There are quite a few things in the world I don't trust. I don't trust that, without the help of steroids, Mark McGwire got better, stronger, and hit more home runs the older he got. I don't trust that Anna Nicole Smith was in it for love, and I'm skeptical when I see "0 grams of fat" followed by an asterisk at the end.
Do you know who else I don't trust? Salesmen.
More specifically, car salesmen.
I'm not alone in this feeling, and that's why TrueCar's (TRUE +0.00%) business of saving car buyers time and money could become extremely profitable in the years and decades ahead.
Here's a look at TrueCar's business, why I'm buying on the recent 10% dip, and what my biggest concern is. Buckle in, this will be a journey.
Negotiation-free car buying
The idea fueling TrueCar's business is simple: the company inserts itself as a middle man between millions of car buyers from its website and its more than 10,000 certified dealerships, and uses its data to generate strong leads for dealerships. When dealerships seal the deal with a consumer from TrueCar, it writes a check to the company for about $300 -- about half of what it typically takes in marketing and advertising to sell a vehicle, according to National Automobile Dealers Association. Car buyers using TrueCar get the advantage of seeing historical sales data and a certificate guaranteeing a vehicle's price when using a TrueCar dealer to complete the purchase.
Sounds like a win for all involved, right? We'll investigate that further in the concerns section, but what isn't up for debate is that TrueCar's financial performance is accelerating in just about every significant category.
Growth story
Let's take a look at every angle of TrueCar's potentially explosive growth story. Let's start with the two most important factors, the consumer end and the dealership end, because this is the basis of TrueCar's competitive advantage and network effect. Only a couple of weeks ago, TrueCar announced that its dealership network had successfully expanded beyond the 10,000 milestone. That puts TrueCar closer to its goal of having partnerships with one-third of dealerships in the U.S.
Graphic source: TrueCar.com
Just as important, or perhaps even more so, is the growth of TrueCar's car buying user base.
Chart by author using information from TrueCar's fourth-quarter presentation
The slight downturn in the fourth quarter is similar to the trend in TrueCar's performance for the same time period in 2013. The automotive industry is cyclical and historically second and third quarters produce stronger new-car sales than the first and fourth quarters. I expect TrueCar's growth to continue and the fourth quarter to be nothing more than a speed bump.
As TrueCar's user base grows alongside its increase in dealership partners, it becomes a competitive advantage for the company. It's a network effect that increases the value to car buyers by tracking more valuable data as sales increase at dealerships, which in turn generates more revenue for TrueCar -- a virtuous cycle, if you will. That increasingly powerful network effect, along with other factors, has helped push TrueCar's revenue per dealership much higher in recent quarters.
Chart by author using TrueCar fourth-quarter presentation http://files.shareholder.com/downloads/AMDA-2R21NS/3969414259x0x810542/2d030c4e-3776-422a-8ab9-f25bc828d926/TrueCar_Q4_2014_Earnings_Presentation.pdf
Looking at just about every important statistical measure over the years shows TrueCar's impressive growth.
Chart by author using information from TrueCar's fourth-quarter presentation
But just how much business is TrueCar really facilitating between car buyers and dealerships? And how much growth remains?
The upside
In 2014's third-quarter TrueCar users purchased a record of nearly 172,000 cars from TrueCar's certified dealers, which generated record transaction revenue of $52 million, a healthy 55% increase compared to the prior year's third-quarter. In the most recent quarter, TrueCar's units checked in at a strong 163,000 units despite being a historically weaker quarter for new-car sales. As of January, TrueCar's transactions accounted for roughly 4% of all new-car transactions in the U.S. and represent 15% of its certified dealerships' total sales. As the company represents less than 5% of new-car transactions, the sky is practically the limit for increasing revenue and profit as the company continues to grow its online presence.
Speaking of growing its online presence, I'm excited about a near-term catalyst for growing its user base: the targeting of my millennial generation.
Think about it, there are simply users that will never use TrueCar, people like my mother who just aren't Internet or tech savvy. Of course, TrueCar won't give up attempting to attract that consumer, but targeting millennials which are more tech savvy and online research oriented is a brilliant move to rapidly increase the car buying base in the near term.
Consider that TrueCar predicts millennials will account for 25% of the new-vehicle market this year -- or about 4.24 million sales of an estimated 17 million total -- and our purchasing power will generate $135 billion in total revenue. Fortunately for investors, guess which user base is rapidly adopting the use of TrueCar's services? You guessed it, millennials, and TrueCar's percentage of millennial buyers increased by nearly 80% from 2013 to 2014. That beat the overall market's growth of millennial participation by a whopping 50.5%, according to TrueCar.
TrueCar also understands that the future, along with its growing millennial user base, is in its mobile presence, and in January for the first time mobile users surpassed 50% of the company's visitors. Having easy access to its services, which could be used by car buyers while cruising dealerships, will help TrueCar keep competitors from gaining ground. Investors also have to consider that there are fewer true competitors than you might realize. While sites like Kelley Blue Book and Edmunds.com are notable, their business model relies more on overall traffic than TrueCar because the latter generates revenue from dealerships completing sales leads.
Furthermore, in addition to the immense remaining growth in overall U.S. new car transactions, TrueCar will focus its near-term energy on products and services to generate revenue from other aspects of car buying, such as how consumers pay for the vehicle, insure the vehicle, accessorize the vehicle, repair the vehicle, as well as vehicle trade-ins. Beyond the near-term opportunities, TrueCar will eventually include international users, or even different segments in the U.S. -- think boats, RVs, and other large ticket items.
Ultimately, the growth prospects are great and TrueCar's business is extremely scalable. As transaction prices and revenue continue to rise, TrueCar is aiming to have its gross margins remain in the low to mid-90% range, while marketing and selling expenses decline from 55% of revenue currently to around 35% in the long run. TrueCar is about to turn the corner in profitability and expects its adjusted EBITDA to grow from about 7% to 35% in the long term.
Chart by author using information from TrueCar's fourth-quarter presentation
It's clear that TrueCar is in the early innings of its main growth story of new-car sales in the U.S., and the company has a wide range of future potential revenue streams. It has years of solid growth in its future and its current financial performance is surging, so what's the catch?
My concerns
There are a few concerns, but only one that I'm worried about. Potential investors might be concerned that new-car sales are cyclical, and on a down-swing TrueCar would feel the pain. However, while it would hinder TrueCar's business to some degree, I don't see massive or sustained downside because the company could pull the lever to increase marketing and take a larger piece of a declining pie -- at only 4% of new-car transactions, there's much available growth to help the company offset overall new-car sales weakness.
Potential investors might be concerned that another business model could gain traction and take a chunk of TrueCar's user base. While that's possible, TrueCar's website is very useful with real world transaction data that is clear, concise, and well presented. Furthermore, as the company's user base and dealership count continue to grow, it becomes more difficult for competitors to break into the market and provide more value and data than TrueCar can. TrueCar needs to improve the quality of its mobile app, but that should be doable in the near term as the company projects to spend $50 million on technology development this year.
Which leads me to my one major concern, how much value is TrueCar really providing? To answer that, I had to hit the pavement for some grassroots research.
Guaranteed savings?
I signed up for TrueCar and decided to research a vehicle I'm very familiar with, and one I'm considering purchasing: a 2015 Mustang GT Premium. Here's what TrueCar showed me, which I found useful.
Graphic source: author's experience using TrueCar
At first glance, the prices seemed pretty accurate and I was pleasantly surprised to see an estimated savings of $1,066.
Graphic source: author's experience using TrueCar
I completed signing up, and had my official certificate for $36,644, but I wanted to dig deeper. How does the MSRP compare to a dealer that isn't certified by TrueCar? What price would I see if I visited a certified TrueCar dealer without using the website for guaranteed savings? What I found was interesting.
First, a TrueCar dealer that I visited without using the service, had a window sticker that showed an MSRP of $37,125 -- keep in mind these are all base prices for a 2015 GT Premium, no options, and including destination charges. Second, a dealer that isn't a part of TrueCar's network, had the same vehicle for the exact same $37,125, and another for $36,925. The only difference between the two was the paint, which can change the cost slightly.
Knowing that this was a small sample size, I wanted to get back to the beginning, building and pricing my very own on Ford's website. Creating the same vehicle I had priced on TrueCar, including delivery charges, Ford totaled me up at the familiar number of $37,125.
So, here's the problem and my concern. Looking back at the $1,066 that TrueCar estimated I was saving using their services, the majority of that was inflated due to TrueCar's MSRP of $37,710, which was higher than anything I found in the real world. In the fine print, TrueCar explains its MSRP is often higher because other websites don't include destination charges. However, as you can see in the window sticker picture, the real world clearly does -- at least in this example -- include destination charges.
Standard window sticker on various sites for Ford's 2015 Mustang GT Premium.
My concern is that it's becoming unclear to me how much money TrueCar is truly saving consumers. Afterall, the dealerships pay TrueCar around $300 per lead when a sale is completed, which accounts for about 91% of TrueCar's revenue. If consumers don't feel like TrueCar is saving them money and time, or creating enough value, it's possible car buyers will stop using the service, which will begin to cripple TrueCar's network effect, car buyer user base, and thus revenue and profitability. If there is any consistent trend that shows car buyers not finding enough value in TrueCar's services, I'll be the first one out the door and selling my shares.
But I'm still buying
I do believe that TrueCar saves consumers time and money, just how much is difficult to determine. Aside from that, TrueCar's website, which has valuable real world transaction data, is certainly useful. I discussed trust in this article's intro, and when you purchase shares of a company you're essentially trusting management to improve the business and reach its full potential in the years ahead. I trust that TrueCar's management understands its business model and will continue to improve the value it offers to consumers, and that in turn will help the overall business succeed in the long term.
Furthermore, despite a sequential decline in unique visitors and units sold, year-over-year comparisons show strong growth and that TrueCar is becoming more efficient at helping dealerships close sales. TrueCar pointed as much out to me recently, on Twitter.
As long as consumers continue buying into the business model, which is clearly happening, I believe TrueCar's future is lucrative and its stock price should reflect that in the years ahead. There appears to be years of solid and profitable growth ahead, and I want to be along for the ride.
