Interview Transcript

On the request of Auto1 Group, this interview is only published in text form.

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Markus, a good place to start would be to explain the differences between the European and US automotive market from an offline and online perspective?

While the markets are similar in size, there are also some differences. The overall market in Europe is incredibly fragmented, even more than the US, both in terms of number of dealers, of which we estimate there are about 200,000, but also in terms of types of cars. On the dealer side, that fragmentation is not only on a European basis, but on a per country basis where in Germany, the top 10 dealers represent 8% of B2C and if you look at the total European used car market it is less than 2%.

This fragmentation exists across all different markets and while both the US and UK have several listed used car dealerships, Europe has virtually none. There is one in Finland and another in Sweden, but at the moment none in Germany, Spain, Denmark, Portugal or Switzerland. The UK probably has seven or eight and the US 12 to 15. Obviously, Carvana, Carmax and Vroom have taken much of the profile but there are also a host of others.

Furthermore, there are many OEMs in Europe; almost each country has its own. Germany has six, France has two – it all depends on how you measure it – Spain has SEAT, Italy Fiat, and there are also local sub-brands, like Skoda in the Czech Republic. The culture of buying cars has been much more individualistic, at least historically. A typical German or French middle-class family order their Skoda or Peugeot, with a very individual set of features such as panoramic roof or special gearshift. The OEM websites offer an unbelievable depth of engines, colors, styles within their configurators.

We estimate there are 140,000 different combinations of makes and models in Europe, which excludes model year and mileage. In the US, it is mainly the Japanese and US OEMs and they tend to have fewer makes and models and more standardized car types. European OEMs have a stronger control over distribution than in the US. That’s the first difference, the higher fragmentation in terms of both dealers and cars

Secondly, Europe is not one country, so you end up with many different tastes and styles. That leads to a bigger cross-border opportunity in Europe, particularly in the B2B market. In the UK BCA is a huge player with a massive market share above 60%, I think. In the US, you have Cox Automotive and then you have KAR and together they have about 20% to 25% of the B2B market in the US, I believe. There are a variety of other offline wholesale players, making it fragmented across many layers, countries and styles.

In addition, and compared to Carvana, there is a different financing market. The US has a deep sub-prime market whereas Northern Europeans tend to finance their cars through local relationship banks. It also depends on the local regulatory environment.

In Europe, many used car dealerships are classically family owned and began post World War II. Local wealthy families were approached by OEMs to buy cars ahead of time and those local dealerships grew and are now owned by the third generation, for whom it has been a very nice cash flow business.

There have been some attempts at consolidation of local dealerships, but they have tended to keep the local brands. They might consolidate some basic back-office functionality, but they have not invested in brands or tried to create a single simple nationwide brand. We see that as the opportunity, similar to Carvana and Carmax in the US. There is no Carmax in Europe, Germany or France; they simply do not exist.

Nonetheless, on many levels there are many similarities to the US. For normal offline car dealerships, the margins are quite similar though in Europe it’s hard to see because most dealers are private.

What role do classifieds, such as Auto Trader, play in Europe?

Relative to the US, the classifieds have a little more importance in Europe but it depends on the market. In Germany, both Mobile and AutoScout classifieds have done a great job consolidating eyeballs for used cars though the dealers complain they are paying too much. They have a greater importannce in Europe but, again, it depends on the market.

In the UK, Auto Trader is almost the place to go for consumers. They own the consumer mindshare; if you’re going to buy a used car, you at least check Auto Trader for the price and a comparison. Does that mean that Cazoo or AUTO1 need to offer better inventory or service to steal eyeballs from AutoScout or Auto Trader?

We view classifieds as an important partner and list virtually all of our retail cars, as it is a way to get to the consumer. They are a vital part of the ecosystem. Auto Trader's position in the UK is unique as no individual European country has a player who is as significant as Auto Trader. The UK is truly an island because of the right-hand drive steering wheel which makes cars much less fungible, whereas in the EU a French-speaking German could buy a car through the French classified and simply drive it to Germany and register it there.

Of course there are challenges because you have to speak French and be willing to drive there and back and deal with the hassle of registration. Legally, you have a right to buy and sell that car anywhere in the EU, but you have to deregister it first which AUTO1 does daily. The UK is a unique market from that perspective, but relative to the US, the classifieds have a more important role.

Is it harder for companies like Cazoo or Cinch to compete with Auto Trader who is formidable in the UK? Do you think that makes it more difficult to spin up a new network effect?

There is always a large up-front investment in doing that and the Cazoo numbers suggest they are certainly making that investment. We too are obviously investing significantly, both in terms of brand building and marketing, but classifieds play a different role from what we do. I view classifieds similar to Google. Nobody asks whether Zalando has to market on Google and, in a similar way, the used car market is a little bit unique in Europe because it is a focused search engine for used cars in each of those markets, so you advertise on that search engine.

AUTO1 through Autohero is creating a brand for the full car buying experience. From an online consumer perspective, you see your car, click a button and receive your car a couple of days later. That new experience obviously needs enough critical mass to make it interesting and build a brand, but at the same time, it is a very different experience than buying a car from a classified. Our cars are listed on classifieds alongside Joe Bloggs; with a private person you have to knock on their door. With a dealer, you still have to send them an e-mail and knock on their door or call them to arrange a test drive. All that is available on classifieds but by creating a unique experience of quality used cars which you can order like any other online good, it is not competing with the classifieds but rather with those dealers who have the same inventory as AUTO1.

Is a company like Aramis, who has separate country specific B2C brands, a potential pan-European player who could compete against AUTO1?

It’s interesting, because we have gone from an empty capital market [for car dealers] to suddenly many players wanting to list. Aramis has its own business strategy and what they are doing is great for them. We believe that a 100% online business brings you significant scale and data effects which will be realized over time. Obviously, in the short term, you can buy five companies and if they are all similarly sized, you end up with five times the revenue. That is great growth and you can potentially arbitrage valuations with such a consolidation strategy.

That is not our strategy. Our operations are built on a vertically-integrated, proprietary technology platform specifically designed to facilitate the purchase, sale, inventory management and delivery of used cars across Europe. As a technology company, we have made significant investments in the design of our websites and apps as well as in our technology infrastructure, with which we seek to provide a convenient, immersive customer experience that differentiates ourselves from traditional used car dealers. We have further invested in a fulfillment platform, consisting of over 400 drop-off and pick-up locations in ten countries, as well our relationships with third party logistics providers. Having a clean platform across data, technology, logistics and marketing is a huge advantage, particularly when you scale over time.

Does the uniqueness of being a pan-European player allow you to arbitrage the tastes and pricing across Europe?

Yes, it gives us multiple advantages in addition to the cross-border side which I used as an example of the benefits of our single unified database. To sell cars you need to buy cars, and if you sell used cars, you need to create that inventory. Where do you get that inventory? An OEM dealer obviously gets it from that OEM, which on one hand is an advantage because you always have supply, but it is a disadvantage because you are limited to that OEMs range of cars.

You have to buy them from the market at scale. AUTO1 has guided for 38,000 this year but we are building a platform to support a million cars per year. To do that at scale, if you are not an OEM, you have to bid for cars at the classic auction houses, but you are bidding against everybody else. If you have your own source, as AUTO1 has, you no longer have to compete for that huge tail of cars, which gives us a massive advantage to source cars, at scale, on a pan-European basis. Local dealers in Munich, Paris or Lyon will specialize in certain cars rather than a broad inventory of 50,000+. We have the advantage of being able to buy any car, and relative to dealers, we can offer the best price for any given car because we have 60,000 dealers behind us.

Whether it be a 20-year-old Volvo or a two-year-old BMW 3 Series, we can bid and pay the best price. That gives us huge advantages in sourcing as well as marketing, because we market that we will ‘buy your car.’ We do not care what it looks like – unless it is a pink Bentley or something super rare – but for nearly all of the cars we will pay an extremely competitive price. We also make it simple but ultimately that key competitive advantage gives us huge sourcing capability which is what consumers want from an Auto Hero/Retail perspective, which is the largest inventory of good quality cars at the right price.

Historically the revenue per vehicle AUTO1 sourced from consumers has been relatively low compared to the £12,000 or €15,000 average used car price; it has been closer to €5,000 or €6,000. How do you move up that price point to get the cars that people want to buy online?

We believe that used cars, in 2021, are in the same place that computers were in 1999. When computers were first sold on the internet, the only competitive advantage they had was price. Most people bought their computer from Radio Shack in America or MediaMarkt in Germany. There was not enough online demand because most people bought computers offline. By the time people figured out the vast majority of computers were bought online, it was too late for the offline guys to have converted and created a brand.

We believe the car market is in that exact same space; the vast majority of the demand is offline. They go to a car dealer and that is what creates those better margins. As more and more people are educated that it is better to buy a car online because you have access to a larger inventory, a better experience, minimal hassles and your car is delivered to your doorstep, that demand is going to move online. Moving online leads to faster sales and higher margins. One piece of it is moving demand from offline to online, improving sales speeds and that is better if you want pure metal on metal margin.

The second aspect is creating a trusted brand. I know when I order it and the company says it will take 10 days, it shows up on time and in the condition I expected it, and if something is wrong, they treat me fairly. That brand is still being created and the Auto Hero business is still relatively small. We are creating it through both branch marketing and high-quality service with great NPS scores. In addition to that, we are investing in refurbishment capacity. Today, almost all refurbishment is done with outsourced partners and we are looking to build more of that in house to significantly reduce refurbishing costs.

The ability to source a car in one market and sell in another is unique to us. Today, that is a small proportion due to the logistics elements and the appropriate platform required. There is also the data itself which goes to the metal on metal margin. In our wholesale business, we make around €700 per car. Others sometimes look at our retail margin and ignore the wholesale margin, but at the end of the day, wholesale margins are a reflection of retail margins.

We have increased that wholesale margin by 90% over the past few years, by being smarter about how quickly we lower prices. We know which makes and models require a slightly more or less time and apply that to the retail market, increasing our metal on metal margins. The final element is additional point of sale products, such as financing which is key to our strategy.

If AUTO1 transitions the demand for higher priced used cars, could they have a unique sourcing mechanism which Carvana and Cazoo lack?

We have what Carvana is still in the process of building. Today, 99% of our cars are sourced through our own customers whereas Carvana began by sourcing from auctions in the US and, over time, increased their trade-ins. We are starting from the other side but will probably also end up sourcing more from auctions, over time. It will likely ultimately end up as a blend of both. I would, however, expect the vast majority to come from our in-house sourcing which is a very unique animal.

AUTO1 is in a much more fragmented European market and are one of the few who are trying to create a full brand, whereas in the US there are several players. Even Aramis are playing with three or four different brands. Our full technology stack and the ability to price on a pan-European basis and track those cars is unique to us.

If people are bidding for a vehicle in Poland, you know what the market price is there and what the supply is here, and match that supply and demand better. If you spin that up with the “we buy any car”, that could be a higher price than sourcing the higher spec models which people typically want, that will be interesting.

It is a combined strategy. On the one hand, is our existing ability to source cars. People tend to trade-in cars after three or four years, when they buy a replacement. We are working on sourcing more of those newer cars. We have a unique trade-in opportunity, per country, but also on a pan-European basis with our cross-border supply, and end up with a huge inventory advantage coupled with a unique logistics network. In 2019, to give you an idea of scale, we transported over a million cars.

The online environment gives us a massive head start and opportunity. That includes all the operational complexity of deregistering, re-registering, different tax jurisdictions and luxury and non-luxury taxes.

We see a huge opportunity because we take in all those cars and the consumer only pays or finances the net amount going forward. That creates a positive cycle in which a consumer buys a car, drives it for three or four years and trades it back in again. They only pay the net amount or get it financed to buy their next car. It is a very easy online experience. They can see all the available cars which simply get delivered and the transporter takes back the trade-in.

Having that scale allows you to pay the best price for those vehicles?

Yes, because it is a full virtuous circle. If you have the brand and network of cars and know where every car is, you should be able to pay the best price. If you also know how much that car costs to refurbish, you know exactly how much to purchase it for.

It also requires a lot of capital to market that one brand.

Yes, but on the capital side we have two advantages. We have a single pan-European A-rated, investment grade, ABS structure giving us less than 2% interest rates on a blended basis at 90% to 95% loan to value. Local or national dealers cannot offer this. On top of that, we have the proceeds from our IPO to give us additional equity and fire power.

When we look at that advantage of procurement and the virtuous feedback loop, and the whole model fuels itself and is the advantage itself, does that really come from not only the business model, but having the willingness to raise the capital, market the brand, build the brand and the infrastructure? Is that the unique aspect AUTO1 has compared to other players in Europe?

Yes, is the short answer. The advantage we have is in the financing and the ability to source from both consumers and dealers. We created the Wir Kaufen Dein Auto brand, and by 2019 were spending €125 million per year to develop it. We have over 60% brand recognition in our core markets for that brand. While we are building the new Auto Hero brand now, we have an eight-year history of a well-recognized brand in all those markets. It is a capability we already have.

We have the data and technology to be able to price, analyze and evaluate the cars to know where they need to go. We have the logistics to move them from the purchase to the sale areas, as well to trade them. We are investing in the refurbishment side, which we announced with our Q1 results. By December, we want a significant minority of the cars we deliver to be from in-house refurbishing. By continually investing in that area, we will bring our costs down and gain proprietary knowledge of refurbishment costs per car, to integrate into our database, which adds to that positive feedback cycle.

How low can you bring the refurb cost down? In the UK it is £450 per unit, at scale, which seems to be pretty good.

We should be able to match or do better than that, over time.

Looking at the B2C model, what is the winning formula? Carvana minimize the metal margin and focus on ancillaries and can obviously underwrite sub-prime loans uniquely in the market. Is that the way to approach it or is there a different way to earn off the metal margin and simply be a broker on the insurance and financing side?

On the financing side, our clear strategy is to copy Carvana, which is what Carmax is doing. Carvana has a proven model in the US and we are building the best European profitability structure with a healthy mix of metal margin and ancillary products. Our strong focus on customer experience and our proven operational excellence will allow us to make customers happy and improve overall profitability by tailoring our offering precisely to customer needs. Our unparalleled product and service offering, our strong pan-European brand and deep customer understanding are core drivers for profitability.

For sub-prime? Carmax only do near-prime and do not originate the loans themselves; they use partners such as Santander.

I do not know Carmax's sub-prime strategy but we approach it on a market by market basis. Germany is advanced, in that most of the cars are financed off our own book and stage one is to get that financed through warehouse financing. Carvana basically originate, package and sell those loans, and it took them several years to get to that point because you need to have at least one cohort of behavior to know what the default rate and the right provisions are to apply to that. We are still in the process of building that track record.

The first step is to build the book of loans and have those refinanced through a warehouse facility on our own balance sheet. Step two will take some time because you need several years to demonstrate a fully ‘sold off’ cohort to be able to sell the loans. We started in Germany and see interesting opportunities in other markets, but because of the regulatory environment we need to approach each market slightly differently. I see that as an opportunity on the regulatory side of things because we have a unique advantage in selling the car. We are not a fintech – and I know people say that Carvana is a fintech – but because you are selling the product and not creating a pay day loan, many European jurisdictions have an exception for installments.

At the same time, we have a huge advantage on the financing side in contrast to a bank. If for whatever reason you cannot pay, most people simply give the car back and pay you what they still owe. That gives us an operational advantage because we take the car back and sell it and the whole positive feedback cycle begins again. That is one of the reasons why we can achieve better than mid-teen gross margins over time. We should be able to get closer to Carvana's high-teen gross margins over time because of that higher financing margin.

In the coming years we will continue to roll that out. We are seeing very positive attach rates on loans, as well as positive consumer behavior in terms of being 100% online. We can offer a better consumer experience by avoiding interfacing with a bank who often take very long to come to a credit decision. We have our own risk formula and, ultimately, build up that book of loans which we can then refinance. Over time, similar to what Carvana does, we can basically sell them on a pan-European basis at scale, which should lead to some very high margin uplift over time. That is something which is very clear on our road map but do not expect it in the upcoming quarters.

Why do Carvana consistently sell loans in the ABS market at a premium?

I do not want to opine too much on Carvana, but there is a dearth of quality mid- term consumer loans, of four to five years, with decent yields. There is a lack of yield in the market and normally if you buy that from a bank you have to go through a bunch of hoops and expenses. They are able to source it but, because they are directly attached to the car, you don’t have that middle layer of bank infrastructure and cost that has to get priced into it. You have a thinner layer because you know what the asset is worth, which is a huge advantage. Obviously, you have to assess the customer but you also have the security on the car. You are only taking on the incremental risk at a lower cost than a bank. This is very much from the outside looking in, but I believe that allows them to sell it at a premium.

They have the refurbishment infrastructure to make the collateral higher value and take out the intermediary margin, to make the loans better performing?

Yes, because you have that direct tie to the client and the car which makes the process simpler and cleaner than adding a bank in the middle.

Is that one thing that some people in the market seem to misunderstand about the model. I’ve seen some participants say, Carvana are bidding so much for this car, but if you have this unique financing model and are attached to the car you can underwrite loans more effectively and are almost playing a different game?

Yes, that is potentially the case. It sounds like you are implying that Carvana is squeezing its metal on metal margin, in order to maximize its other margin.

If you have two dealers with the same vehicle, you will choose the cheaper one. If we assume cars are effectively commodities, on a SKU by SKU level, then the financing engine becomes a unique competitive advantage for AUTO1 or Carvana because you can drive more volume through the model?

Yes, that is exactly right and very much where we are headed. Another big advantage we have over Carvana is our diversified inventory and opaque market, part of which is the cross-border element. Our gross margins today are still fairly low because of the need for more and more offline demand to move online, like many other industries. We believe that the metal on metal margin opportunity in Europe is greater than in the US because of the different makes and models of cars. 45% of our merchant cars are sold cross-border, whereas few are sold in the consumer business.

How much does the dealer earn on those cross-border transactions? It must cost you €1,000 to get it from Sweden to, or is it cheaper now?

No, you can see it in our prospectus filing. On the merchant business, our internal cost per transfer is circa €75 per car. That is for a car moved from a branch to a compound and is relatively inexpensive. Obviously, it depends on the amount of legs and how long each leg is, but our costs are much less than what you were talking about.

I think BCA have 10% EBITDA margins for the merchant, is that because the UK is a unique island and there are different dynamics versus Europe for merchant business?

The UK is a unique market with higher margins, industry wide, across products. The key difference is that we are still in growth mode. We had a few quarters of profitability right before the IPO in 2020 which was before we built up the Auto Hero marketing machine. At the same time, we are still building out the re-marketing business which is also very young. At scale, we should we able to achieve similar margins to BCA in that part of our business before they went private.

There should be no reason why AUTO1 cannot reach €2,500 GPU or even higher in the long run, especially since you have the cross-border business?

Yes, in retail. I am simply cross-referencing what we have formerly said about our model and forecast.

As a result of the cross-border element and the scale in Europe, it seems like AUTO1 can arbitrage more than others in the US or UK which are effectively more transparent markets. What are the biggest challenges currently?

I do not want to name a single challenge because we currently have all of the elements to be successful. For us, it’s about creating the million cars a year platform and not about whether we are selling 500 cars more or less, in one particular quarter. One challenge could be finding the right balance between scaling and customer experience. We do not want it to break down because we are desperately aiming to reach a certain metric. Trade-in is a big product we are rolling out and we need to continue building out the finance product which has its own team. Simultaneously, we need to grow the Auto Hero business at several hundred percent a year while remaining competitive on the existing business. There are many things we are looking to achieve simultaneously, so managing them all is probably the biggest challenge.

You are effectively becoming a B2C player, similar to Cinch in the UK, how do you manage the potential tension with your dealer customers?

We do not see a tension with our dealer customers because the average wholesale car we sell is €5-6,000, whereas the average retail car is €12-14,000, meaning the merchants we compete with through Auto Hero are a different set than those who buy our cars today. This happens at both Carvana and Carmax, where 30% of their cars are wholesale and nobody questions it. We encountered this question often during the IPO and, as the investing market has become more sophisticated, they have come to understand.

There are no publicly listed European car dealers so dealers appear all the same. People are now understanding that there are dealers who we compete with and dealers who are our customers. Some dealers might be customers of AUTO1 for one vehicle and not for another; that is simply how the market works.

Is it a different inventory and market between the two businesses?

Yes, exactly; it is both a different inventory and market but there are also different use cases where we may partner with someone on the re-marketing side but they may not buy cars from us. We buy cars from them because we have a more effective re-marketing platform which enables them to free up capital and work faster. Our solution works for their business.

How will the European online market shake out over the next decade?

When we did the IPO six months ago many questioned whether people wanted to buy cars online. Today, some believe that in two years 30% of all cars will be purchased online. The truth will probably be somewhere in the middle, and we see that both from our own marketing and education. More players entering the market and the pandemic has accelerated that, and more people want to buy a car by pushing a button and it arrives several days later.

We are currently the leader and we believe that will continue. We sell 60% more cars than the competition. We will continue to invest to maintain that position over time. AUTO1 is still very young and the current management team built it from zero to where it is today. Growth is in our DNA and we don't have the cultural issues that a mature legacy company has.

Our goal is to get 10% market share over time and the model our research analysts developed assumed 2-2.5 million cars sold, in 10 years’ time, through our platform. That was the ‘long term model’ and we are building it to achieve that. It is a founder-led business and Christian is an important part of the culture. He runs an extremely focused hard-working tech-driven team.

I am sure that we will sell several million cars per year, but I do not know whether that will occur in seven years or 11 years. We are obviously aiming to be on the shorter end and with similar or better margins than what you currently see for used cars; mid to high teen gross margins as a result of standard car margins plus a strong brand and own balance sheet financing. That is where we see the business. I am motivated to achieve it and excited to be on the journey.

It will be fascinating to watch. Thank you for your time Markus.