CarGurus, Inc. (CARG) Earnings Call Transcript & Summary

Great. Welcome, everybody. I am Aaron Kessler, senior Internet analyst at Raymond James, covering the Internet sector. Pleased to have with us for our next presentation CarGurus. With us from CarGurus today will be Jason Trevisan, CFO; as well as Scot Fredo, SVP of FP&A and Investor Relations. So maybe for those who are not familiar with CarGurus, if -- Jason, if you may just provide a very brief overview, and then we'll go into some Q&A. And for those investors on the line, feel free to e-mail me questions at [email protected]. We can ask those questions at the end of the call as well. With that, let me hand it over to Jason for a brief overview, and then we'll dive into some Q&A.

Perfect. Thanks, Aaron, and thanks, everyone, for joining. CarGurus is the largest online automotive marketplace in the world. We have built a site which brings together the largest amount of dealers in the U.S. and their inventory as well as the largest audience of shoppers looking for cars. What -- and so we aggregate that inventory for consumers so they can shop with the most information at their hands. The way we differentiate is really on 3 ways: we offer the most inventory; we give the most information on those cars, the pricing and the dealers; and then we sort that in a way that is most compelling to consumers by showing them the best deals from the top-rated dealers. Our business model is one where dealers subscribe to different levels of service from our site, including data analytics tools, branding as well as the ultimate value unit, which is leads on their inventory. And we have about 24,000 paying dealers in the U.S. today and about 40,000 on our site in total. We operate similar marketplaces in both Canada and the U.K. as well.

Great. Thank you, Jason. And maybe just to start off, just covering a little bit of a background of what you're seeing in the U.S. car market right now, I think we've seen some uneven performance. Obviously, overall, the market was impacted kind of in the March-April time frame. We started to see a nice recovery in the spring and then maybe just a little bit of a slowdown again in kind of the fall period. Kind of what are you currently seeing? And what does this used car market mean for the health of the dealer channel? And what should we expect maybe in 2021 in terms of recovery?

2020, by any measure, has been a very, very odd and volatile year, and it's been, I think, maybe even especially volatile in the car, in the auto industry. So needless to say, in March, April, May, COVID really shut things down and many dealers were not able to be open. And so car volumes plummeted. At the same time, dealers were realizing that they needed to be more online. And so we introduced a number of features to our site that allowed consumers to shop for dealers who would do appointment setting and contactless purchasing and so forth. So there was, again, no great insight here, a real push to online behavior, and dealers adapted quickly to be able to sell remotely. Coming out of that with -- coming out of a period where not many cars were sold, there were 2 other factors at play: one is a move to the suburbs and people needing to buy cars or wanting to buy cars; and two is a reluctance to use mass transportation, so people wanted to buy cars. So what you had was a variety of factors that increased demand dramatically and a variety of supply chain factors that decreased supply. OEM plants had been shut for a while. The wholesale physical auctions had been closed down for a while. So dealers' inventories were depleted. And this was, honestly, one of the bigger, maybe a larger impact than COVID. So over the summer, you had dealers that normally had 150 cars in their lot had 60 cars in their lot. And demand was high. So they had very few cars, and it was very easy to sell them and, as a result, many felt compelled to not have to market. That has now started to really normalize and come back. Inventory levels are rising again at dealerships, and dealers are starting to awaken to the fact that at normal inventory levels, they need to market more.

Got it. And what does this all mean for kind of the health of the dealer channel? I think we've seen a number of maybe smaller dealers closed. I think we've seen some talk about more consolidation of the dealer channel space. What is your thinking on kind of what this means for the dealer channel, which is obviously kind of your key customer base?

I think probably the most -- aside from the inventory and demand volatility in the year, probably the biggest headline for dealers is they've realized they don't need to staff as large as sales team. And so I think a lot of the public dealers have fared very well through this with -- despite some top line volatility, they're emerging with just more efficient models, which gets into a whole theme of digital retail, which I suspect we'll get into later. But -- so for the dealers, probably an awakening of, hey, we can run a tighter business. We haven't seen much in consolidation. I do think some of the smaller independent dealers have had a harder time weathering the storm, and so we've certainly seen some closures. And we've seen in our business that they are more likely to churn in tough times and then come back in good time. So churn has been higher for them at larger franchise dealers. But I don't think there's been, other than the efficiency on the sales front, a structural change to dealers.

Got it. That's great. Yes. Well, let's just dive into the digital commerce side as well because I think that's, obviously, been a big focus for investors and as some of the traditional dealers have started to shift more to digital. Maybe your thoughts on overall kind of what inning we're in for digital. I assume we're still relatively early. Obviously, we have the Carvanas and Vrooms, but those are still representing, I believe, kind of low single-digit market share in total. And so I guess the key question for you guys, obviously, from a marketplace perspective, how is CarGurus positioned to offer solutions to dealers wanting to digitize? And what are some of these key products that we should expect? And kind of what timeline should we be thinking about?

Yes. I think we're in the top of the firsts of digital retail for auto. Digital transactions is a bit of a squishy term because it can mean different things to different people. But fully digital transactions where the cars bought online, number one to note, it almost always involves phone calls, multiple phone calls, but number two is that, that's sub-1% today. And so if you look at other sectors, which are obviously much more penetrated, we think there's a long runway to go. And we believe that consumers are increasingly amenable to doing it, and COVID accelerated that. Dealers ironically maybe were behind the curve in their propensity to adopt and embrace digital retail, but I think COVID has accelerated that. So we believe that a growing percentage of the market will interact and transact digitally, but we do think that it will not be a lock, stock and barrel. Everyone is just going to start fully buying their cars online and having them delivered. What we know is the consumers like different elements online, but still a vast, vast majority of consumers like to go touch and feel and test drive a car. So our approach to digital retail is to look at the different steps of the process and develop them in an a la carte fashion because different consumers are going to want to do different things online and different dealers are going to be open to doing different things online. If you look at the steps of digital retail, the first is making cars known and available to consumers that aren't near the dealership. And so we've addressed that with Area Boost. The biggest time consumer in a dealership is consumer financing and so we've started to address that with prequalification on our site. We furthered that by integrating into route one. So when a consumer walks into the dealer, now in the dealer's systems is that consumer's prequalification. There are other elements, pre-document signing, which include fees and taxes, a trade-in calculator, F&I cross-sells, and we're in the process of working through pilots for all of those elements. You then set the appointment, go into the dealership because, again, most digital transactions still have a dealership visit, and you complete the documentation. And then the final steps are tax, title, registration and shipping of the car. This sounds like a belabored process outline that I'm illustrating, but it's because it's a belabored process. So between partnering and building, we are working with various dealers to bring each of these markets.

Got it. And if a dealer were to kind of adopt all these services, how should we think about how much this can add on to kind of what you charge dealers today? Probably tough to quantify exactly, but any sense of a magnitude of how important this will be?

I would answer that by saying our biggest push is to gain adoption, and it's not to focus on -- as much on near-term monetization. We would much rather have -- we would much rather get consumers doing our site as the site that is the most digitally capable and dealers considering us as the partner that makes the transactions much more easy for them, and we'll worry about monetization later.

Got it. Great. And then you've seen -- obviously, with the slowdown in car sales that we saw due to COVID, CarGurus significantly cut your marketing during kind of Q2, Q3, yet your traffic level stayed pretty healthy. And so I guess the question is kind of what changes were made? And how should we think about sales and marketing efficiency going forward as well?

So we remain focused on lead volume and less on traffic, just -- it's important for me to say that because I think there is an overweight put on traffic that, frankly, we don't pay as much attention to. Dealers care about the leads they're getting, not the traffic they're getting. Yes. So again, COVID created a lot of ancillary effects, but more people moved online, competitors started spending less. And meanwhile, though, we continued to work on, in hundreds of small ways, efficiency of our acquisition. So through some external factors as well as some internal factors, we have continued to grow our lead volume and especially our leads to paying dealers at a pace that we think is extremely healthy.

Got it. Great. And how should we think about the freemium model going forward as well? You offered a very robust kind of freemium offering to dealers and some dealers are probably getting, obviously, a lot more than they paid for, which is nothing. But how do you restructure the freemium offering going forward? And kind of what do you think that will mean maybe to potentially adding more paying dealers as well longer term or adding more value to your current paying dealers?

Yes. So this has been an ongoing discussion and exploration for us for years. We realize that we serve 2 constituencies: a consumer and a dealer. And so anything we do to our site needs to balance the needs of each side. In looking at our free tier, we saw that there were dealers that were receiving literally hundreds of leads a month for free. And some were quite good at converting those and, as a result, never felt compelled to come on as a paying dealer and, in essence, were skimming off the top of our paying dealers. And so we've tested a variety of, I guess, models and methods and ended up in the course of 2020 evolving our free product to say, you'll still be on our platform, we still want to give consumers access to all the inventory, but at a certain point in any given month, when you as a dealership have gotten a certain number of leads, we're going to cut you off and limit the number of leads you get and the value you get as a way to try and encourage dealers to come on. It's hard to say exactly what that has triggered in terms of dealers on-boarding, but we do track the percent of dealers who are coming on that have hit their cap. And we think it's absolutely having an impact on encouraging more dealers to come on. [indiscernible] a dozen stories of dealers who said this was the best free thing in my life over the last 5 years, and I'm sorry to [ say that ].

Yes. Great. And then maybe just on that point as well. Paying dealers, obviously, has declined a little bit, obviously, with COVID here. What's the confidence level that these -- some of these dealers that have turned off will come back over the next couple of quarters? And how should we think about the long-term dealer potential? Obviously, I think you talked about 40,000, roughly, dealers in the U.S. You're kind of at mid-20s right now. You were a little bit -- obviously, a little bit higher before. What's a good way to think about long-term dealer count at this point?

Yes. So again, 2020 had 2 stories, COVID and inventory, and I think both of them were powerful. The other thing is that we did -- and we called this out in our last earnings that total dealer count is really sort of the tale of 2 segments. Large dealers saw really nice growth in Q3. Emerging smaller dealers saw a continued decline. We're at mid-20s, thousands of dealers, 24,000 plus, I believe, and we still believe that we can get to 30,000 dealers. We have 40,000 plus on our site. There are some who will never see the value in it, and that's their prerogative, and we're comfortable with that. But we think that if we continue to do a great job demonstrating our ROI and continuing to grow our scale, then if we're the largest and the most efficient and sort of value oriented, then there's fewer and fewer reasons why a dealer wouldn't join us.

Got it. Great. And then I think last -- end of 2019, you were starting to talk about part of the marketing strategy to be more to help consumers differentiate between the various marketplaces, a little bit more on your advertising strategy. How are you thinking about that going forward? And maybe where does the digital commerce strategy fit within that as well?

Well, I don't think the digital retail fits into it yet. I think it will fit into it in the form of consumer ease and convenience and to the extent it's differentiation that's gravy. In terms of differentiating today, if you rewind a few years, our deal rating alone was a relevant point of differentiation. We've seen many sites put deal ratings onto their sites. They tend to be good and great deals, and they tend to not cover the spectrum in an unbiased way as we believe ours do. And so we need to make sure that the consumer knows the distinction between a more transparent and unbiased consumer experience versus one that tries to mimic it.

Got it. Great. And to your comments earlier about you think dealers are realizing maybe they don't need as many salespeople on the floor. If they can maintain sales volume with less salespeople, do you think that just makes the dealers more profitable? Or are they going to reallocate some of that spend to platforms such as CarGurus to increase the marketing spend or maybe a hybrid of that?

You probably have to ask the dealers. I think it's probably a mix of both. I think there's probably a profit-maximizing answer, which is part growth and part margin.

Yes. Got it. Okay. And then maybe just on some of the newer product offerings you've rolled out over the last couple of years on the marketing side, if you can just talk a little bit about the traction on the real-time performance marketing and maybe just provide an update on the OEM advertising as well, which I believe came back nicely last quarter.

So our real -- our RPM, which you just referenced, has done really well in early days. We launched it at the beginning of this year. It -- for those who aren't as familiar with it, it is a variety of digital marketing executions that leverages the data garnered from our site, while those consumers are in other third-party environments. So the best example is if a consumer is shopping among a dealer's cars on our site and then we see that consumer in Facebook, that dealer can market to that consumer leveraging the data that we bring to the equation. It's highly effective, highly efficient. Dealers spend more in that type of digital marketing than they do in listings. So it's a huge market. And we think we have -- logically, we believe we have the largest data set and the most sophisticated data set on consumer shopping habits. So dealers have adopted it nicely. And these are -- this is a spend that drives consumers to the dealer's website, not to our website. There are going to be various features and developments and advances in RPM, probably all under that RPM umbrella that we expect to continue to expand on. OEM. Yes, OEM market came back very, very fast, much faster than we expected. And I think -- I'd like to think that in the course of doing that as well with a bit of a COVID reset, there was also a flight to quality. And we have consistently heard year in, year out that we performed very well for the OEMs from a performance standpoint and from a scale standpoint. And so I think that's why they have come back to us in the midst of coming back to the market very quickly.

Got it. Great. And then maybe if you can just provide a brief update on the international strategy. Obviously, you've exited a couple of markets, but still in a couple of large markets such as the U.K. Kind of how important should we think about international going forward and maybe some of the initiatives there, such as PistonHeads?

Sure. So international remains a big opportunity for us and a high-growth opportunity for us. We did go through the process of focusing on the U.K. and Canada. That was the absolute lion's share of our revenue in that segment. And with limited resources and limited hours in the day, we decided that we were better served by focusing on those 2 markets, which were 2 of the largest and certainly the most mature. In each market, it's hard to talk about them in generalities, but there are some parallels in each market, there's a large incumbent, and there's a dearth of other sizable competitors. And so we think the door is open for someone to emerge as a clear #2. And we think that for the same reasons we've been successful in the U.S., we can be successful there. We're solving similar consumer pain points and dealer pain points. We've spent a lot of 2020, making those businesses more efficient so that we can continue to reinvest as much as possible in growing the audience while still on a reasonable path to profitability. PistonHeads is an acquisition we made in the U.K. It's a -- both a listing site as well as a very large forum of car shoppers. And it's really in 2021 where in earnest, we're bringing those 2 sites together to offer dealers more of a combined package, more of a one plus one equals three.

Got it. Great. And then maybe quickly on monetization. Obviously, they are a key lever of your model. How should investors think about the mix? Maybe potential price increases on the core business with, obviously, driving more leads to those dealers as well as kind of cross-sells or add-on sells. Obviously, digital retail could be a part of that longer term. But how should investors think about the various levers of monetization longer term?

Specific to monetization, there's growing dealer count and growing spend per dealer. We do think there's runway in dealer count, as I said earlier. And then on spend per dealer, it's a KPI which is quarterly average revenue per subscribing dealer, again, for folks not as close to it. And we've talked about there are 3 key levers there. One is just growing the volume of leads to a paying dealer. And we think there's a long runway of lead growth. I mean the -- there's audience growth for one, but today, we have roughly, for easy math, 100 million sessions a month, and we're -- in the U.S., and we're generating roughly 3.5 million leads a month. We believe there's ample opportunity to grow that 3.5% conversion rate without degrading the quality of the leads. So simply driving lead volume is one. Anyone who's done channel checks knows that we are often described as a far better ROI than any of our competitors. We don't want to abuse that position, but we also think that, that implies that over time, especially as we continue to grow scale, we have some pricing opportunity over time. And then the last is new products, and RPM is an example, but there's other examples of products even more close to home in terms of listings, like Area Boost or like Featured or Featured Priority, where we can do a better job of monetizing the existing leads that we are sending them. So if you look at those 3 levers, historically, at least in the past couple of years, they've actually been pretty balanced. I would say lead volume growth has been the prevailing one, but unit pricing has been a steady contributor as has new products.

Got it. Great. And I'm going to ask on maybe Autolist. Maybe if you can provide a brief update on the Autolist acquisition. I think that helped you kind of maybe monetize some of that freemium inventory as well. Kind of how has Autolist done so far and played into your strategy?

Autolist, well, it's done fantastically. Autolist is a site that is similar to CarGurus insomuch as it -- they aggregate inventory from dealers and try and give consumers a terrific transparent experience. They've also developed really well in the app world to create an even stickier relationship with the consumer. So that was a scale acquisition for us insomuch as we were buying more leads to be a more important partner to our dealers. And they have grown leads during our year of ownership much faster than we expected. They've really done a terrific job.

Got it. And then in terms of kind of just the EBITDA leverage going forward, kind of how are you thinking about kind of balancing growth and some of the investment spending here with showing some incremental leverage as well? And obviously, you've seen some nice leverage this year on the marketing side.

Yes. So if you eliminate COVID effect, we had been on a steady march of increasing margins, especially in the U.S. but consolidated as well. COVID just poured gasoline on that fire. And so because we got so much more leverage in sales and marketing, we saw spikes in margin. We think those big chunks of that marketing leverage will remain and sustain. And so while we don't think Q2 or Q3 is indicative of a steady-state margin for us, we do think that it took the slow march up in margin and gave it a step function improvement. And we don't think we're at a new baseline to only grow from. We think there's going to be a bit of a post-COVID hangover, sort of setback, but then we think we'll be back on a steady march.

Got it. And anything -- maybe finally, anything you think gets misunderstood by investors at this point? Obviously, there's a lot of investor excitement on the D2C side of the market, but as you said, it's only about 1% of the market overall. It's still 99% on the traditional dealers' side. Kind of what are you hearing from investors and what do you think might be misunderstood at this point?

I think what is -- forgive me if I mentioned it earlier in this talk. I think that there's too much attention paid to traffic sometimes. And the example or analogy I draw is we could have substantially more traffic tomorrow. And if it had one fewer lead to our dealers, our dealers would call us angry. So we're focused on what the dealers' value, which is leads. The second thing is I do think there's a lot of enthusiasm for digital retail. We share in it. I think it is, by some, perceived as a threat to our business whereas we see it as an opportunity. We see digital retail and our ability to build the components of it as an opportunity to serve our dealers better so that every dealer is on a playing field much like merchants that sell through Amazon are put on more of a level playing field than larger counterparts. So we're excited by it, and the virtual dealers are our customers, and we're their partners, and we're helping them grow. And I think that's viewed as more of a threat or more adversarial than we see it.

Yes. And it seems like a lot of the dealer groups are trying to become kind of these more virtual dealers and as well are kind of direct-to-consumer, although there's only going to be some many like Carvanas or Vrooms with brand name out there. Is that your thinking? How many of these kind of D2C dealers are really going to have brand names out there without leveraging a platform like CarGurus?

Yes. I mean every dealer today is a direct-to-consumer dealer, and they're trying to build a brand. I think what has changed is that, historically, dealers have been largely confined by geography. And digitization is breaking down those geographic walls. If you take your average or even your above-average dealer and consider their ability to invest in all of the technology resources to build all of this out, it's daunting. And we're the first to admit it. It's complex. So we think if we can build a complex machine and make it easy for everyone to use, that's probably an easier path than them trying to build on their own. You do see a lot of the larger dealer groups, though, now announcing that they have a solution, and those tend to be -- they're partnering with a technology provider who has created a solution. And that's [indiscernible]. We view that as different and complementary to us bringing a set of solutions to dealers as well.

All right. I think that's all the questions for today. I want to thank Jason from CarGurus once again for great insights today, and we'll like to talk to you again soon. And everyone, have a good rest of the day. Thank you, Jason.

Thanks, Aaron. Thank you, everyone. Appreciate your interest.