Last month, Carvana acquired ADESA, the second largest wholesale auto auction business in the US, for $2.2bn. Carvana is debt-financing $3.3bn for the acquisition and $1bn incremental capex to add IRC capabilities to the 56 ADESA sites. This acquisition places Carvana within 100 miles from 78% of the US population.
We believe this transaction not only accelerates Carvana’s retail growth trajectory, but could also fundamentally restructure the wholesale auto market.
We share our thinking below which is based on multiple executive interviews across the industry and a recent investor dialogue on CVNA vs KMX:
The acquisition of ADESA gives CVNA two strategic benefits: a more efficient logistics network and potential access to fleet-managed inventory.
After listening to Ernie Garcia, it’s clear every decision at Carvana is focused on improving the retail customer experience. The ADESA acquisition is no different; CVNA adds ~2m units of IRC capacity and is within 200 miles of 94% of the US population with ADESA's network.
The more IRC’s, the closer CVNA is to the end customer, the shorter the delivery time and the better the customer experience.
Also, the denser the IRC network, the better the unit economics. CVNA estimates $750 of cost savings per unit sold within 200 miles of the customer relative to the average shipping distance.
A denser logistics infrastructure drives improvements in four areas that improve CVNA's unit economics:
It’s hard to parse out the exact retail / wholesale unit economics accurately for CVNA, but we estimate there is ~$1,000 IRC parts and labour per unit, ~$200 IRC overheads, and ~$200 inbound transportation included in retail cost of goods. In 2021, CVNA also reported ~$1,127 advertising cost per retail unit and ~$350 outbound logistics across all markets.
Although the inbound transportation cost will decrease because Carvana is closer to the end customer to pick up trade-ins, it seems most of the $750 unit cost savings will come from a lower CAC and improved outbound logistics.
According to IR, it costs CVNA ~30c per outbound mile compared to ~$1 for retailers that outsource to 3P haulers. If CVNA reported $350 outbound logistics cost per unit across over 300 markets, there is potential for nearly $200 cost savings per unit if CVNA only ships within 200 miles.
It’s harder to calculate the improved CAC per unit from an improved sales conversion without specific cohort data. In the 2019 10-K, CarMax reported between 38% and 52% of vehicles sold were acquired from customers and we’d expect the majority to be sold within the same market. In 2021, KMX's ad cost per retail unit was ~$340, ~30% of Carvana’s unit cost.
We can also get a sense of CVNA's scalability from an old 8-K disclosure that shows the EBITDA per unit in Atlanta, CVNA’s oldest market.
In 2018, when CVNA had ~2% market share in Atlanta, the company generated $1,288 in contribution profit and $478 EBITDA per unit. The $810 difference in fixed costs includes inbound transportation, out-of-market advertising, and all other corporate expenses. If we take IR's estimate of inbound transportation costs at $200, this leaves $610 for advertising and other costs per unit in mature markets.
In 2021, CVNA reported $1,573 of other costs per unit and $1,127 of ad cost per unit across all markets. If half of the $610 of Atlanta’s 2018 fixed cost is out-of-market advertising, the improvement in CAC as markets mature will explain a large part of the $750 in cost savings that CVNA estimates from the ADESA acquisition.
Either way, this disclosure is helpful to back out the potential profitability of CVNA at scale. Last quarter, the company reported Atlanta is growing 50% at 3.5% market share so we can expect the numbers to be even better today.
If CVNA wants to sell 3m vehicles in the future, they first need to source 3m vehicles. This is the second reason the acquisition is interesting; ADESA potentially gives CVNA access to 1m vehicles per year.
However, the reason CVNA ‘potentially’ gets access to inventory is because it’s unclear how buyers and sellers in the wholesale market will react to the fact a retailer now owns ADESA.
ADESA transacts ~1m cars per year with a 50/50 split between dealer consignment and fleet inventory (off-lease, rental, repo, etc).
The first question is why would any dealer sell or buy vehicles through ADESA if CVNA now owns the auction? Dealer inventory is typically lower quality which is less attractive to CVNA but the demand is important to make the auction competitive and drive conversion.
Maybe small independent dealers don’t care too much but it’s unlikely CarMax will purchase through ADESA. This means ADESA is likely to lose the largest source of demand in the wholesale market. This will reduce conversion and could make ADESA less attractive than ACV or Manheim.
Access to fleet inventory is more important than dealer inventory to CVNA because it’s typically higher-quality off-lease or rental vehicles. As a car rolls off a lease, it’s offered to the franchise dealer first who has the choice to retail the vehicle. If the car doesn’t fit the grounding dealer’s spec, it is sent to auction.
This is where the conflict of interest potentially sets in: if CVNA can now see all vehicles coming to wholesale, it has a huge advantage in acquiring vehicles over other retailers. CVNA can now also leverage years of ADESA's wholesale data to inform their own buying at Manheim and other channels. It’s hard to believe that the industry will allow CVNA to bid, view, or receive data on wholesale inventory and pricing before other licensed dealers.
Would the OEM’s really be happy with off-lease vehicles not running through an independent auction?
But fleet owners and dealers don’t necessarily love physical auctions either. ACV and Backlot have been slowly winning share by providing a cheaper, more efficient, and transparent digital auction than physical players.
What inventory owners, both fleet managers and dealers, do care about most is receiving the highest price for inventory as quickly as possible.
Maybe CVNA can facilitate a completely new transaction by giving fleet owners access to sell directly to retail customers at a higher margin?
Last year, CVNA announced a partnership with Hertz to provide a channel for the rental company to sell rental vehicles directly to retail customers. Historically, Hertz sold vehicles via auctions, direct-to-dealer programs and from 68 Hertz retail locations. This was Ernie explaining the deal in 2021:
as it relates to Hertz, they've got an incredible asset, which is a high-quality flow of vehicles coming directly from manufacturers that have been utilized in their rental fleets and then ultimately make their way into the hands of another consumer. So they've got a really high-quality asset there. And then I think that would be very hard for us to replicate on our own. We would like to think at least that what we've built, which is a really high-quality, highly scalable platform to sell cars to customers, would be very hard for them to build. And so we're natural partners in that way. - Carvana CEO, Q3 21
If CVNA’s ‘high-quality, highly scalable platform to sell cars to customers’ is attractive to Hertz, why couldn’t it be attractive to other institutional fleet owners?
The US franchise dealers certainly wouldn't be happy given used car gross profit is 12-15% of their total gross profit. However, if the OEM's and captive fincos want to get the best price for the vehicle, CVNA is a real possibility in the long run.
As CVNA leverages ADESA’s physical network and continues to aggregate more retail demand, it could bypass the traditional wholesale channel completely and offer fleet managers higher margin sales directly to retail.
Just like Amazon provides the rails to sell general merchandise, or Wayfair for online furnishings, CVNA’s IRC and logistics infrastructure provides the same for any vehicle owner.
This comment from a portfolio manager in our recent investor dialogue highlights the comparison well:
I think Carvana, at scale, is just a natural flow business. What drew me to Carvana is similar to what drew me to Wayfair and Amazon. I look for businesses that have distribution advantages and all of these are companies that position very specific goods, very close to the end customer. I think of it like Akamai, in the physical world. This is a content delivery network of cars; Amazon is a content delivery network of general merchandise and Wayfair is the same for large parcel. The closer you get to the customer, the more you split the nodes, the better the customer service levels, the higher the throughput that the network can handle and you should, naturally, over time, see Carvana’s turns increase a lot. Every 10 days they shave off days to sale, it’s $100 of GPU. - In Practise Investor Dialogue
Like Hertz, fleet owners can maintain ownership of the inventory and pay CVNA a marketplace fee for facilitating the transaction. CVNA can also earn finance and insurance ancillary revenue from the retail customer.
The fact CVNA doesn’t speak too much about accessing inventory and ADESA’s core auction business could suggest management expects to lose a chunk of ADESA volume and that the transaction is more for real estate than auction EBITDA.
If OEM’s and dealers no longer supply ADESA, ACV, Manheim, and Backlot (owned by KAR) will pick up ADESA's volume at a very low cost. Although Manheim will likely win the most share, ACV is in a unique position being the only independent digital downstream wholesale auction platform at scale.
ACV has a great reputation with dealers because it has a unique inspection process and 90%+ of vehicles sold are ‘green-light’ with ACV’s assurance program. This provides peace of mind to dealers buying on ACV.
Maybe ACV is an attractive target for CarMax?
KMX wholesales ~500,000 cars per year at an average selling price of ~$5,000. The auctions are held at 76 CarMax stores and only include KMX-owned inventory. Most wholesale vehicles are older, higher-mileage customer trade-ins that KMX doesn’t have the IRC infrastructure to recondition and sell profitability.
By acquiring ACV, KMX could free up space in stores to turn more retail inventory and use ACV's technology to sell wholesale inventory online at higher GPU.
These are all ideas at this point, but with a nationwide logistics network that can collect and deliver 3m vehicles to 94% of the US population, CVNA is building the most efficient rails of the auto industry. This puts the company in the unique position to help inventory owners monetise wholesale vehicles more effectively than the traditional auction channel itself. We will be following closely to see how the industry reacts.
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