Cazoo SPAC Debut & Carvana: A Market Analysis

Cazoo's U.S. Listing Plans and Market Conditions

The announcement regarding Cazoo, a U.K.-based pre-owned vehicle retailer, planning to become publicly listed in the United States through a Special Purpose Acquisition Company (SPAC) isn't unexpected.

The recent surge in SPAC activity has resulted in numerous American blank-check firms actively seeking investment opportunities, extending their search beyond national boundaries.

Precedent and Potential

Beyond this general trend, the Cazoo deal aligns with existing market dynamics. The valuation of Carvana, a comparable U.S. company, has significantly increased following its initial public offering in 2017.

Carvana’s demonstrated ability to enhance its gross margins provides a model for Cazoo’s anticipated improvements in financial performance over time.

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Market Uncertainty

However, Cazoo’s announcement coincides with growing concerns in the public market, suggesting a potential decrease in investor risk tolerance.

Recent lackluster initial performances of several Chinese companies, coupled with downward pressure on the public offering of Deliveroo, a food delivery service, highlight this trend.

Shifting Investor Sentiment

Is the public market’s appetite for technology IPOs diminishing? A slowdown would negatively impact companies pursuing SPAC-led public listings.

Firms such as Latch, which finalized their SPAC mergers during a more favorable market period, could face challenges in a risk-averse investment climate.

Analyzing the Situation

Let's briefly examine the Cazoo investor presentation and then consider what current market indicators reveal about investor interest in higher-risk stocks.

Understanding these factors is crucial for assessing the potential success of Cazoo’s planned U.S. listing.

Cazoo

Observing the recent news concerning both Cazoo and Deliveroo, one is prompted to consider whether there exists a uniquely British tendency for companies with names concluding in "-oo" to experience difficulties. Your thoughts on this are welcome.

Irrespective of that observation, the investor presentation for Cazoo’s SPAC transaction is now available. Those interested may wish to review it; we will begin our analysis on page 33, where the company’s 2020 performance is detailed alongside projections for subsequent periods.

Several key assumptions underpin these forecasts, notably consistent improvements in gross margin, robust revenue expansion, and a reduction in operating expenses as a proportion of revenue. Essentially, should the company achieve positive outcomes across all profitability metrics over the coming years, it anticipates ceasing cash burn by 2024 – coinciding with the attainment of adjusted profitability and operating margin breakeven.

The company has ambitious growth strategies, encompassing expansion within Europe, the development of financial products, and an increase in subscription-based car sales. Cazoo also plans to enhance gross margins through increased sales of higher-margin financing options and streamlining its vehicle sales process. Furthermore, anticipated reductions in customer acquisition costs, driven by increased online ordering, contribute to the company’s overall strategy.

However, is this strategy viable? To a degree, yes. Carvana, a comparable American company, presented the following charts in its Q4 2020 report:

Like Cazoo, Carvana directly sells vehicles to consumers and delivers them to their homes. The chart on the left demonstrates the American firm’s consistent progress in improving gross profit per vehicle, which translates to overall gross margin gains.

The chart on the right illustrates the company’s aggregate adjusted and GAAP profit margins, which improve in line with gross profit performance, as one would expect. Carvana’s experience demonstrates the potential to increase gross margins in used car sales and subsequently reduce corporate losses over time, at least within the American market.

Currently, Carvana’s market capitalization stands at $44.2 billion. Its shares reached a low of $22.16 in mid-March 2020 during the COVID-19 market downturn. As of today, the share price is $255.68. Based on its Q4 2020 revenue, Carvana’s annualized revenue is $7.30 billion, resulting in a valuation multiple of just over 6x.

How does Cazoo compare? The company reported £162 million in sales for 2020, equivalent to $223.2 million at current exchange rates. With an anticipated market value of $8.1 billion (an enterprise valuation of $7 billion), its pricing is approximately 36x sales.

The question arises: Why would investors assign such a high valuation to Cazoo, given Carvana’s superior profitability? The primary justification centers on growth potential.

Considering Cazoo’s revenue forecasts for 2022, and utilizing its enterprise value rather than its expected equity valuation (as the former is a smaller figure), the valuation appears somewhat less extreme:

Interesting.

Our detailed analysis has allowed us to assess the pricing of the Cazoo deal. We can conclude that the valuation appears ambitious. This isn’t necessarily a negative aspect, but it does illuminate the company’s expectations regarding market valuation upon deal completion.

When is this completion expected? According to the company’s announcement: “The transaction is expected to close in the third quarter of 2021.”

Indeed.

It’s important to remember that the announcement of a SPAC deal does not signify its finalization. These releases are more akin to engagement announcements. The actual merger occurs later, followed by the combined entity’s operational life. Cazoo’s investors anticipate that market enthusiasm for growth-oriented stocks will remain strong in Q3 2021, ensuring that its optimistic revenue projections are considered credible and justify the anticipated valuation when trading commences.

Recent Market Corrections

Over the past several days, several high-profile companies have experienced setbacks. Deliveroo was compelled to reduce its initial public offering (IPO) price, while BiliBili’s Hong Kong stock market entry underperformed expectations.

Furthermore, Zhihu experienced a significant drop in its stock price upon its debut, opening 15.3% below the IPO price, as reported by MarketWatch. This occurred despite the IPO already being priced at the lower end of its projected range.

Software sector stocks have also seen declines from their recent peaks. The Bessemer Cloud Index has fallen by over 20%, officially entering a technical bear market.

A considerable number of Special Purpose Acquisition Companies (SPACs) are currently trading below their initial value. Even Bitcoin has ceased its upward trajectory.

The question arises: can the market sustain the optimistic valuations embedded in the pricing of numerous SPAC-driven initial public offerings? The answer remains uncertain.

However, a substantial volume of speculative investments are currently being made that warrant careful consideration.

Concerns Regarding Market Optimism

The recent performance of these companies and assets suggests a potential shift in investor sentiment. A degree of caution is advisable given the current market conditions.

It is important to note that these are complex financial instruments and their performance can be influenced by a variety of factors.

• Deliveroo’s IPO price reduction signals investor hesitancy.
• BiliBili and Zhihu’s disappointing debuts highlight risks in the Chinese market.
• The Bessemer Cloud Index’s bear market status indicates broader software sector weakness.
• Underwater SPACs demonstrate the potential for significant losses.

These developments collectively raise questions about the sustainability of the prevailing market optimism.