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The £1.75 billion company that could go to zero - a major report from Tom Winnifrith

By Tom Winnifrith | Thursday 12 October 2017


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.


The red flags are obvious. The business model is one that could blow up with the asset bubble that has created it. Even in a best case scenario the valuation is absurd. Oh and Neil Woodford is a major investor. Need I say more. After Purplebricks (PURP) which is a nailed down zero, this is my number 1 short for the Autumn.

Lets start with a bit of macroeconomics and a few charts. The first shows that the economic growth of the past few years has been driven by consumer spending but that this is not spending financed by a rise in real incomes. So how have we all embarked on an unprecedented spendathon.


Savings as % of disposable income


Chart two gives you a hint. Quite simply a nation of savers have run down their savings to levels not sen in modern history. That fall in savings is not sustainable, all bar the most prudent have spent it all. And sooner or later as interest rates start to rise and folks also start to see job losses they will realise that having some savings is a good thing. At best savings cannot be consumed much more since they are now at such a low level. At worst folks will actually save more meaning that there is even less consumption.

 

Re: Credit Suisse 



The other side of the coin is in charts three and four - personal debt. Chart three shows UK household debt at well above the levels of 2007 and we all know what happened next. Chart four shows the amount of unsecured (i.e. expensive) debt. Part of its surge to record levels is student loans but £300 billion equates to c £10,000 for every working adult. Interest rates on this will be c £1500 pa for every working adult. This is clearly not sustainable let alone repayable.

 

UK household debt to GDP is well above that seen in 2007

Ref:tradingeconomics.com,BankforInternational Settlements

 

 

Ref:PWC,BankofEngland


One particular type of debt that has soared to record levels is car finance as you can see in chart five. According to the Finance & Lease Association (FLA) in 2006 in the UK around 45% of cars were purchased with finance. That has now risen to more than 76% (excluding non FLA members) , a trend reflected in the massive growth in financing volumes and values.


So how does car finance work? Welcome to Personal Contract Purchases (PCPs). This is pure credit bubble stuff as the graphic below demonstrates. In essence the customer can walk away from the contract at the end of the term or just roll it on into another PCP for a new motor. The primary issuers of PCPs in the UK are subsidiaries of the car manufacturers. In the UK, according to the FT so it must be correct, non banks account for £34 billion of the £58 billion annual car finance market. So in essence car manufacturers are lending money to customers to buy their cars but, critically, retaining all the asset price risk.

 

1. Customer pays deposit and monthly payment for a new car

2. Monthly payment covers APR and depreciation over ~3 year period

3. Final payment allowsthe consumer to buy thecar or roll any equity into the next deal

 

 



Who wins from this craziness?

In order to drive PCP sales, issuers of this high risk finance must share the spoils with intermediaries such as car dealerships and finance companies. There are big incentives to push this junk debt and some have grown rich on the back of it.

Chart six shows the operating metrics of CarFinance247 Limited. Founded by Reg & Louis Rix it bought Carcraft.co.uk from the administrators in 2015. All cars on its site are sold in terms of £/month deals - i.e PCP finance. Sales grew by 260% in 2015 and 150% in 2016 and its estimated that it has arranged £300-500 million of loans.

 



Chart seven shows the metrics of Zuto Limited (formerly Car Loan 4U Ltd) a market leader in auto finance and a company that describes itself as a "credit broker not a lender" offering a headline rate of "8.9% APR on a £10,000 loan with excellent credit" but caveating that with "20.1% APR representitive." The company works by matching finance to your car pick, it gives the punter a quote, the mug goes to find a car. It is "preferred partner" of Auto Trader. The key point here is to note the massive disparity between 8.9% and the representitive rate of 20.1%. That tells you everything about the typical credit rating of Zuto's customers. It is dire.



Charts eight and nine show the metrics of Car Shops Limited, the "Number 1 UK Car supermarket" with outlets in Cardiff, Doncaster, Northampton, Norwich and Swindon selling 20,000 cars a year. The recent OM recovery coincides with increased focus on high margin financing but sadly for Car Shops it has also coincided with a massive increase in their stock levels ( chart nine) which suggests that if there is a sharp downturn as macroeconomics dictates there will be - they may well go belly up. Discussions with an industry insider indicate that the (my bolding as this is critical) credit cycle has now extended to much lower quality vehicles on hire purchase and credit card like interest rates. Car Shop is known as a leader in hire purchase.

 

 



So let's drill down to how they operate. Here is a car for sale on Car Shop. A 1.3 litre CDTi Corsa with 48,000 miles on the clock made in 2008 which you can snap up for £3225 or £71 a month. Bargain! Lovely Jubbly., That is an APR of 14.9%.

 


But hang on. Remember that Zuto was headlining 8.9% APR but its typical loan was at 20.1%. The 14.9% APR Car Shop advertises is for an "excellent credit rating". If you are the sort of person who wants to buy this sort of motor and cannot afford £3,225 up front I suggest your credit rating will not be excellent and so your APR will be much higher. But it gets worse. Is the car really worth £3,225? Er no....

A search on Auto Trader for the same make and model built between 2007 and 2009 and with 40,000 to 50,000 miles on the clock shows a stack of motors fitting the bill on offer with a full service history and 12 months MOT for £2,500! So that means the APR offered by Car Shop is distorted, you are borrowing £3250 to buy a motor worth only £2500 and the guy who is ripping you off also gets a kicker for arranging uber-expensive finance. No wonder car dealers are almost as poorly trusted as journalists.

 


On a 60 month hire purchase you will thus end up paying £2000 of interest on an asset really worth £2500 which is an APR of way over 20% ( not 14.9%) and that is assuming that you are offered the 14.9% deal which most punters are not. One can see why Car Shop is profitable but is that sustainable....

What we are seeing here is a massive credit bubble which can only exist by ripping off poor customers and by the willingness of the customers to exhaust their savings and take on more debt. By definition that is not sustainable.
When does the bubble collapse? Well the end of the diesel show is starting that process - this will impact car dealers directly as they see residual values fall off a cliff. Accelerating demand for electric and hybrid cars is also impacting on residual values of petrol cars in a direct way. The macro picture on debt and savings will be a killer as interest rates start to rise, possibly as soon as next month. Finally the FLA says that there is now some evidence of market saturation (we have all the cars we need!) with a declining growth in financing. That is demonstrated in charts ten and eleven.

 

AutoTrader provides evidence of this from its subsidiary Glassbusiness.co.uk. In March of this year its director of valuations noted:

"Looking forward one must expect that where 2016 was the largest market for new cars in many years, the residual value of these units coming back as used vehicles in 3 years is likely to be markedly lower than experienced in recent times. Even the increase in retail demand from the growing number of drivers on the road will not accommodate the wave of new cars due to come back to the market.

In summary the market is beginning to shift in both new and used car terms. A level of uncertainty is weaving itself into the trade driven by the changing shape of the economy which has undoubtedly been a result of Brexit. These changes are manageable and there is no need for any form of panic but there is a requirement for development of robust strategies to take the industry into a more turbulent phase."

Since Auto Trader's clients rely on healthy market conditions you would expect it to understate problems and also blame Brexit in order to avoid accepting the existence of an unsustainable asset bubble.

So who will suffer when the bubble implodes? And how can we prosper as shorters of shares. Sadly there are no liquid used car dealerships and no pure financing intermediaries on the stockmarket although Zeus Capital likes floating train-wrecks so perhaps it might remedy that. Car makers are already on single digit PEs and while some may go bust the bad news looks largely discounted. Anyhow the UK credit bubble is only one of their problems.

Auto Trader (AUTO) is listed and as THE online market place for used cars and as a company clearly exposed to car volumes and values ( which will fall) and to the advertising budgets of the car makers it is, at 366p, a stock which is not one to own. But it is not THE BIG SHORT!

Sell BCA MarketPlace (BCA) at 223.5p - target 100p (bull case) 0p (bear case)

BCA is the largst auction house for used cars in Europe and the owner of WSeBuyAnyCar.com. It is geared up and massively exposed to used c ar sales and volumes. Neil "nomates" Woodford is a major backer and that is only one of the many red flags.

The market cap is £1.75 billion. Net debt is £320 million. The forward PE is a stonking 23.8 and the EV/EBITDA multiple is a scary 21.7. Such multiples are pricing in perfection but as we have seen above there is a massive storm brewing. With operating margins of 3.7% clearly going to suffer real pressure this is the big short. The question is not whether profits and the share price collapse but by how much.

Charts twelve and thirteen show how ( for now) BCA makes its money.

 



So what are the red flags?

Number one is the way it floated and who floated it. After a number of years of ownership in the hands of PE firm, Clayton, Dubilier & Rice, the company attempted to IPO in 2014, shortly after the acquisition of WeBuyAnyCar.com. The IPO failed as the company was priced too highly – Cenkos, who brokered the deal, argued for a high growth technology multiple.


In December 2014, Haversham Holdings Plc was listed on AIM as a cash shell, raising £30 million at £1.15 a share with the intentions of making acquisitions in the automotive sector –The admission document contains no mentions of BCA Marketplace. In April 2015, Haversham acquired BCA Marketplace by means of a reverse takeover alongside a £ 1 billion equity raise: £711 million of cash was used to buy the equity. £294 million was used to repay a portion of the debt. £160 million of new debt was used to repay the other outstanding debt of BCA. £23 million went yto City brokers and advisers, mainly Cenkos, for expenses and commissions. Coke & hookers all round. Job well done. An IPO achieved albeit by route 2.

This deal was brokered by Cenkos, a small cap broker also known for:

  • AA Plc: Down 20% from listing, facing a governance crisis, too much debt and declining revenues, rising short interest. 
  • Quindell: Cenkos was fined £500,000 for their part in this fraud.
  • Avanti Communications :The over-geared satellite operator with little hope of repaying its debt mountain and one of our great shorts of the past three years. The FRC has forced Avanti to restate statements.
  • Rosslyn Dta - a grossly misleading prospectus signed off by Cenkos has seen punters lose 80% on this dog which has missed all its targets.


The list of Cenkos dogs goes on and on. A back door listing by Lagos Securities is a red flag.

Red Flag 2 - Vehicle Remarketing

Operating from 52 centres across Europe (primarily leased), with the majority in the UK, it handles around 1.3 million vehicle sales a year. In the UK, vehicle exchanges handle c20% of used vehicle sales, but this figure is growing:
PCPs mean that used vehicles are increasingly being sold by corporates who are much more likely to sell through an exchange. Vehicle Buying services (WeBuyAnyCar) are growing rapidly, and they tend also to sell through exchanges.

Red Flag: BCA has been changing its business model to drive growth:

  1. It has started a new programme which it calls "Outsourced Remarketing Contracts", which involves BCA taking title of the car – This came through in a near tripling of its inventories
  2. It has been aggressively growing its BCA Partner Finance service, which sees it lend money to its customers on 120 day loans, and the loan book has doubled to £113 million during the past 12 months – It borrows money to fund this.
  3. Both of the above practices increase the exposure of BCA to any downturn, by increasing the potential for bad debts and exposing the company to declining asset values.

The bottom line: BCA's core business is being made increasingly risky through aggressive business practices.

Red Flag 3 - We Buy Any Car

Founded in 2006 by the McKee brothers, Darren and Noel. The McKee brothers used to own Carcraft, which they sold through an Apollo backed MBO in 2014, just before it went bust. WBAC simply extracts a profit by taking on price risk of used cars which it sells through the auction houses/exchanges. Used car prices have been rising thanks to the PCP bubble. WBAC has been an extraordinary success. This is demonstrated in chart fourteen below.

 

The growth model is reliant on WBAC being able to buy cars and so, without access to a liquid market into which the stock can be sold, their balance sheet will very quickly be taken up with stock. Selling the business to BCA Marketplace ensured they had preferential access to the largest used car market in Europe. A return to 2013 inventory levels, as a proportion of sales, would equate to £60 million of inventory as you can see in chart fifteen.

Conclusion: This is high growth (for now) but low margin and adds yet more balance sheet risk.

Red Flag 4 - The Balance Sheet

With £320 million of net debt on an adjusted EBITDA of £135 million, the company does not look over-geared, but there are a number of problems with this analysis:

  1. The company leases its properties with no break clauses until 2031. 1.This equates to £37 million a year on rent, rising at 3% per annum. These onerous clauses were put in place by the PE firm (CD&R) before it sold it. Adding these to the balance sheet in their full scale would double the apparent debt burden. 
     
  2. Although the company reported £135 million of Adjusted. EBITDA for the year to April 2017, its cash generation was poor: Cash flows from operations were £138 million, but this included an £85 million increase in payables - adjusting for this would see OCF crater. Free Cash Flow was negligible.
     
  3. The business model is increasingly exposed to the value of used cars. WeBuyAnyCar.com and Vehicle Remarketing are increasingly using the company's own balance sheet – I estimate 30 days of inventory could use up £120 million of cash. 
     
  4. The company's customers are used car dealerships, and then the public, both of which have growing balance sheet problems In 2014, BCA started lending money to their customers to help drive sales - £113 million of loans and growing rapidly
     
  5. BCA has made a statement of intent to borrow more money – it now has £500 million of debt available, with £375 million drawn and continues to make acquisitions. Giving this company more debt is like handing out more rope to a fellow on suicide watch. It will not end well.


Conclusion: This is an increasingly risky business model with a rapidly deteriorating balance sheet.

Red Flag 5 - Insiders are selling

  • Clayton, Dubillier & Rice - SELLERS at the IPO. The PE firm owned the business for many years, investing heavily and expanding it across Europe. That experience probably gave it good insight on when to sell. 
     
  • McKee Brothers -SELLERS: The founders of WeBuyAnyCar.com and previous owners of Carcraft. Started by their father, Carcraft became one of the largest car dealers in the UK and went bust the year after they sold: These guys know the industry.They are not listed as significant shareholders of BCA
     
  • SMA Vehicle Remarketing, Paragon Automotive, Ambrosetti -SELLERS: Various insider groups have been selling their businesses to BCA for cash at multiples of 5 to 12x EBITDA, versus the BCA multiple of nearly 20x...
     
  • But.. the Board are buyers.
     
  • The Exec Chairman -She ran an autos logistics company, delivering new cars into the value chain, but has no track record in used cars. Although she has been purchasing stock, she received a £7 million bonus in 2016 for getting the company listed so really it is just reinvesting a bit of her obscene winnings. It is the least she could do. NEDS – these are all asset management guys, or from unrelated industries (oil and gas, for instance!). Although the Board has been buying, they are not industry experts.


Who is right?

BCA - The Summary

The autos sector faces long term headwinds globally owing to the emergence of automated cars.Meanwhile ICE cars will face declining demand in the short to medium term as consumers and regulators favour EVs and hybrids. The car companies have been stuffing the channels with ICE cars to extract as much value as they can from this fading technology, by incentivising innovative new financing packages(PCPs).


The UK market has been a centre for this credit bubble and is showing signs of maturing,with declining volumes. BCA Marketplace has benefited from the boom in used car sales but has become highly exposed through aggressive business practices and a process of acquisition.

Red Flags:

  1. A backdoor listing onto the AIM Casino, led by a broker, Lagos Secs, with a patchy record. And patchy is being generous to Lagos.
     
  2. Aggressive practices in the company's core business line which increase its reliance on market liquidity and pricing. The acquisition of WeBuyAnyCar.com further exposes the company to market liquidity and pricing
     
  3. A balance sheet which is much worse than a cursory glance would suggest and is deteriorating
     
  4. Insiders are selling assets and the Board is inexperienced in the sector.
     
  5. Neil Woodford is a major shareholder. Not only is this a bad sign in itself given the "nomates" kiss of death but as his funds come under firther pressure from redemptions this is one of his positions which is liquid enough to dump. Woodford may well be a forced seller. 

So what is the company worth?

It is quite possible that if the marco headwinds are especially hostile BCA might ultimately face financial distress.
A correction in the used car market could see the value of sales through the exchanges decline by 20%, which could wipe out BCA's profits altogether given their high degree of operating leverage.

A slow down in the exchanges would quickly lead to the company's inventory rising, necessitating a sharp cut in the prices it pays (which would exacerbate the problems hitting the exchange) or simply a cessation of new purchases, advertising the company's problems to the market.

The leases, which equate to over £600 million of future liabilities, would come into focus in the context of the company's balance sheet.

Because the company is such a major player in the market for used cars, any indications of financial distress could be self-fulfilling, causing prices to tumble.

With £320 million of net debt, this scenario could see the equity go to zero.

Assuming no contraction in earnings,but simply a no growth scenario,the current growth multiple would be unjustifiable and a derate would be inevitable. Perhaps fair value would be c 10 xEV/EBITDA, or around 60% below the current price.

On a trailing basis, it is trading on well over 20x EV/EBITDA This is in the context of no free cash flow and a deteriorating balance sheet which is clearly crackers. The market has given it a growth multiple because of historic growth, but the future is different

Under the second scenario the derating would see the shares head back towards 100p. On scenario one the target is 0p. Either way, at 223.75p offer this is a stand out sell and for Autumn 2017 our big short!


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