Artisan Canvas

Vroom, Vroom, Vroom!

Did you hear that sound? That was the sound of Vroom’s engine shutting down. If you’re not familiar with the name, Vroom, was, an online-only used car retailer, which along with Carvana and several other upstarts, aimed to disrupt the incumbent “old-school” auto retailing model. With the announcement that Vroom is winding down its e-commerce operations, we looked back at our Q2 2021 portfolio letter. In it, we compared the business of Vroom to one of the incumbents, AutoNation, through the lens of our three margin of safety investment criteria: business economics, financial condition and valuation.

At the time, both businesses were valued at roughly the same market value, approximately $5.5bn, so we posed the question: if you had to pick one of these two businesses to buy, which would you choose?

Vroom was growing rapidly at the time, with revenue up 200% YoY as of the June 2021 quarter. While gross profit per unit sold was improving, we argued further sales growth would be needed because Vroom’s losses were mounting as they grew—a real world example of the timeless business joke, “we lose money on every sale but make it up on volume.” As for valuation, it was difficult to take a snapshot of Vroom because it was not expected to earn a profit for at least five years and required external financing to fund growth. However, the business sold at a healthy multiple (~1.7X) of 2021 sales.

As Jeff Foxworthy might say: “back in the good ol’ days when money was free, investors rewarded revenue growth and incremental margins. Also, the more disruptive the potential of the business, the better!” That wasn’t too long ago, what two years? Sure, it worked for a time. Though, as we called out then, how was it tethered to economic reality? Because ultimately, business fundamentals and valuation should match economic reality.

As we also called out then, in our process we adhere to economic reality in all times. Our process is grounded in fundamentals. Strangely, we need the market to have these bouts of euphoria and pessimism to create our opportunities! In this case, it was pessimism around AutoNation’s future. Vroom’s revenue growth was a clear sign of consumers’ interest in buying cars online. However, traditional auto retailers weren’t sitting idly by. They were also responding to changing consumer habits. Thanks to its scale, AutoNation had spent years building digital tools that allow consumers to buy cars online without setting foot in a store, essentially matching the service provided by online-only car retailers like Vroom. AutoNation also sold new cars and had a valuable parts and service business, but it was selling for just 8.0X 2021 earnings.

Fast forward to 2024 and we can see how it turned out! From July 2021 through January 2024, AutoNation generated an annualized total return of 16%. Vroom is now bankrupt, and its stock sells for pennies.

AutoNation’s market return was driven by the underlying economic value the business created. From 2020 to 2022—a great time for the used car business due to pandemic-related tight inventories—AutoNation’s revenue grew from $20bn to $27bn, a 15% cumulative annualized growth rate (CAGR). It also generated nearly $5bn in free cash flow, with more than 85% used for share repurchases. Vroom, on the other hand, grew revenue from $1.4bn to $1.9bn, a 20% CAGR over that same period, yet burned through $1.1bn in cash and issued $1.3bn in equity.

Of course, we didn’t anticipate the period of booming sales growth for AutoNation. But we knew it was a good business, highly likely to remain one, and wasn’t priced with respect in the market. Vroom, on the other hand, needed a miracle and quickly! That could have happened, but it didn’t. In investing, it is essential to have a lens focused on the fundamentals rather than on the market headlines. 

We often don’t take a victory lap. This is a humbling business, and being value investors, you know we don’t buy new cars, we don’t buy top-trim models, and we decline all extras like warranties and GAP insurance. But in this case, maybe we will spring for the leather seats and power windows! We are still paying cash though!

 

Artisan US Value Team manages portfolios which held securities issued by AutoNation as of 31 Dec 2023. Portfolio securities are subject to change.