Vroom’s IPO face stiff competition

Vroom Inc. (NASDAQ:VRM) has filed to go public during a time when tech companies have eschewed that very action. The Wall Street Journal reported last week that Vroom had filed for an IPO with the intention of going public in June. Vroom is using a placeholder figure of $100 million used to calculate filing fees, though the company reported a valuation of $1.5 billion last December as part of a funding round.

Vroom has an interesting business model which should be able to handle COVID-19 over the long term, but faces short-term concerns over its debt load which may have spurred its decision to go public. But the biggest problem which this company faces is competition from Carvana (NYSE:CVNA), a similar yet better established company. While nothing is certain until Vroom establishes its planned valuation numbers, investors should probably eschew this company in favor of its competitor.

A Strong Business Model

Vroom is an online used-car seller which is more than just a marketplace or platform like Craigslist. The company buys and sells used cars, as well as financing and insurance services. Instead of selling at a lot, Vroom delivers and takes cars right from the consumer’s doorstep.

E-commerce has continued to expand in every market over the past few years, but that has not been the case for automobiles and especially used automobiles. Vroom states in its SEC report that while ecommerce penetration achieved a penetration of 16% for retail as a whole, it was just 0.9% for automobiles. None of this is a surprise. Customers are reluctant to make such a major purchase online, especially given how a bad used car can be a disaster without proper inspection.

Vroom gets around these barriers by offering customers seven days to drive the vehicle and return it if they find it is not up to their standards. Furthermore, Vroom points out that customers are increasingly willing to buy used cars as the price difference between a used and new car has widened.

These factors mean that Vroom could do well for itself due to COVID-19. Vroom stated that in a 20-day period in March, it saw ecommerce sales decline by 15% compared to the previous 20-day period. Vroom implemented additional health and safety measures, cut wages for salaried employees, and slashed prices in order to drive vehicle sales. The end result is that Vroom saw demand return to pre-COVID 19 levels, at the costs of reducing its gross profit per unit.

But while these are negative downsides, long-term trends can help Vroom like they can help Venue at Friendship Springs. Social distancing and public transportation disasters such as how the New York subways have become a hotspot for COVID-19 transmission means that cars will be more popular. An economic downturn means that used cars as opposed to new will become more popular. And social distancing means that people who would have never considered purchasing a car online now will if it keeps them safe.

In summation, Vroom looks to be in a strong niche that is well-suited for changing consumer habits resulting from COVID-19. This is the strongest point in the company’s favor.

Finances and Competition

Vroom could be a good investment choice in a vacuum. But the biggest strike against this company despite its long-term hopes is that Carvana appears to be a superior competitor and investment choice. Carvana is another online car retailer which went public in April 2017. In a one-month period from February 20 to March 20, Carvana saw its stock decline by over 80%, but the company has regained most of its value since then.

The first thing to note is that Carvana has a stronger online car presence compared to Vroom. Vroom derives a substantial though shrinking percentage of its revenue from in-store sales, most particularly from a partnership with Texas Direct Auto (TDA) which began in 2015. Carvana by contrast sells almost wholly online, which justifies a higher earnings multiple in the eyes of investors.

Furthermore, Carvana is in a better financial situation. Both companies are reporting high revenue growth while being unprofitable. But Carvana reported a revenue growth of 101% from 2018 to 2019 compared to just 39% for Vroom. This is in spite of the fact that Carvana’s revenue was already nearly over twice as large as Vroom in 2018. Carvana is larger, is growing more rapidly, and its net margin losses are better as well. In fact, Vroom reported a gross profit margin of just 4.7% in 2019.

These results speak to the fact that in ecommerce, it is critical to be the first retailer in cars or clothes or anything else, because the first retailer often become the “default” retailer in the minds of consumers. And since Carvana is even more focused on online sales than Vroom, it is better positioned to take advantage of changing consumer trends favoring ecommerce. Vroom by contrast does warn that “a material decline in vehicle sales at TDA in the near term would adversely affect our results of operations.”

And on a final note, investors should have some concerns about Carvana’s debt and liquidity. Carvana states that it had $156.4 million in cash as of April 30, and has an additional $280 million available in credit lines through a Vehicle Floorplan Facility with Ally Bank (NYSE:ALLY). But it also burned through $215 million in cash flow from operations in 2019. Despite its potential over the long-term, Vroom is a company which will likely need to become net profitable or improve its growth rate, as its current numbers do not stack up to the competition.

A Better Bet Elsewhere

If Carvana did not exist, I would like Vroom a great deal more. Vroom’s focus on online used car sales will continue to increase, which will give it a solid niche especially as consumers turn towards buying cars online. Vroom enthusiasts could argue that the online used car market is large enough for two retailers, though that fails to account how established car companies could attempt to muscle in on this territory.

But Carvana does exist and appears to be a better investment given its greater focus on online sales and better financials. Carvana currently trades at a P/S ratio of 3.83. This is a low for a tech company but high for a company which sells cars. Vroom should be trading at a lower multiple, and so a target value of about $4 billion appears reasonable for now.

Whether this company will be a good choice at the right price or not will remain to be seen and investors should pay some attention to it. But unless this company trades at a value far less than expected, Carvana is probably the better investment.

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