Activist Investors Can’t Overcome Automotive Industry Headwinds

You don’t need to be an industry analyst to know that the U.S. automotive industry is facing major challenges. This year is likely to see lower new car sales, higher interest rates, decreasing vehicle affordability, tariffs, and continued margin pressure that is forcing automakers to make radical changes in their product lines and business models. These changes are also impacting the behaviors of their dealers, who are sharpening their focus on expenses, reducing both new and used inventory, and even considering selling their businesses. Then, there are also the potential impacts of strategic investments, like mobility startups, personal vehicle ownership alternatives, and autonomous or electric vehicles, which are all expensive gambles for automakers and potential disruptors for car dealers. Recognizing these issues, investors have been relatively bearish on the auto sector throughout much of the bull stock market over the last couple of years. In the past six months alone, the stock prices of major automakers, retailers, and almost any company with close ties to the industry, have underperformed the broader market averages. Nevertheless, despite eroding industry conditions and the poor stock performance of the entire sector, certain activist investors have used this underperformance to promote their initiatives to maximize shareholder value.

In 2017, well-known activist investor and billionaire, David Einhorn, targeted General Motors (NYSE: GM) with a plan that he claimed would “unlock billions of dollars of shareholder value.” GM had done almost everything to improve its stock performance, yet investors were not impressed because of industry realities – the auto industry is slow growing, cyclical, and capital intensive.  Einhorn’s plan assumed that creating two classes of GM shares, one with dividends and one without, would elevate the stock price. Einhorn argued that one class could appeal to growth-oriented investors, while the other could appeal to yield-oriented investors. But, as I told Bloomberg last year, Einhorn’s plan “doesn’t make sense” and is “dubious at best.”

During Einhorn’s attempted shakeup, investor sentiment was that GM and the rest of the industry, while profitable, were confronting an inevitable drop in unit sales while pouring money into investments in mobility, autonomy, and electric vehicles, which cost billions but might never yield a return. Unsurprisingly, GM’s board of directors rejected Einhorn’s plan as they felt that the financial engineering scheme would not increase shareholder value and would tie up cash that GM needed for future investments. In response, Einhorn attempted to solicit the support of other major shareholders (like Warren Buffet) but failed again and subsequently sold many of his own shares.

A more recent example of shareholder activism within the automotive industry is that of Starboard Value’s purchase of 9.9% of Cars.com (NYSE: CARS), a digital automotive portal that is among the top visited for online automotive shoppers. Last month, Starboard published a letter and listed among other demands, operational changes within the company to offset decreasing revenue, customer losses, and other factors as part of its rationale for action. And despite the significant stock price decreases across the entire automotive sector, Starboard explained that there are “industry-specific tailwinds” that should have supported Cars.com’s growth. Like Einhorn, Starboard failed to understand the dynamics of the automotive industry, that affect its investment in a company that is dependent on advertising revenues from auto dealers and automakers. Incidentally, Starboard never named the “tailwinds” that failed to inflate Cars' sails, but a more plausible case for its argument would require that disclosure.

Starboard is learning that there are only headwinds for auto-related companies to contend with. Cars.com obtains nearly all of its revenue from selling advertising to auto retailers and automakers, which are facing lower sales volume and profits while also eliminating models. As I wrote earlier this year, the automotive digital marketing space has reached maturity, and the established companies that operate in this space are subject to the same industry realities as every other automotive company. After capturing significant dealer market share and reaching a mature size, company growth becomes dependent on taking share away from rivals, which usually means lowering prices or proactively remaining in the forefront of digital marketing through new product development, current offerings refinement, and acquisitions. This same reality is found in Cars.com’s only publicly traded U.S. competitor, CarGurus (NASDAQ: CARG). After CarGurus’s successful IPO in 2017, the company traversed the country by signing up new dealers and raising prices for existing dealers, quickly achieving revenue growth but also expediting its approach to inevitable maturity. We note that CarGurus’s stock price is down 36% since its post-IPO high.

Unfortunately for activist investors, the auto industry is not a sector for impatience or financial engineering stock market games; it is a highly cyclical industry that is dependent on macroeconomic factors. Automakers, part producers, dealers, and all companies supporting this industry are vulnerable to the same trends and investor prejudices. For mature companies to survive, they must maintain nimble models during the market downturns but also invest in R&D and acquisitions, which are not only fundamental to survival but also the only path to growth.

Maryann Keller is principal of Maryann Keller & Advisors, a New York area automotive strategy consultancy.