit activity collapsed in Q2, with firms opting to hold marked-down assets rather than sell at a discount.
On the deal-making front, late-stage investments outpaced early-stage rounds in Q2 for the first time in at least five years. Relatedly, the VC industry is on pace for a record number of mega-deals, while first-time fundings are tracking for their lowest annual total in 10 years. Together, these trends illustrate how firms have been eager to pad the balance sheets of current portfolio companies that may be most likely to achieve a successful exit while being reluctant to make new, riskier investments, particularly when in-person meetings with new founders are more difficult than ever.
VCs have experienced a surprising fundraising boom amid an otherwise turbulent market. Firms closed $42.7 billion worth of venture vehicles in the first half of 2020, a higher sum than all but three of the past 15 full years.
Strong fundraising signals that the venture capital sector is very much open for business in the midst of this pandemic.
The Final Word: Fortune Favors the Bold
Taking a step back, despite the somber reality of rising cases and deaths, there’s increasing confidence that a vaccine will be ready by early next year. Once a vaccine is announced, the threat of COVID-19 should begin to fade. Timing is still anybody's guess. But when that day arrives, it seems safe to assume that post-pandemic life isn’t going to go back to being the same as before.
For the automotive industry, the big question is whether the pandemic will be a catalyzing change that accelerates the trajectory of automotive shopper preferences for online purchasing and servicing options.
What dealers and OEMs have learned about being more efficient with fewer workers, as well as squeezing fat out of their vendor and supply chains, should mean persistently higher profits coming out of the crisis. Dealers will be scrutinizing their adverting and software expenses more than ever.
My worst fear about thousands of dealers being forced into bankruptcy, thankfully doesn’t seem like it will come to fruition.
But, we can be certain that we’ll exit 2020 with much higher unemployment than we have experienced pre-COVID, and consumer confidence and spending patterns will be dampened as a result. Which will likely mean fewer new and used cars sold in the mid-term.
I continue to expect opportunistic M&A over the latter half of the year. We should be in for some big announcements before the year is out.
I’ll wrap up by mentioning two things: First, I’ve launched www.AutoTech.jobs to help the thousands of automotive industry employees who have found themselves unemployed because of the pandemic. Employers can post their positions at no cost. Hopefully this will play a small part in helping some of our industry folks get back to work.
Second, if you’re an early stage automotive technology company that needs help either raising money or thinking through your exit, please reach out. I’d be honored to help you think through potential scenarios.