Automotive Ventures' 2023 Predictions

It's a brand new year, and that means it's time for another round of predictions for 2023. So let's get started:

Number 1: Reynolds & Reynolds is Acquired

With the passing of industry icon Bob Brockman in August, my prediction from back in 2021 may finally prove correct in 2023.

It’s uncertain how Brockman’s $2 billion tax evasion case with the U.S Government will be resolved, and what sense of urgency his estate may have to get this matter settled so proceeds can be divided up amongst Brockman’s heirs.?

Once both lawsuit and estate are settled, it may make for a strong case to have dominant DMS player Reynolds & Reynolds change ownership in 2023.

While AutoTech valuations have receded from their recent highs, Reynolds is still one of the premier software (SaaS) assets in the AutoTech landscape and should achieve strong interest.

Number 2: Tekion Acquired by Salesforce.com

This was another prediction from back in 2021 that never bore fruit. But I’ll dust it off and predict that 2023 is the year that Tekion sells to Salesforce.com.

Tekion is one of the darlings of the automotive SaaS segment, attempting to take on the oligopoly of Reynolds & Reynolds and CDK Global.

Tekion, a cloud technology company and provider of a SaaS DMS they call their “Automotive Retail Cloud”, announced their Series D financing round of $250 million at over a $3.5 billion valuation back in October 2021. Tekion is looking to build the entire constellation of software products that surround the DMS, while simultaneously playing nicely with third-party SaaS companies that want to integrate.

In October 2022, Salesforce announced their Automotive Cloud CRM. A handful of auto dealers have transitioned over to Salesforce.com as their CRM of record.

Rumors of Salesforce entering the dealer software solution market have circulated for years. A takeout of Tekion might provide a fast path for Salesforce to find a like-minded disruptor to accelerate its entrance into both the DMS and CRM segments.?

Number 3: Carvana Acquired by Amazon

A third prediction from back in 2021 whose time may have finally come.

I’ve believed for years that Carvana would be a natural acquisition target for Amazon, the latter having struggled for some time around how they could provide driveway delivery of vehicles without forcing the consumer to interact face-to-face with the dealer.

Carvana has proven they can accomplish this at scale with Carvana-owned vehicles. The missing puzzle piece is how Carvana might convince dealers to list their inventory on the platform (first with used cars, but then eventually with new cars). I’ve argued in the past that once they figured this out, they would become a compelling acquisition candidate for a big ecommerce player like Amazon.

Sadly, Carvana had to roll back their “Marketplace” product in 2022, which allowed dealers to list their vehicles on Carvana.com.

With the challenges the company is facing in the short term, could this be the year that Carvana is sold to a strategic buyer? I’m betting so.

Number 4: AutoTech Valuations Reset

In 2023, the fundraising market will thaw, but at materially lower valuations than we experienced in the first half of 2022.

The SaaS Capital Index, which tracks the valuation of larger, publicly-listed B2B SaaS software companies, currently sits at 6.3x annualized current run-rate revenue (ARR), well off its high of 16x a year ago.

And how the mighty have fallen. The dramatic valuation correction in the public markets for the big tech players in 2022 (Amazon down 51%, Tesla down 69%, Apple down 29%, Meta/Facebook down 64%) has impacted late-stage private companies who are close to public listings but has yet to dramatically effect earlier stage deals.

Over the course of 2023, we’ll continue to see valuation correction for private companies in earlier stages of funding rounds. This will inevitably catch up with and reflect in AutoTech company valuations, whether companies are raising capital or looking to sell.

Number 5: Dealership Valuations Drop

U.S. dealership activity (“buy/sell”) hit another record in 2022, both in terms of number of stores as well as total valuation transacted. Record valuations are being applied to record profitability (Kerrigan Advisors reports that over the trailing 12 months through September 2022, the average U.S. dealership earned an estimated $4.24 million, a 205% increase from pre-pandemic levels).

Public dealer groups, voracious acquirers back in 2021, have taken the opportunity to “tap the brakes” (publics represented 7% of acquisitions in the first 9 months of 2022 vs. a 29% share for the full year 2021).

The two largest public dealership groups had significant declines in share prices last year (AutoNation 20% from peak: PE Ratio: 4.39; Lithia 41% from peak: PE Ratio: 4.58). Declining valuations means less “currency” to play “multiple-arbitrage” (acquiring stores at a lower valuation than public market valuations, which provides immediate value creation).

With the natural acquirers pausing their voracious appetite to buy stores and a higher interest rate environment making capital more expensive, it’s likely that acquisitions will dramatically slow, and 2023 the year that valuations will come back down to more historical norms.

Number 6: Dealerships Focus on Cost Reduction

Automotive dealerships are coming off three years of record profitability, fueled by an environment where consumer demand remained strong through a shortage of new and used vehicle supply. The result? Record profitability per unit sold.

But all signs point to those days being behind us. Profitability in 2023 is expected to start to come back closer to historical averages. Dealership employees, who have been conditioned to simply “take orders” during COVID, may have lost the “muscle memory” of how to actually market and sell cars.

As we return to an era of profit margin compression, vendor and spend management will become increasingly important areas for dealers to focus on.

Noting the efficiencies of having scale,?Bryan DeBoer, President & CEO of Lithia & Driveway, recently said, “top 10% stores have around 43% SG&A as a percentage of gross…to compare and contrast...the smallest 10% of stores have about 75% SG&A as a percentage of gross.”

Number 7: Artificial Intelligence (AI) Goes Mainstream

Artificial Intelligence (AI) is on track to be the most hyped technology of 2023. AI is transitioning from being an interesting academic exercise to delivering impact for businesses and consumers.

We’re witnessing the impressive capabilities of image- and text-generating AI programs, including DALL-E, Stable Diffusion, and ChatGPT. 2023 will be the year when AI becomes truly accessible to the general public. An influx of capital and attention in 2023 will accelerate the category’s growth.

2023 will see AI adoption skyrocket by the rapid adoption of models into all kinds of applications. Standardized software and devices that organizations use daily will become smarter with the infusion of AI.

AI has reached an inflection point where it will be commercially viable for a variety of use cases, and 2023 will be the year where we'll start to see more and more real-world applications.

Incumbents SaaS providers may find themselves behind in the application of state-of-the-art AI techniques, which may force them into build vs. buy decisions and create a wave of early-stage AI acquisitions.

Number 8: Next Wave of AutoTech: Process Automation

The automotive space has always fostered a healthy amount of innovation. Just walk around the convention floor at NADA each year to get a sense of the sheer volume of technology companies that support dealers and OEMs.

We strongly believe that the next wave of automotive tech will help dealers and OEMs automate processes and reduce costs. In many cases this will be by reducing vendor cost and complexity, reducing headcount, or making existing headcount far more efficient.

Artificial Intelligence (AI) is going to fuel automation that disrupts knowledge work. Manual, repetitive tasks will start to go away, freeing human capacity for more creative and complex problems in the world. The end result will be a whole new class of "intelligent software" that acts dynamically with the user's intentions in mind. Machine Learning (ML) will create a second wave of SaaS innovation that will dramatically increase worker productivity and reduce operating costs as a direct result.

Number 9: Consolidation of Mobility Companies

An unprecedented amount of capital has flowed into mobility technology companies, pursuing autonomous driving, the electrification of vehicles and infrastructure, and vehicle connectivity.

During the past year, as the IPO window closed and share prices of many recently public mobility tech companies plummeted, investors have pulled back. Many startups have taken steps to conserve cash and cut costs. For many startups that struggle to raise new capital, consolidation will likely provide the most viable means to move forward.

Because many startups avoided raising money in 2022, many startup companies will be in the market for capital this year and while there is plenty of venture capital sitting on the sidelines waiting to be deployed, VCs will be much more selective.

As a result of these trends, 2023 will see a number of mobility companies opportunistically combine. The merger of Lidar companies Velodyne and Ouster, and the possible merger of automotive data companies Otonomo and Wejo are just two combinations already announced.?

Number 10: Private Equity (PE) Acquires Public Companies

The market capitalization of several public mobility tech startups has plummeted below the level of cash on their balance sheets, thus leaving them vulnerable to takeout and liquidation.

Automakers such as Volkswagen, Mercedes-Benz, BMW and Stellantis are trading at 5 times forward earnings, a roughly 25% discount to their 10-year average.

Dry powder (cash reserves on hand available to make investments or acquisitions) ended the year at $1.3 trillion globally for Private Equity (PE). As a result, PE might prove the best M&A option for many companies in 2023.

Private Equity may shift their gaze from the private markets to the public markets, as depressed share prices are too compelling to ignore.

Bonus: 2023 Will Be The Year of the EV

The Inflation Reduction Act (IRA), passed in August, has already had a huge effect on the EV industry as automakers work to onshore their supply chains and factories. While automakers in 2022 scrambled to set up factories in the U.S., most critical materials still come from China, so they will need time to configure new supply chains.

J.D. Power is expecting the 2023 market share of EVs in the U.S. to reach 12%, up from 7% today. Cox Automotive forecasts more than 1 million retail EV sales in 2023.

In addition to retail sales, a key element of the IRA are incentives designed to entice fleet operators to consider electrified vehicles.

All of this means that all of the ancillary services needed to keep EVs running will need to accelerate.

In 2023, expect to see big investment (government, utilities and private firms) into charging infrastructure, energy storage and energy transmission. This is the beginning of a new era: a massive focus on decarbonization and associated technologies for the U.S. economy.

The IRA will drive billions of dollars of capital into the sector over the next decade. Many leading VC firms have dedicated climate funds now and we see huge amounts of capital available for climate startups with strong teams and novel approaches.

Steve Greenfield is CEO and Founder of?Automotive Ventures, which is raising its first?DealerFund?to help auto dealerships navigate through the next decade of unprecedented change and participate financially in the AutoTech startups they help to grow.

Note:?This article was?originally published in the January 2023 Automotive Ventures Intel Report. Download your free copy?here.