Shift Stock: the clock is ticking. Go bankrupt or go to the moon? (NASDAQ: SFT)


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Shift Q1 2022 Results Review

Despite a difficult macro-economic environment (lower used car prices, higher interest rates), Shift (NASDAQ:SFT) managed to beat revenue and adj. GPU tips, which were $220 million (up 107% YoY) and $1,681, respectively. According to Shift management, used car prices have slowed in recent months, but the supply of new motor vehicles is still very low and, as a result, used car prices are expected to remain high. While I think used car prices can’t stay high any longer, I recently visited a Honda dealership, and field inventory was minimal, and the wait time for an HR-V was 15 days. Therefore, I see a gradual decline in used car prices over the next twelve months, and I believe that a normalized used car market is much more ideal for Shift than a market with a severe shortage of stocks.

Letter to Shift Q1 2022 shareholders

Letter to Shift Q1 2022 shareholders

In the first quarter of 2022, Shift sourced 96% of its e-commerce units directly from consumers and partners (i.e. it still doesn’t buy much from the auction market in wholesale, which the company reported as very expensive in Q3 2021). Looking at some non-financial data, we can see that Shift’s average monthly unique visitors increased to 823,000 (up 16% YoY); however, the average days to sale slowed to 56 days, indicating lower conversion rates despite higher inventory levels. In its plan for 2022, Shift management foresees higher conversion rates as (sales) staff return to the office.

At the end of the first quarter of 2022, Shift had 5,464 vehicles listed for sale on its website, compared to 3,736 vehicles last year. According to Shift management, the first quarter would be the high point of inventory this year, and no new regions are expected to be added this year. Shift’s days of hyper-growth seem numbered as the company aims to limit cash burn and improve profitability; however, Shift is still expected to grow at 50% + CAGR over the next three years.

Shift Q1 2022 Filing 10-Q

Shift Q1 2022 Filing 10-Q

In 2022, we are focused on balancing growth and profitability, which includes driving operational efficiencies, cost savings and improving our liquidity position.

– George Arison, CEO

Shift’s first quarter results were fully in line with our expectations, and the reiteration of guidance for the remainder of 2022 was very reassuring, given the challenging macro environment. For the second quarter, Shift expects revenue of $230 million (in the middle of the forecast range), which means a growth rate of about 48% year-on-year. Although the drastic drop in growth rates may seem frightening, it is the result of difficult compositions and a balanced growth and spending plan by management. For 2022, Shift guide for adj. EBITDA of -13.5%, which would mean a marked improvement in the second half of this year. During the earnings call, Shift management reiterated its confidence in the forecast. In my opinion, cutting adj. A mid-single-digit EBITDA would be a spectacular feat for Shift. If the company can provide those numbers, I think raising capital will be very simple.

Letter to Shift Q1 2022 shareholders

Letter to Shift Q1 2022 shareholders

However, the big question is – “Can Shift avoid bankruptcy in 2022?

Shift is a binary bet

Let’s see what the company is doing to avoid a liquidity crunch in the business over the next six months. We’ve discussed Shift’s cash burn situation extensively (multiple times) over the past three quarters as the company literally went bankrupt (trading roughly at its cash position [liquidation value]). Here’s how I think of liquidation value:

Shift has a liquidation value of approximately $270 million (cash + inventory), of this we remove the $100 million Flooring line of credit, leaving Shift at $170 million in cash. Of these, I remove some current liabilities (~$50) to reach my final liquidation value of $120 million (approx current market cap). The remaining debt of $144 million is convertible debt (very unlikely to be repaid in cash), and this equity dilution is factored into my valuation model.

Source: Cats Beating The Market

In my opinion, the market is essentially offering this business for free, which was built at an astronomical cost of around $500 million over the past decade. In the fourth quarter, Shift announced Softbank as a new equity and debt investor, but there has been nothing since, and the stock has continued to trade lower and lower.

In Q1, Shift used ~$88m of its cash (well, $38m was spent to increase inventory), leaving only ~$107m of cash on its balance sheet (including restricted cash ). Fortunately, Shift’s cash burn is expected to slow significantly over the next three quarters.

Letter to Shift Q1 2022 shareholders

Letter to Shift Q1 2022 shareholders

While investors are getting nervous with Shift’s liquidity stance, management seems pretty relaxed about it. I would like to believe that they are confident in their ability to raise more capital; however, if credit markets freeze, how long will Shift take?

Today, Shift has approximately $107 million in cash, $160 million in inventory, and a $150 million At-The-Market facility (which was set up last week). If management were to completely deplete its balance sheet, Shift still has about $250 million of cash on its balance sheet, and it can raise an additional $150 million by selling shares through the ATM (highly unlikely at these depressed prices ).

Letter to Shift Q1 2022 shareholders

Letter to Shift Q1 2022 shareholders

Dilution risk for Shift is increasing by the day, and management is looking to raise new capital via debt or equity in the coming months, but if nothing materializes, Shift will tap into the $150 million ATM facility. dollars to maintain its liquidity position. However, this would be massively dilutive for existing shareholders.

As we know, the company won’t be able to reach FCF breakeven until 2025. And my calculations show that Shift needs at least $300 million in additional capital to achieve positive free cash flow. We’ll see how this cash burn situation plays out over the coming quarters, but for now, the thesis remains unchanged. Shift is really a binary bet – “If it goes bankrupt, the stock drops to zero. If management succeeds in raising capital (via debt or a stock at a reasonable valuation), the stock could multiply many times over in A few days”.

Fair value and expected return

In my opinion, Shift is a mini-Carvana (minus the hidden dilution and family control) with room for exponential sales growth. Given Shift’s TAM of $840 billion and its 2022 sales forecast of $1.1 billion, Shift’s growth story is just beginning. In the fourth quarter 2021 investor presentation, Shift’s management charted its course to profitability, and I’m confident these numbers could be achieved within the next four years. As sales growth matures, Shift should be able to generate free cash flow margins of 5% to 10% through operational efficiencies and the sale of ancillary services. However, to put a margin of safety in place, I base my assessment on a potential FCF margin of 3%, which is a very conservative estimate for an end-to-end e-commerce business.

Hypotheses:

2022E revenue [A] (our estimate)

$1.2 billion

Potential free cash flow margin [B]

3%

Average number of diluted shares outstanding [C] (including Fair dilution)

~92 million

Free cash flow per share [ D = (A * B) / C ]

$0.404

Growth rate of free cash flow per share

42%

Terminal growth rate

3%

Years of high growth

ten

Total number of years to boost

100

Discount rate (our “next best alternative”)

9.8%

Results:

LA Stevens Assessment Model

LA Stevens Assessment Model

LA Stevens Assessment Model

LA Stevens Assessment Model

Final Thoughts

Shift is undoubtedly a high-risk, high-reward bet. The used-car e-commerce platform is priced out of business, but it has at least three-quarters of cash left in it, and if Shift starts tapping into its $150 million ATM, then they could probably continue for another five quarters. Shift faces a tricky cash burn situation as the used car market remains highly volatile due to a stagflationary environment, and this situation is further complicated by labor shortages. However, I think Shift has strategic value (for your information: over $500 million was spent to build this company). Trading at liquidation value, Shift may be an attractive acquisition candidate for many automotive retailers (including Lithia Motors (long-term investor and strategic partner of Shift)). In my opinion, the chances of a strategic takeover are pretty good. Shift management could also raise capital and expand its runway. Given the asymmetric risk/reward opportunity and management’s execution history, I remain bullish on Shift. In a nutshell, Shift’s Q1 report was solid and the thesis remains unchanged.

If you would like to learn more about my investment thesis for Shift, please refer to my previous work on the company:

  1. Shift: A Trillion Dollar Opportunity [Original Thesis]
  2. The state of our stocks Part 35 (Part II) [Q2 2021 Update]
  3. A 100 times rare and viable opportunity that is not without risks [ Q3 2021 Update]
  4. Shift Q4 Review: I’m More Bullish Than Ever [Q4 2021 Update]

Takeaway key: I view Shift as a solid buy at $1 per share (with the caveat of limiting portfolio allocation to 1-1.25% of its AUM).

Thanks for the reading. Feel free to share your questions, concerns or thoughts in the comments section below.

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