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

Good morning everyone who's joining us today. My name is Nick Jones. I'm an Internet analyst here at Citi. If you need my disclosures for the fireside chat, please email me, and I could send them or our Corporate Access team can also send them to you. We're really excited to have CarGurus here. We have CEO Jason Trevisan with us today. Jason, thanks for being here.

Of course. Thanks for having us. Look forward to it.

To kick things off, I think it'd be great to maybe just kind of talk about the current environment. The last 18 months have been really interesting, to say the least. We saw unprecedented shutdown of the economy in 2Q last year. CarGurus acted quickly to support dealers who were struggling. Since then, demand bounced back rapidly, creating supply constraints. So can you talk about what's changed in the industry through all of this in terms of what dealers are looking for and how consumers are looking to kind of transact and discover their vehicles today?

Sure, happy to. And thanks again for having us on, Nick. Yes, the last 18 months have been strange for a lot of industries but certainly for the auto industry. So I think the prevailing theme, dynamic, that has affected the last 1.5 years has been inventory. It is -- as you pointed out, inventory has been constrained largely because of the chip shortages. And so new car production has come down. Meanwhile, demand has increased, and that increase in demand and reduction of new car supply has put a strain on used car supply. So inventory has been down. I think the second theme is digital adoption has increased significantly, as it has in most industries, while we've all been stuck at home. And so that digital adoption is -- manifests itself in 2 ways. One, in more consumers being interested in completing more of the transaction online, not necessarily all of the transaction, but more aspects of the transaction online. The second digital adoption has been in wholesale, where dealers have found that it's -- for safety reasons because of COVID but also for efficiency reasons and selection reasons, that it's a lot more compelling to do a lot of their wholesale sourcing in a digital environment versus a regional physical auction. And then I think the third dynamic is sort of the confluence of the 2. When you've got an inventory constraint and you've got more digital adoption, it's this bridging of the retail and wholesale worlds for dealers and consumers that has really started to accelerate. So the -- one example for consumers is they're eager to sell their car online and see what sort of cash offer they can get for that. Likewise, dealers are starting to compare wholesale and retail pricing more directly side by side because of volatility in pricing. And so the confluence of retail and wholesale is something that is pretty new but presents pretty good opportunities for those who adopt it.

Great. Great. That's helpful. So as things -- hopefully, when they start to normalize, do you think the way people are aiming to transact, you had mentioned people like to do more of the transaction online, do you think that'll be resilient? Or -- and maybe a bit more permanent where things kind of revert as things begin to normalize? Or is it just kind of simply too soon to tell?

I think there may be -- there might be spikes being caused right now. But no, I think we believe digital retail is absolutely here to stay. I mean consumers like flexibility, they like convenience, they like selection. So today, still a small percentage of cars are bought primarily online. But 80% of consumers say they want to do some elements of the car-buying process online. And so whether that's getting a trade-in valuation or doing financing, shopping for cars that are farther away, bring it all the way to a $0.01 perfect deal. And so whether or not it's end-to-end digital retail, I think that will grow share from 1% to 5%, 10%, 15%, 20%. But the percentage of transactions where they want to do substantially more online, I think, is already -- we're already seeing that skyrocket. So a lot of the offerings that we've built, whether it's trade-in valuations or offering F&I products from dealers as part of CG Convert, we're trying to meet the customer, the consumer where they want to be and where the dealers want to be, which is going down that path of digital retail.

Great. Great. Maybe kind of one more question around kind of the pandemic. How are you thinking about the COVID variants from here? Is CarGurus and the ecosystem prepared for maybe another surge? Or maybe through CarGurus, are dealers more prepared for potential shutdowns and able to kind of react quickly and, I guess, transact digitally if needed?

Yes. I mean I think we are in no position to be able to forecast if we'll be prepared for what may come next from a variants perspective. Safety is always #1 for us, for our employees, for our consumers and dealers, all of our customers. But I do think that we have made -- we as a company have made a number of advances and introductions and innovation during this time, which, again, just allows for much more of the transaction to occur online. And so we think we're sort of ever increasingly prepared for that trend, and we think that trend will continue, whether Delta is the worst of it or whether there's more to come because of it.

Great. Great. So maybe expanding a little bit on the supply constraints. How -- for both new and used. This has been a big topic for investors kind of over the last year and dealers. How does this dynamic impact the relationship with dealers and CarGurus if they don't have as much inventory to sell? Is it harder to kind of extract similar economics? Or is it kind of more important now because they're really trying to sell quickly the inventory they have and also discover inventory?

So for our listings business, dealers have had a good environment, high demand and albeit low supply, but that's led to really nice margin expansion for them. And they've had a relatively easy time selling the cars that they do have. So some dealers have chosen to not market aggressively during this time. And others have continued apace. They maybe had a better ability to maintain inventory levels on their site. But some dealers have chosen to pare back. At the same time, we have taken the path of not trying to necessarily take any price increases during this time. We know that a dealer who normally has 100 cars in their lot and now has 60, that it's not -- we don't feel it's appropriate to try and take price increase there even if we might be delivering more leads. And you've probably seen, Nick, that our lead growth has continued through this time. So the listings business is tied to inventory levels to some extent. And what we started to see in January, February this year as sort of COVID abated at the time before the inventory issue is more like a normal quarter for us where we were adding hundreds of dealers. And since that time, the inventory has probably put more dealers on the sidelines from a marketing perspective. But we fully expect that, that will revert to normalcy at some point, hard to tell when. And chip shortages seem as if they'll impact the industry for certainly into next year, and -- but we're prepared for that period but also for when we come out of it. And we continue to get the feedback that we're the best ROI and the highest volume. So we think we're really well positioned when dealers are ready to expand.

Great. So I think a great segue from supply constraints is to maybe start talking about CarOffer. This is something you're excited about. It's a recent acquisition, still integrating this business. Can you walk us through the potential size of this new segment and some of the early learnings so far?

Yes. And we're off-the-charts excited about not only CarOffer in its own right but also the combination of CarOffer and CarGurus. So CarOffer is a digital wholesale platform. And that industry historically has been about -- has had about $8 billion worth of fees in the industry. And it's historically been a physical regional business model. And CarOffer does 2 things. One, it moves to fully digital. And what that allows is a much wider selection and sourcing capability. The average car in CarOffer that gets transacted travels about 600 miles, 600 to 700 miles. So you're not constrained by regional geography. The second thing is it's an instant trade platform, which is different than an auction. An instant trade platform allows a dealer to configure exactly what they want to buy, what types of cars they want to buy, how much they're willing to spend. And it then -- it offers those offers to the inventory on the whole system and transacts whenever it's available. It doesn't need to wait for an auction. So it's a far more efficient model. And if a dealer says, I would like to buy 5 of this type of car and I'm willing to pay x, then we will go out and see if we can fill those 5 orders. Likewise, on the selling side, what it means is that at any given time, we have offers on a -- most of a dealer's inventory and present them those offers. So they don't need to run an auction in order to understand the value of that car in a wholesale transaction. It's more like a stock market, if you will, than a series of auctions. So it's far more efficient, which creates a tremendous dealer satisfaction. I mean it's not uncommon to see a dealer quote that says, this is game changing. This is changing how I run my business. And then it also reflects itself in the business model efficiency, where you're seeing that CarOffer is growing extremely fast and is profitable, which is unlike a lot of other high-growth businesses in the sector. So in its own right, we're really excited and think it can gain a meaningful share in that $8 billion-plus market. When you start to combine it with -- you want to pause there or talk about the combination?

Yes. No, please talk about the combination.

Okay. So a couple of sort of easy, obvious ones are we have 23,000 paying dealers, and we're introducing CarOffer to them, and those are converting very well. So we're helping fuel the rapidly growing installed base of CarOffer. The other thing we're doing is we're giving CarOffer IMV. So dealers on CarOffer now can say -- can set their bid parameters either based off of wholesale book value or retail IMV values. A third example is in our dealer dashboard, when dealers are testing and measuring with price changes, they now see standing bids on all their inventory in there. So they could decide rather than try and sell a car retail, we're going to just sell at wholesale tomorrow because that price is compelling enough. Where I think it gets really interesting, though, are with things like Instant Cash Max Offer. So that's where our platforms are pulled together to take the power of our 35 million monthly uniques with the power of these standing bids in the instant trade platform to be able to offer consumers an instant cash offer on their car that is the highest bid across thousands of dealers, which is a really compelling consumer value prop.

Can you maybe expound a little bit on the kind of Instant Max Cash Offer? Launched it in a few states, had seen some early traction. What has been some of the early feedback from both dealers and consumers on this new offering?

Yes. So we launched it about 5 weeks ago in 3 states. And the product itself is, as I said, a consumer can come to our site in those states, enter their VIN or their license plate, answer a few questions about the car, and they'll get an instant cash offer that's a guaranteed offer on that car. And then we'll -- they need to upload some documents, but we'll arrange a pickup time. And we'll come to their house, pick it up, and they'll get paid. The -- from a dealer's perspective, the bid that they're getting is the result of, as I said, hundreds or thousands of dealers who have said, I would like to buy that type of car, and here's my bid on it in advance. And so when dealers are competing for that car, the consumer is going to benefit because they're going to get the highest offer. And our belief is that in most cases, when you have hundreds of dealers bidding on a car, you're going to get a higher offer than you would if it was a single dealer or a single dealer group just by auction theory alone. So consumers -- the feedback we've gotten from consumers in terms of the offers has been great, which is why they're converting. The feedback we've gotten from just an NPS and customer satisfaction perspective has been outstanding. It's a very white-glove service. And then dealers are just clamoring for inventory right now. And even in an environment where inventory is not as tight, dealers would love more consumer -- fresh consumer trades. Historically, they've only been able to get them through trade-ins or through the wholesale arena. And now there's this new channel that we're offering, which is sort of mass access to public cars. And so we're so pleased with the progress of Instant Cash Max Offer (sic) [ Instant Max Cash Offer ] that I'm excited to share that later this week, we'll be live in a few more states, and more details will be coming this week.

Well, that's a great segue. And I guess my next question is around Instant Max. How should we think about the rollout plan and maybe the incremental marketing spend to kind of raise awareness to consumers of this offering?

Yes. So it's all happening in parallel. We -- in this first states' launch, we wanted to make sure that we did have the operations and the conversion and the funnel, executing well enough so that the consumer and dealer experience was good enough. But we have a number of growth levers, what I think are sort of low-hanging fruit growth levers. So the first is rolling out in more states, and you just heard that we'll be rolling more out imminently. The second is leveraging our site real estate. I mean we have, as I said, 35 million uniques shopping for a car. The majority of people shopping for a car have a car to sell. And we now offer them the ability to work with a dealer to trade it in. They could sell it in Instant Max Cash Offer or they could try and sell it peer to peer on our site on their own. So we give them a lot of choice there. And then the third is marketing in the states where we're live. And we're starting to turn that up now in those states, and all 3 of those things can happen in parallel, which is why we're seeing such growth and why we're excited about really how we're executing on it and the economics of it, which is why we're ready to expand.

As we get -- as we think about Instant Max and the type of car owner, who himself did this, encroach on the P2P market, where people are just kind of trying to sell their car to someone else, I mean, is this just kind of a compelling, easier way to do it? Or are car owners who are looking to buy maybe choosing to do discrete transactions, sell their cars separately from when they buy as opposed to kind of traditionally trading it in and bundling with it whatever the transaction is they're trying to accomplish?

Yes. I mean the -- we think of them as -- although they're all the similar end result, they're very different, right? In the trade-in environment, that's a huge market and will continue to be. The dealer that's selling the car has a baked-in advantage because they -- the consumer can get the tax advantage from trading in their car to that dealer. So they just have an inherent ability to really offer more in a trade-in, all else being equal, than they would in an Instant Max Cash Offer. From the peer-to-peer side, and for context, about 10 million cars are sold peer-to-peer every year in the U.S. and about -- just over 20 million are sold from a consumer to a dealer each year, most in trade-ins. Peer-to-peer is a really unique instance. You need to be willing to market your car for a while. You need to be willing to engage with people. A lot of times, there's spam. If it's not on our platform, there's spam involved. You have to do test drives with strangers. You're going to need to transact in a parking lot somewhere. So that just is a very different process from either a trade-in or an instant cash offer. But I do think that putting that one aside, I do think that the instant cash offer is becoming increasingly attractive because the logistics systems are more prepared and these digital platforms, like ours, are allowing more dealers access to public consumer cars, which is making it a more efficient segment of the industry than it ever has.

Great. So you have CarOffer, you have instant max, you have the traditional kind of marketplace business with other kind of adjacencies. As investors look at car fit and dealer count, how are you thinking about TAM? Is it really in terms of dealers and how much you can attach of all these solutions, particularly D2C? What are your updated views on what the opportunity is for CarGurus as you kind of launch these new solutions that are quite different than any kind of traditional marketplace you're running?

Yes. I love this question because this is what's getting us so excited and has us so excited. So when we were just a listings business, we had a U.S. TAM of about $3 billion. That is what dealers spend on listings marketplaces like ours. We've added some other digital marketing tools and features which tap into another pool of spend among dealers that's sizable. But that just gives you a sense, sort of $3 billion in listings plus. The wholesale -- traditional dealer-to-dealer wholesale arena is $8 billion in fees alone. And when you add in transportation and inspection and other sort of ancillary products around wholesale, that's about a $10 billion, $12 billion, $14 billion business. And digital is only taking share, and we believe CarOffer has an advantaged digital solution versus others and is adding dealers at a pretty incredible pace. And so we think there's a long runway there for them to gain material share in that, call it, $10 billion, $12 billion market. There's 2 other areas, too, which are instant cash offer, which -- that's a TAM that is captured in neither of the ones that I just mentioned. That's a pretty early market but growing really, really fast. And I was just telling somebody the story this past weekend. Happened to drive by 2 dealerships, each of whom had put out signs that say we pay cash for cars. So this is something that dealers are starting to want much more and is growing really rapidly. So we're in 3 states, soon to be more, and we're seeing tremendous success and growth. So we think that's a big opportunity. And then lastly, which we haven't talked about yet, are the advances we're making in digital retail. And so digital retail is us bringing more of the transaction between a dealer and a consumer onto our site. And as we do that, we're bringing more value to that transaction. We're helping with prequalification. We're helping with selling other F&I products. And so there's a lot of value being created there that we haven't even started to monetize that.

As we think about this huge opportunity, maybe focus more on the marketplace business, how do you think about the competitive dynamics today? Does this converge into kind of a winner-take-all or winner-take-most vertical like we see in the U.K.? Or is there kind of -- does this kind of remain kind of fragmented? Maybe there's fewer players, but the competition kind of remains strong as everyone competes for these large opportunities?

So in some of our international markets, there is a strong incumbent who has not had many challengers of scale in the past. And I think we're proving to be the strongest challenger to them and feel really good about that. In the U.S., it was more of a multiplayer. There's more fragmentation in the market. I think logic would sort of academically hold that in a marketplace model with transaction -- commerce transaction capability like we're building, the platform with the most liquidity would eventually win, and we do believe that. I do, however, think that getting from here to there, you have some reluctance among dealers to put all their -- too many eggs in one basket. They want to have variety and choice. And then from a consumer, consumers do like to check multiple sites. It's a big enough purchase that even if they were told site A has much, much more inventory than site B and gives you more information on the cars and dealers, they still may go to site B to try and find that special one-off steal. So we think it's a winner-take-most. And over time, we think as we build in, as I've said, more of these transaction capabilities and then do a better job marrying wholesale and retail, we become the single best place to buy and sell a car, whether you're a dealer or a consumer. And if we stay on that mission, then we think we'll just continue to gain share on both fronts over time.

Great. Great. Maybe switching to international -- your international markets, are you seeing any different dynamics in kind of Canada or the U.K. relative to the U.S.? Or broadly, are these markets kind of behaving similarly granted your position in those may be a bit different?

Yes. So again, and just as context for folks, we have a business in the U.K. and a business in Canada. And each market is a little different and unique from the U.S. and from each other, and they take time to scale and -- because we're scaling a 2-sided marketplace. We have long believed that even in just our core listings model alone, that we have a differentiated value proposition to both consumers by giving them more choice information -- choice and information, and to dealers by giving them a better ROI and a more aligned service to what they have with others, that that's a winning strategy. And so we proved that certainly in the U.S. I think we now feel pretty strongly that we've proved it in Canada because we brought Canada to profitability. And the U.K., which is a bigger market, is on the path to do that because the unit economics are all moving in the right direction. We do also think, though, about how we can differentiate more. And so again, each market is different. The competitive set is different. Consumer behavior is different. And so as we think about how we are differentiating ourselves in the U.S., their listings features outside of our listings model, some digital retail features, some wholesale features now, we're looking at identifying which of these can and should we bring to these other markets to differentiate us relative to what's there already. So both are growing nicely, and we're really excited about our prospects in both.

Great. And I'd like to switch to pricing. You had said earlier that you're not taking kind of this as a moment to increase pricing on dealers who maybe normally have 100 cars in a lot, they have 60 today even though they may be seeing strong gross profit. How should investors think about the opportunity to continue to increase pricing? Is it something that just kind of manifests over time? Do we need to wait for supply constraints to kind of normalize? Is there, I guess, ultimately room to continue expanding pricing of the solution?

We definitely think there is. We think there's room as long as we're delivering a strong ROI, and we have confidence that we are doing that. In a normal environment, as we grow leads to a dealer, we have been able to grow our subscription rates and also, in some cases where it's appropriate, grow unit pricing. These last 18 months, 2 years have obviously not been normal. And so with COVID and then the inventory challenges, we have decided not to take price really or to renew and increase subscription rates. We think that was the right call. We've also been more measured in the volume of lead growth that we offer to our dealers. You've probably seen that we continue to grow leads. But if we're not going to renew dealers, then there's not a ton of value or logic to -- for either us or the dealers to grow in leads a lot. So we've been more measured in that. But we do think that we've made our business much more efficient, and we've done that by acquiring higher-value consumers more efficiently and delivering those to dealers better, specifically to dealers who want to pay more to get more. And so we think we're creating a more efficient ecosystem. And as long as the ROI is there, then we're going to be very well positioned, when dealers are ready to spend again to come back, to the highest-ROI, highest-volume platform. And we've started to see -- we saw that in Q1 of this year before the inventory challenges hit, where we had kind of a normal quarter where we added hundreds of dealers. So we'll get back to that soon.

Maybe talking about traffic and lead volumes. Can you talk about -- CarGurus generates a massive amount of traffic, near kind of -- I think monthly, near kind of what annually is sold in cars. So can you talk about what are the puts and takes in how you drive quality leads? Is it a balance of creating kind of more questions for users and creating a stronger funnel so you know the intent? And then, I guess, what's the impact of potentially seeing higher balance rates as you try to qualify leads further? So I guess what -- ultimately, what goes into driving these better leads? Is it the technology, the way you're marketing or way you're winning these users? Any clarity there would be great.

Sure. It's a combination. It's a combination of continuing to build and establish our brand to get better and smarter with our performance marketing, algorithm and traffic acquisition, and then to create better and smarter conversion on our site. There's always the balance that we don't want to have any of that result in a lower-quality lead to a dealer. I mean we could generate 10% more leads in the next couple of months if we wanted to, but it would come at the expense of quality, and we don't pull those levers. What we've -- I think the big shift that we've gone through over the last couple of years is moving from trying to acquire any lead as efficiently as possible to doing a better job at acquiring higher-quality leads. And so we are getting better and better, we have a large data science team that works on this, getting better and better at identifying the types of people who are, a, more likely to convert; but b, perhaps more likely to convert on a higher-priced car, which would have more margin in it, for instance. And then the final lever is in creating content and a site experience that also generates organic traffic. And so we are doing more in content creation and starting to do more in -- honestly in upper-funnel consumer discovery that, again, is all in the vein of making consumers more informed and smarter so that when they do connect with a dealer, they're that much more likely to convert. So a stat that I'm -- we're very proud of is that dealer -- or, sorry, consumers are 3x more likely to use our site last before purchasing their car than any other site. And that tells you that we're giving the right information, we're giving the right content and that dealers who decide to partner with us on the listing side are putting themselves literally in the sort of supermarket checkout aisle. They're making sure that they're there where the consumer is, right, as they're making their decision.

Great. And I'd like to, I guess, sneak one in on M&A. There's CarOffer currently, which has got you excited and I think a lot of people excited. Are there other opportunities out there to add breadth to the platform or maybe talent or technology? How are you thinking about kind of M&A from here?

There's a ton of opportunity for M&A. And we think that we've shown that it's a really good lever for us. Our first couple of acquisitions were really good ways for us to scale more in listings in more efficient ways than organic growth. But with CarOffer, I think we have proved that it's a great mechanism to expand in a big way into a new area. And so we have every reason to believe that we'll continue that. We're spending a lot of time and energy on focusing on the right M&A targets and think that as we build this transaction commerce capability on top of our marketplace, that's ambitious and there's a lot to do. And we fully believe that we'll be acquiring some businesses to help us accelerate that more, whether it's in the wholesale or the retail arena.

Great. Well, I want to -- I think we're kind of at the end here, but I'd love to ask kind of one last kind of question. What do you think the biggest misconception is by investors of CarGurus today given the recent acquisitions? And what's gone on during the pandemic? We'd love to get your perspective.

Yes. Thank you for the opportunity to answer that. So I -- the sense I get from talking to a lot of folks in the investment community is that, one, there is a very -- there's -- feels like there's a short-term focus on the inventory dynamics. And those are real, to be sure, but they are -- they will be short lived in the scheme of things. And we think that -- as I said, we -- our platform gets better every day. And so we are well positioned for when dealers are ready to start spending aggressively again, and that will come soon. I think the second thing, if I may, is the combination of the CarOffer runway just in and of itself and the advances we're making in digital retail. When you put those 2 together on top of our market-leading marketplace, you get a really powerful combination of full life cycle transaction. You get dealers who will be able to source, market and sell their cars, and you get the ability for consumers to buy cars and sell their car in any way possible. And so having the commerce capability, both retail and wholesale, on top of a marketplace, we think, is pretty transformative. And we think that's what will really differentiate us from anybody else who's offering any one of those point solutions.

Great. Well, Jason, thank you so much for joining us today. We really appreciate the time. And this will conclude the fireside chat.

Thank you, Nick. Good to see you. Thanks, everyone.

You as well. Take care, everybody.

Bye.