Originally published in our May 2017 Newsletter:
Transaction: The spin-off of Cars.com was announced on September 7, 2016. The idea of the spin seems straightforward – – TEGNA trades at high-single-to-low double digit EV/EBITDA multiple. And in Slide # 5 of a company presentation for Cars.com, management makes a case for mid-to-high teens forward EBITDA multiples for the spin. So this spinoff was mainly about separating a unit that could garner a significantly higher valuation as an independent company.
On May 31, each TEGNA stockholder received one share of Cars.com Inc. common stock for every three shares of TEGNA common stock held at the close of business on May 18, 2017, the record date for the distribution. The separation was tax-free for Federal income tax purposes. In the spin, Cars.com transferred $650 million to TEGNA funded by floating rate debt. One thing to note is that TGNA pays a quarterly cash dividend and CARS will not so that could have or might result in investor-base rotation.
Cars.com: I believe that most of us have researched car prices on websites like Edmunds.com, Truecar.com or Cars.com etc. when buying or selling a car and already know how these sites function. Cars.com generates 80% of its revenues through the sale of advertising space to auto dealerships. The website hosts approximately 4.7 million vehicle listings at any given time and serves approximately 20,000 franchise and independent car dealers throughout all 50 states. The company generates 17% of its revenue through the sale of display advertising to national advertisers. Also, the spin-off included DealerRater, acquired in August 2016 which you can check out here.
Competition: Cars.com competes for car dealers’ advertising dollars with internet search engines (Google etc.) and online automotive sites such as AutoTrader.com, eBay Motors, Edmunds.com, KBB.com, Autobytel.com, CarGurus.com, Carfax.com, NADAGuides.com and TrueCar.com. In addition, its competitors include sites operated by auto OEMs, providers of off-line membership based car-buying services like Costco Auto Program and other off-line sources like newspapers, trade periodicals and classified listings.
Market & Growth Drivers: According to a company presentation, Cars.com’s addressable market size i.e. total dollars spent by 42,000 U.S. auto dealers on advertising is $30 billion. Of this, around 52% is spent on digital (~$16B) and the rest on traditional (print, cable etc.) media. The company cites Borrell 2016 Industry Outlook which estimates that digital will grow 10% annually while overall auto-dealership advertising will grow 5% per year. If you take this at face value, then Cars.com has a 4% share of the digital ad spend with the potential to grow topline 10% annually. That’s quite a long runway with healthy growth prospects.
As a side note, I recently came across a Reuters article talking about the glut of used cars in the U.S. and how it will intensify over the next few years with a multitude of cars coming off leases. Will this dynamic motivate dealerships to spend more on advertising to clear out inventory? It’s certainly possible.
Near Term Outlook: On May16, TEGNA held an Investor Day for Cars.com – provided guidance of 0%-2% topline growth in 2017. Now this certainly doesn’t square with the 10%-type industry growth outlook mentioned in the company presentation?
What’s going on here, per management, is that 27% of 2016 revenues were generated via what the company calls “wholesale channel”. These are revenues generated via former owners of Cars.com, through agreements in place, that are below market rate – – approximately 60% of the rate that the company gets through its internal sales team.
In addition to being below-market, wholesale channel is a drag on revenue growth. But the agreements start to expire in 2019/2020 and Cars.com has also set minimal performance standards with these “affiliates” which if not met, allow the company to move the accounts to their internal salesforce.
Another factor that has impeded revenue growth is a technology ‘reset’ which impacted traffic on Cars.com last year. Apparently, the old platform was outdated and the company revamped it in 2016 and into 2017.
Free Cash Flow: In 2016, Cars.com generated FCF of $189 million but as part of TEGNA. I haven’t seen FCF guidance for 2017 but based upon the comments made during May 16 Investor Day, I estimate it as:
|Cash Taxes @28%||($44)|
|Free Cash Flow||$187 million|
Insider Ownership: As a starting point, management and directors own negligible shares immediately after the spin-off distribution. However, per Form 10 filed on May 5, under Cars.com Omnibus Incentive Compensation Plan, the company will reserve 18 million shares for issuances. This is quite a significant sum when compared with 71.5 million total shares outstanding. Will need to keep an eye out for stock/option issuances post spin.
Valuation: There aren’t many good public comps for CARS except TrueCar (Ticker TRUE) and U.K.-listed AutoTrader.com (Ticker AUTO:LN).
Table 1: Cars.com relative valuation and other metrics
|Price||Shares O/S||Mkt Cap||Net Debt||Enterprise Value||Revenue||Adj. EBITDA||Adj. EPS||EV/Revenue||EV/EBITDA||P/E|
|TRUE||$17.32||92.9||$1.61 B||($123)||$1.49 B||$291 M||$20 M||($0.07)||5.1x||74.3x||NM|
|AUTO:LN||£4.20||975.0||£4.10 B||£353 M||£4.45 B||£310 M||£211 M||£0.152||14.3x||21.1x||28x|
|CARS||$25.62||71.6||$1.83 B||$641 M||$2.48 B||$633.1||$259.8||N/A||3.9x||9.6x||N/A|
Note: AUTO revenue, Adj. EBITDA and EPS are consensus estimates for FY ended 3/31/2017; CARS revenue and adj. EBITDA are CY 2016.
In the Sep 7, 2016 management presentation, TEGNA management showcased M&A transactions in the auto-related space and remarked that EBITDA multiples paid ranged from mid-teens to low 20s. Examples cited include TRADER acquired in July 2016 by Thoma Bravo, J.D. Power in April 2016 by XIO Group, CarProof in Dec 2015 by HIS and DealerTrack in June 2015 by Cox Enterprises.
In any event, Cars.com does indeed appear to be trading at a significant discount to public peers as well as to the M&A multiples paid in the space.
But even if one were to take the high road and value Cars.com on an absolute basis, for an internet platform with a lot of growth potential and low financial leverage, CARS seems to be attractively valued at a FCF yield of 10%.
Can I digress for a moment? What seems like a lifetime ago, during my MBA, my group and I did a valuation of Amazon.com, a small company that sold books on the internet and was about to go public (yup, I am older than dirt). It was a classic value class and in our term paper, we concluded that AMZN IPO was overpriced at $18. Since then, AMZN stock has split three times (2-for-1, 3-for-1 and another 2-for-1) and now trades at ~$1,000 per share.
Time and time again, I have let fantastic internet platforms like GOOG, FB etc. pass me by because they always looked expensive to me or certainly not inexpensive, early on in their life-cycle.
I am not suggesting that CARS is one of these companies that will change the world but it is a digital platform. In the near-term, it is fine to focus on points like this year’s guidance, extra-ordinary items in the spin, issues impacting auto retail outlook and where the comps are trading (the trees) but it is equally important, in my view, to look at the big picture (the forest)…
… what we have here is a newly independent company that does $630 million in revenues in a $16 billion market that is growing double digits. That’s a lot of growth potential and that’s my takeaway.