The used car market is huge – around $700B (yes $B) and super fragmented. The top 100 players only control 7% of the market. It’s mainly structural – used cars have been sold more on a regional basis than nationally.

Carvana (NASDAQ: CRVN) is offering an online direct-to-consumer model with they own inventory and a national footprint of automobile conditioning centers and delivery network. [You can also review the Carvana IPO roadshow slides.]

The consumer experience at car dealerships has probably improved in the last several years but it’s still far from what it could be. Customer expectations are always going up. I should be able to order a late model BMW 330ix convertible today and have it delivered next week right? With a 7 day return privilege too! Maybe not (yet) by helicopter but that day may be coming.

Carvana started slowly in Atlanta but then picked up steam going in to 2014. Sales volumes started to grow and drive more brand awareness. The company expanded into additional markets – first Nashville, then Texas, then Florida. By the end of 2016 they were in 21 markets and revenues grew 180% in 2016 to $365M.

The model is working in the markets they serve and they are accelerating their entry into new markets. To date their footprint only covers about 20% of the car-buying population so it’s still early days.

Margins have expanded dramatically from a negative gross margin of $200 per vehicle two years ago to a positive $1,000 per vehicle today. The company believes they can drive margins higher and ultimately reach a positive 7% to 11% EBITDA margin.

We’ve worked on this market for some time. Back in 2012 we were doing some advisory work on TrueCar (NASDAQ: TRUE) and published this report (PDF): TrueCar – Another “One Way Door” in a Big Market. [For the sake of completeness here is the TrueCar IPO roadshow transcript.]

But TrueCar largely failed to deliver on the promise of changing the way cars are bought. Price discovery is a big plus but the resulting lead didn’t change the ultimate buyer experience. Their feud with dealers often stood in the way of their success.

After changing management even TrueCar is on the mend with the shares up from their $5 lows a year ago to $17 today. Their $1.6B market capitalization is just over 5x sales.


There are 17.5M shares being offered and total outstanding will be 139M. There are two classes of shares – A and B so that the management team can maintain all the voting control. Welcome to new world dual-class shareholders in technology. We can thank Google and Facebook for that.

At the $15 mid-point of the range, the market cap would be $2B. Investors will at least do some back-of-the-envelope figuring on how much stock to buy in the aftermarket.

Taking $365M from last year we can look at both penetration and fulfillment capacity to estimate future medium term revenues. In 2016 they sold 18,761 vehicles. In their oldest markets, they achieved 1.1% share but this is still growing rapidly. In the other markets, their share is 0.25%. Their fulfillment capacity is said to be 12,000 vehicles per month.

Even if their market share growth stalls out Carvana can generate $1.6B from their existing markets alone in the next 24 months. Their production capacity would be able to deliver that many cars as it stands today. Based on these static numbers the proposed valuation of $2B is at least supported.

Longer term the company will enter additional markets and continue to gain share. Improvements in gross margin are planned as well to help them get to 10% EBITDA. If they were to achieve national coverage with a 1% share revenues would be on the order of $8B and a potential $800M of EBITDA. At those levels the shares would be trading at $60.

The big question is just how much share can they gain. Their results in Atlanta and Nashville will be closely watched to see if and when they plateau. Today they are at 1.1% and still climbing rapidly.

Carvana is doing some new and interesting things in terms of technology and data science that we’d like to cover in greater depth. In the meantime you might read about some of it in the Carvana IPO roadshow transcript – there’s some gold in there.

So what are the risks to this story?

Unlike Wayfair (NYSE: W), Carvana is spending heavily to ensure the customer experience. In this case there we don’t have the heavy “un-modeled expenses” that we talked about with Wayfair.

However there are still questions about consumer trust with the brand and how dealers will react to their success. There is also some direct competition. The closest company is CarMax (NYSE: KMX) which is a much bigger company with a larger selection of cars. CarMax is more about volume than quantity. They are a decent alternative versus a traditional car dealer but their process is pretty much the same.

Carvana has a capital-intensive model although they have much tighter control of inventory than the typical vehicle retailer. They will need capital to fund expansion and if we experience a market slowdown it could impact their ability to finance their growth.

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