Will You Invest in WeBuyCars? 🚗

The Finance Ghost  thinks WeBuyCars is a success story. Although you can't currently trade directly in the shares, Transaction Capital is poised to give WeBuyCars the opportunity to soar independently. What might be the potential result of that?

Transaction Capital is a sad and sorry state of affairs. After flying high and earning itself genuine “market darling” status, the joy was crushed by huge problems at SA Taxi. The group is now in crisis management mode, with the founders trying hard to salvage what was built. It’s going to be a long, hard slog.

Transcation Capital

As part of this effort to steady the ship and avoid the problems getting any worse, the company is seriously considering an unbundling of WeBuyCars. This would effectively put Transaction Capital’s 74.9% stake directly into the hands of Transaction Capital shareholders. WeBuyCars would be separately listed on the JSE, which means a wonderful market phenomenon will take place: price discovery.

Simply, we will find out whether the market believes as strongly in the WeBuyCars story as Transaction Capital did.

The group paid up for WeBuyCars over the pandemic period based on strong growth assumptions. With the used car market having cooled off considerably in the past year, this probably isn’t the best time to be talking about an unbundling. Without the crisis at SA Taxi, these conversations certainly wouldn’t be taking place.

Of course, imperfect timing means the potential for volatility, which is when your ears should prick up as an investor. Will there be an opportunity here?

Carving out a slice of the value chain
WeBuyCars is a success story because the group managed to take advantage of a situation that was crying out for disruption.

Do you remember seeing adverts along the lines of “URGENT SALE due to emigration: 1.4 Polo”? There were all over websites like Gumtree. But when last did you see one of those?

For far too long, used car dealerships could make ridiculously cheeky offers to sellers of vehicles who weren’t finding any joy in the private market. WeBuyCars changed that game, putting an effective price floor in the market for almost every type of car. In the same way that a market maker ensures that a stock has liquidity, WeBuyCars created a liquid market for just about any model you can think of.

The days of having to sell a car way below market value in a desperate sale are behind us. The winner? Consumers of course, along with WeBuyCars itself. The losers? Traditional used car dealerships who have had a slice of the pie taken by WeBuyCars.

One thing we know for sure is that there’s a need in the market for this business model. If there wasn’t, WeBuyCars wouldn’t have sold 141,851 vehicles in 2023 – a number that grew 13% year-on-year.

It’s worth highlighting that the vehicles are bought almost exclusively from private sellers. To make that easier, there are 69 “buying pods” in addition to the 15 vehicle supermarkets. It’s a simple, yet highly effective business model that achieves significant throughput of vehicles.

The WeBuyCars name says it all, really.

What about selling the cars?
WeBuyCars achieved core earnings of R658 million in FY23, down 14% from R762 million in the prior year. Importantly, the second half was much better than the first half of the year. Earnings fell 4% in H2 vs. a drop of 21% in H1 – and this was despite no branch expansion in the second half of the year.

This cooling off in performance brings us to some of the important risks in this story.

The used car market can be a cyclical beast, impacted by everything from interest rates through to supply chain impacts on new car availability. To be fair, we’ve seen a far more violent version of this cycle than usual in the post-pandemic era. The supply chain problems caused by COVID were unprecedented, driving wild swings in car values and particularly unsustainable increases in used car prices. This was good news for a car supermarket sitting on tons of stock, giving WeBuyCars a taste of what it must feel like to own a nursery where the inventory is growing in value every day – literally!

But when prices drop faster than normal as a cycle normalises, it becomes bad news for that same car supermarket. Suddenly, that room full of shiny metal is quickly becoming a headache.

Aside from the cyclical risks, there’s the broader structural challenge of South African consumer affordability. Although this pushes consumers towards used rather than new vehicles (which is good for WeBuyCars), it also has a negative impact on the ability of this group to sell more upmarket vehicles. You make a lot more by selling a R1 million car than a R100,000 car, especially as they take up the same amount of space on the floor. WeBuyCars has had to pivot the business away from the more premium stuff towards cheaper cars.

We also can’t ignore the reputations and quality risks associated with the business. Much as they work hard to make sure there’s a Dekra report that gives buyers transparency, I can also tell you that many people in my petrolhead circles see WeBuyCars as a place to go dump a car that has something wrong with it. This is the ugly side of building a brand around being willing to buy just about anything.

Still, the Dekra-supported approach seems to work, as sales to consumers more than offset the decrease in sales to dealers in FY23. People are willing to take risks at the right price.

This brings us neatly to the opportunities in this business. The good news is that there are many of them.

Revving up for success
Leaving aside the year of correction that was FY23, there’s zero debate around whether the business has proven its resonance with consumers. The brand exploded from relative obscurity and is now a household name in South Africa. That’s not easy to achieve.

By winning the trust of consumers as buyers of cars and not just sellers, WeBuyCars can significantly increase its penetration of finance and insurance (called F&I in the industry) products. This allows WeBuyCars to take yet another slice of the value chain traditionally enjoyed by used car dealers. In other words: the margin per vehicle sold can improve from here.

Will demand for used vehicles continue to be strong? Well, mobility is literally the lifeblood of economic progress in South Africa, as the public transport system is a joke and many career opportunities require private transport. This makes the purchase of a car a priority for upwardly mobile South Africans. With new car affordability becoming increasingly difficult, that’s good for WeBuyCars.

There are other elements of the business model that I like. For example, new car dealers are often pressured into buying stock from global manufacturers even when existing stock hasn’t been sold, leading to discounting on a product that already has poor margins. In contrast, WeBuyCars has absolute control over what it buys from consumers. Although I believe it would hurt the brand if they start becoming too picky, there’s clearly more room for flexibility in this business model than at your local BMW dealer.

What’s it worth?
WeBuyCars has a different business model to other automotive groups on the local market. It’s probably too simplistic an approach to take those earnings multiples and apply them to recent results at WeBuyCars.

Instead, we can consider the way in which WeBuyCars generates a return on capital and what investors might be willing to pay for that. To do this, we need to find the return on equity percentage. A search in the integrated report for the year ended September 2023 reveals this table:

It gives us everything we need, showing that WeBuyCars achieved a 21.2% return on equity. That’s a really strong result, well ahead of many other businesses in South Africa. The table also tells us that the total equity was R3.6 billion.

Now, if investors demand a 21.2% return from a business like WeBuyCars, then they would be willing to pay a price/book of 1x. In other words, the market cap would be R3.6 billion.

If they were happy to only receive 15%, then they would be willing to pay a premium to book value. We can calculate this by implying what the price would be in order for R21.20 (the return on equity expressed as a rand return on a R100 investment) to be a 15% return instead of a 21.20% return.

The calculation is: R21.20 / 15% = R141.33.

In other words, an investor could pay a price/book of 1.4133x for WeBuyCars and get a 15% return. This would put the market cap on nearly R5.1 billion.

My gut feel is that the market will look for an effective return on equity of around 18%, so it will be willing to pay a price/book of around 1.2x. This would put the market cap on somewhere around R4.3 billion.

If the unbundling is to go ahead, then much more disclosure will need to be made around the business and the financials. This will help the market make a more accurate assessment of just not the value, but also the strategic opportunities and risks in the business.

Transcation Capital

The best thing possible for the unbundling would be a strong set of 2024 numbers, so keep an eye out for further Transaction Capital updates that include any commentary on the performance at WeBuyCars. If the unbundling is forced to take place after a disappointing set of numbers is released, then brace yourself for the price discovery process to be violent.

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