William Martin of Raging Capital Management believes TrueCar Inc (NASDAQ:TRUE) investors should pay attention to objects in their investment’s rear-view mirror, like the company’s poor earnings quality, which may be closer to impacting the stock than they appear.
In the fund’s recent letter to investors, it detailed its short thesis on TrueCar Inc (NASDAQ:TRUE), which Martin admitted went against his fund in the first quarter (and since), as the stock gained nearly 24%. Nonetheless, Martin believes that the market is overvaluing TrueCar’s low-margin business model and ignoring its “poor earnings quality”.
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As Martin stated, while the company reported $15 million in 2016 EBITDA, it also capitalized $12 million in software development expenses, which are excluded from EBITDA calculations, raising what Martin described as a “red flag” on the company’s earnings quality. Martin also pointed to TrueCar’s $7.4 million in rental and mortgage expenses, which are also excluded from its adjusted EBITDA calculations. Despite that financial maneuvering, Martin says there’s no hiding the fact that the company is struggling to keep its head above water, with negative operating cash flow.
Raging Capital’s letter also referenced a growing value disconnect between stocks that feature prominently in ETFs and those which don’t. This is a growing sentiment among active investors, including Murray Stahl of Horizon Asset Management, who recently blamed a lack of passive investing in Lions Gate Entertainment Corp. (USA) (NYSE:LGF) as a primary reason for that stock’s underperformance. Whereas Lions Gate was held by just 2 ETFs according to ETF Daily News, TrueCar could be found in 28 ETFs, despite having less than half the market cap of Lions Gate.
“It also appears that algorithmic-based trading strategies, which typically feature a momentum factor in their models, are serving to push many of these same favored stocks higher. This index/algo combination has created a circular feedback loop that appears to be feeding on itself,” Martin exclaimed.
While Martin believes that TrueCar Inc (NASDAQ:TRUE) CEO Chip Perry does have the potential to optimize the company’s operations and innovate, he is skeptical of the results. TrueCar did announce solid first quarter results yesterday, including adjusted EBITDA of $5 million, a big improvement over the year-ago quarter’s $1.1 million. The company also raised its 2017 EBITDA guidance to between $23 and $26 million, from previous guidance of between $20 and $24 million. It also raised its 2017 guidance for revenue and total sales.
15.1% of TrueCar’s shares were collectively held by 16 of the hedge funds in our database at the end of 2016.