July 8, 2019
Auto Trader is the UK’s dominant online used car marketplace, connecting consumers with 13,000+ used car retailers as well as manufacturers and direct consumer to consumer sales. The business employs a subscription-based business model, with retailers paying monthly subscriptions to list vehicles on the website.
Auto Trader embodies many of the quality characteristics Fairlight is searching for; recurring revenues, excellent cash flow conversion and strong organic growth. Although quality is paramount when assessing businesses, Fairlight is not willing to pay any price for quality. Instead we look for underappreciated quality, opportunities where the market may misunderstand the competitive advantages of the business or be paying undue attention to certain risks our analysis indicates are overstated. One avenue to finding underappreciated quality is in industries the market has pigeonholed as ‘no-growth’ or structurally challenged. Auto Trader is a high-quality business operating in a challenged industry facing Brexit-related headwinds, however it has several levers at its disposal to generate growth despite being in a ‘no-growth’ industry:
“Great companies in cold, non-growth industries are consistent big winners.” – Peter Lynch’s Golden Rules for Investing
Dominant market position in a profitable niche
Auto Trader has an unusual history for an online classifieds business, beginning as a magazine in 1977, it successfully transitioned from print to purely online in 2013. This long history and first mover advantage have created an incredibly strong brand and a dominant market position. Today, Auto Trader is the number one ‘most trusted’ automotive brand, boasts 93% brand recognition amongst UK consumers and captures 75% of all automotive-related online minutes - 5x more than its next nearest competitor. Pleasingly, this is a competitive moat that will strengthen over time due to its self-reinforcing nature; the largest selection of trusted car stock feeds the best car-buying experience for consumers and thus delivers the largest consumer audience, which in-turn, creates the most effective sales channel for retailers and drives increased stock on the website. And on the flywheel spins.
Auto Trader’s dominant market position and deep competitive advantages result in enviable financial characteristics:
The primary macro factor that drives Auto Trader’s business is the volume of used car transactions. This can be broken down into three key variables:
With two of the three variables currently headwinds, the volume of used car transactions declined in 2017 and 2018 and is expected to decline again in 2019. Despite this, Auto Trader has generated organic revenue growth of 8% p.a over this period.
Multiple growth levers
Underpinning Auto Trader’s ability to grow in a difficult industry is its multiple levers for growth (see Figure 2), two of which are independent of macro factors:
The Fairlight View
When evaluating high quality growth investments, Fairlight seeks to find misunderstood and underappreciated quality. Auto Trader’s proven track record of generating organic growth despite a difficult macroeconomic environment underpins its ability to continue to compound value for shareholders over the long term.