Here’s Why You Should Dump Vroom Stock Before the IPO Hype Fades

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Vroom (NASDAQ:VRM), a New York-based used car retailer that enables consumers to buy, sell and finance cars online. Early indicators already show a little volatility in Vroom stock, but the company seems to be bucking the current economic pessimism and trying to convince investors to get behind its business.

Source: Lori Butcher / Shutterstock.com

How else do you explain holding an initial public offering (IPO) on June 9 of this year as all indicators pointed to an American economy that has fallen into a deep recession due to the Covid-19 pandemic?

While VRM stock had a great debut, rising 118% and more than doubling to $47.90 a share on its first day of trading, there are plenty of reasons for investors to be skeptical of the company, as well as the market for buying and selling used cars over the Internet.

With the U.S. economy in the midst of the worst downturn since The Great Depression, is now the time for investors to place a bet on used cars?

A Closer Look at Vroom Stock

Buying shares in Vroom is an extreme act of faith. The company has never been profitable since it began in 2013, has racked up mounting debt and is not close to being able to provide a dividend to shareholders.

These facts have not dampened investors’ enthusiasm for VRM stock judging by its market debut. Poor fundamentals also haven’t dissuaded celebrity investors such as Microsoft (NASDAQ:MSFT) founder Bill Gates and former NFL quarterback John Elway from putting money into the company.

Vroom managed to raise over $440 million in Venture Capital and Private Equity funding prior to its IPO. The stock is now trading just below its IPO close at $47.69 a share.

Perhaps investors are attracted to the fact that Vroom is run by former Priceline.com Chief Executive Officer Paul Hennessy, or that Vroom’s business model is similar to online vehicle broker Carvana (NYSE:CVNA), which has seen its stock rise 775% since it went public in 2017.

Regardless of the reasons, the company’s fundamentals and the current economic environment make Vroom stock a risky investment. Even if you’re willing to look past the company’s 2019 net loss of $143 million, VRM stock still has significant downside risk that should be carefully weighed.

The Global Pandemic and Vroom Stock

Vroom is hoping to capitalize on the Covid-19 pandemic and betting that growing numbers of cash strapped consumers will buy a used car online amidst the current lockdown measures that have closed car dealerships and led more than 40 million people to file for unemployment insurance since February.

Vroom’s growth seems to indicate that this strategy is a sound one, with the company’s vehicle sales more than doubling to 7,930 in the first quarter of this year compared to 3,187 vehicles sold in the first three months of 2019.

However, overall motor vehicle sales (new and used combined) have fallen steeply since the pandemic reached American shores and were down 33% in May compared to a year earlier. Numerous surveys show American consumers are prioritizing saving over spending on big ticket items that include vehicles, a trend that could intensify if Covid-19’s resurgence continues to accelerate across the U.S.

While Vroom has seen an uptick in its online sales during the pandemic, there’s no guarantee that the trend will continue after a vaccine for the disease is developed and car dealerships fully reopen and offer numerous incentives to drive foot traffic. Industry data shows that car sales have been slow to move online compared to other retail categories.

A survey by eMarketer found that online sales account for just 4.2% of all car sales in the U.S. With other products such as music and books, half of all sales are now done through the Internet. When it comes to car sales, consumers prefer to kick the tires before making a purchase.

For its part, Vroom has said that it will not turn a profit until it sells at least 200,000 vehicles online annually. The company has a long way to go when you consider that it sold less than 20,000 vehicles last year (18,945 to be precise).

Not Quite Like Carvana

Investors hoping Vroom stock will takeoff as CVNA stock has are ignoring some important differences between the two companies.

While both companies provide a streamlined process for used car transactions online, they differ in that Carvana owns its reconditioning centers as well as the logistics network that brings cars to and from customers. Carvana had $543.5 million in property and equipment at the end of 2019, and the company generated $3.4 billion in revenue.

By contrast, Vroom only owns one of its vehicle reconditioning centers. At the end of 2019, Vroom had just $7.8 million worth of property and equipment and generated $1.2 billion in revenue — about one-third of Carvana’s revenue.

Also, Vroom outsources financing for car buyers to partner banks and lenders, while Carvana provides the loans itself and then turns around and sells those loans to financing partners.

Analysts have criticized Vroom’s approach, noting that the company may lose the potential to generate profits from the parts of its business that it outsources. While Vroom does have a similar business model to Carvana, the companies are far from identical.

The Bottom Line on VRM Stock

With the U.S. economy in recession and Americans holding cash for the time being, now is not the time to be investing in an unprofitable company that sells used cars exclusively online.

While Vroom’s sales may have risen in recent months, the vast majority of Americans still prefer to buy a vehicle (new or used) in-person. Jumping on the Vroom bandwagon in hopes that the stock will replicate the performance of Carvana would be like throwing a handful of dollar bills at a speeding car as it passes you on the street.

As of this writing, Joel Baglole held shares of MSFT stock.