Questioning Market Leaders For Long Term Investors
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GREGORY SULLIVAN - UGLY DUCKLING CORPORATION
(UGLY)
CEO Interview - published 06/12/2000
DOCUMENT # KAE618
GREGORY B. SULLIVAN has served as President and Chief Executive Officer
of the Ugly Duckling Corporation since July 1999. Prior to that he
served as Chief Operating Officer of the company since February 1996,
after serving as a consultant to the company since 1995. Mr. Sullivan
formerly served as President and principal stockholder of National
Sports Games, Inc., an amusement game manufacturing company that he co-
founded in 1989 and sold in 1994. Prior to 1989, Mr. Sullivan was
involved in the securities industry and practiced law with a large
Arizona firm. He is a member of the State Bar of Arizona and a graduate
of the University of Virginia School of Law. Prior to that, Mr. Sullivan
received at Bachelors of Business Administration degree from the
University of Notre Dame.
SECTOR: AUTO DEALERSHIPS
TWST: Could you start out by giving us a brief overview of Ugly Duckling
Corporation, the company's history, product, services, customers, those
kinds of things?
Mr. Sullivan: Ugly Duckling is the largest used car dealership chain in
the country focused solely on people with credit problems. We finance
virtually all of our sales and hold the loans ourselves, so we are also
one of the largest sub-prime auto finance companies in the country. We
have 77 dealerships today. We went public in June of 1996. At that time
we had seven dealerships, all in Arizona. And now we've expanded to 11
markets in eight states from coast to coast. A lot of people know the
name Ugly Duckling from Ugly Duckling Rent-a-Car that was founded in the
1970s. Basically, our company is the successor corporation to that one.
TWST: Do you offer all makes of cars?
Mr. Sullivan: Yes, we do. Generally we deal with cars that are four to
seven years old, with typically 80,000 to 100,000 miles. We focus on
maintaining the cost of the vehicle affordable for our customers, so we
deal with older cars. We focus on making sure the cars are reliable and
capable of performing for the life of the loan, because unlike most car
dealership chains, we're also the finance company, financing virtually
100% of our sales. So we're a partner with our customers. It's in our
best interests to provide our customers the highest quality vehicle we
can for the cost. Therefore, we buy all our own cars, inspect them and
make sure the quality and price are sound. Then we recondition the cars
to make them better and safer for our customers.
TWST: How about geographic expansion? Are you planning any geographical
inroads? I think you're pretty much in the Sunbelt now, aren't you?
Mr. Sullivan: Yes, we are. We're in California, Arizona, Nevada, New
Mexico, Texas, Florida, Georgia and Virginia. We plan to continue to
stay in the southern part of the country for the near term. There are
plenty more markets for us to add just in our existing states. In
California, we're only in LA; and in Texas, we're only in Dallas and San
Antonio; in Florida, we're only in Tampa and Orlando. We plan to add new
markets in areas contiguous to our existing markets. Eventually, we plan
to be in virtually every state in the country, and there's no reason why
we can't do business in the North. It's just easier for the foreseeable
future, generally and operationally, to stay contiguous to our existing
markets.
TWST: Yes, warm weather helps, too.
Mr. Sullivan: It does. You don't have snow days that shut you down for
retail business, and the cars generally don't have the rust issues you
encounter in the north. But our business works well everywhere. There
are tens of thousands of buy-here/pay-here dealers operating very
successfully in the North, and we expect to join them someday.
TWST: How about the competition? What are Ugly Duckling's competitive
advantages? What sets the company apart?
Mr. Sullivan: There are approximately 22,000 franchised new car dealers
and 58,000 independent used car dealerships in the United States. We
compete primarily with the tens of thousands of small, independent buy-
here/pay-here dealers. With 77 dealerships, we're the largest out of all
those 58,000 independents. We're really the first to take this
fragmented, unconsolidated industry and develop a national operation
with consistent standards. One of our biggest advantages is advertising.
Generally, an independent dealer is selling 20 cars a month. He's lucky
if he can afford a newspaper ad in the Sunday paper. We typically have
nine dealerships selling about 500 cars a month in a market. We spend
about $100,000 in that market every month in TV and radio. As a
consequence, everybody in that market knows that if you have credit
problems, Ugly Duckling is the first place you go to look for a car.
Also, we offer our customers respect and a quality product, and we take
care of the customers. We have first-class facilities, quality cars and
much better inventory selection. The typical independent dealer maybe
has 30 cars on his lot. In a market where we have nine dealerships, we
will have about 1000 cars available for our customers to choose from. So
we offer our customers a lot broader selection. As I mentioned earlier,
we put a lot of effort into the quality of our cars. So we think we
offer a better product all around. What we are selling to our customers
is opportunity. Opportunity to have a quality car ' when they don't have
good alternatives to for that ' and opportunity to earn good credit. We
will report to the credit bureaus, so if they perform well with us, they
can move up the credit ladder to lower financing costs, possibly a new
vehicle and maybe a home loan. We have distinctive programs to give back
to our customers who perform exceptionally well. If you make your first
six months' payments on time, we give you a Visa card. If you make all
your payments on time, we give you your downpayment back. So we really
think we offer a unique way of dealing with this market, and it's had a
great reception. We're selling lots and lots of cars in every market
we're in, and people, I think, are reacting very well to what we do.
TWST: I have a hunch that your bad debt rate isn't too bad.
Mr. Sullivan: You have to understand that we are in the business of
financing folks who have historically had problems paying their bills. A
large number are not going to make it through the life of the loan. What
we do is select those that have the best likelihood of making it and
work with them to help them keep the car as long as they can, hopefully
through the end of the term. In this sense, you can compare it to the
rent-to-own business. When a customer comes to us, we pull their credit
bureau and typically we find they have had some credit issues. We
interview the customer and do reference checks to try to determine if
the customer is a good person with good intentions and ability to pay us
back who had an explainable problem in the past, or if they are a person
with poor intentions or ability to pay us back. If we decide that they
are a good credit risk, we emphasize to the customer the commitment we
are making to them and the importance of them performing on their
commitment to us. Then we follow-up with our customers' through the life
of the loan to call upon that commitment and to deal with the occasional
issues that come up during our customers lives, such as medical
emergencies, divorce, funeral expenses and car problems. As I said
earlier, it's like we are a partner with our customers. We have a
relationship with them and we try to help them perform and improve their
credit.
TWST: Where would you like to see the company in three years?
Mr. Sullivan: We're planning to continue to grow in the 20% to 30%
range, top line; in three, four years we should be a $1 billion company.
You'll see us basically doing the same thing we're doing now, which is
selling cars to people with credit problems and financing those people.
We're not looking for new business niches. We're in a huge industry.
We're the biggest player in it, but we're still tiny. We're under one-
half of 1% of the market. So we just want to continue executing what
we're doing, dropping more to the bottom line and tackling new markets.
TWST: Do you anticipate any major changes in your markets in the future?
Mr. Sullivan: One of the good things about our business is its
stability. Obviously, the world is changing a lot through technology,
but I feel confident that in 20 years, people are still going to be
driving cars, and in 20 years, there are still going to be people with
credit problems. Sure, there are some things that are changing in the
nature of the business, but in general, those two things will be there.
And it's a very people-related, relationship-oriented business. So we
feel very confident about our position in the market. One thing that's
interesting is the Internet and its effect on business. In the new car
market, it's very significant. You see a concern about tightening
margins because of the Internet. That's not true in used cars. A four-
to seven-year-old car with 80,000 to 100,000 miles is extremely
difficult to price off the Internet because the condition of the car is
so critical to the value of that car. And the complexity is increased
when you add a customer with credit problems. But what is interesting,
though, is that many customers with credit problems want to use the Web
as a way to find out if they can get financed without going to the
hassle and embarrassment of driving from dealership to dealership and
possibly getting turned down for financing. Typical sub-prime finance
companies have a very difficult time filling this need because the car
is so tied to the transaction. You can't have financing without the car.
We have the advantage of offering folks who come to us through our web
page the complete transaction. We can assure them the financing they are
looking for and the car they need. So we really feel like the Internet
works to our advantage. Since we started our customer Web page a little
over a year ago, our Internet business has gone from 0% of sales to
about 5% and climbing. We think that this will continue to climb, and
that we have a huge advantage over dealerships not as large as us or
that don't have their own finance companies, and a huge advantage over
finance companies that don't have their own dealerships.
TWST: Acquisitions, joint ventures, mergers, partnerships and those
kinds of things ' are they part of your future?
Mr. Sullivan: Acquisitions, certainly. We're probably the only
consolidator in the industry. Out of these 58,000 independent dealers in
the country, we are the only active acquirer. Last year, we made two
small acquisitions: a four-dealership chain in Orlando, and a five-
dealership chain in Richmond. It gives us an advantage that we can enter
a market and have an existing base of employees, plus existing
dealerships with customers. And it enables us to start achieving
advertising and operating efficiencies from day one, versus opening one
store at a time. So yes, we expect to continue to do that, and we will
continue to open internally developed dealerships in those markets. For
example, we have added four new dealerships in the Orlando market since
the acquisition last September. Of our 77 dealerships today, 33 have
been through acquisition, and 44 we've developed on our own.
TWST: Apart from the general economy, where are the risks or concerns
regarding Ugly Duckling? Anything about the company that keeps you awake
at night?
Mr. Sullivan: People want to know, of course, about rising interest
rates. We'd prefer that interest rates didn't rise, but neither are we
extremely concerned about them. Our existing portfolio is shielded from
interest rate risk, as we have financed the portfolio at fixed rates
through securtizations. As far as ongoing business, we are able to pass
on higher interest costs to our customers through higher rates or higher
margins. The other thing that people may be concerned about is the
threat of a recession. The good news of a recession is that we will
likely get many more people experiencing credit issues, a tightening of
credit from traditional financing sources. So it would present an
excellent opportunity for us for more business. On the other side, our
existing portfolio could be subject to pressure from customers losing
their jobs. We are not sure that our customer base would be hit as hard
as other credit levels by a recession, but there could indeed be more
unemployment issues. The good thing we have going for us is that we are
very relationship-oriented and used to dealing with customer issues,
such as loss of job. We do not just have to knee-jerk react and
repossess the cars. We can meet with our customers, determine the
likelihood of the customer getting a new job, etc. The other thing going
for us is that the car is not a luxury for our customer. It is a
necessity for getting back and forth to work ' or to hunt for a new job.
We feel that we are in very good position to deal with a recession. We
have an economic model and capital structure that allows us to take
higher losses should they come ' and we aim to minimize those losses.
Most importantly, we feel like we are going to have huge opportunities
for new business out of an economic downturn.
TWST: How's your management team doing? Are they equipped to handle your
ambitious strategies?
Mr. Sullivan: We have a very strong management team. And we work well
together. We are very candid and contest each other's ideas. We don't
let egos get in the way. We are just trying to make the company better
every day and have fun along the way.
TWST: Does technology play much of a role in Ugly Duckling?
Mr. Sullivan: Technology is a big driver for us. A year- and-a-half-ago,
we completed putting all of our business on one proprietary system that
we call 'CLASSì for Car Loan Accounting and Servicing Software. CLASS
covers all aspects of our business from cradle to grave, from purchase
of a car through the sale of the car to the customer, to collecting the
loans, to repossession. Since completion of that, we've been able to
manage our business much more effectively because we have better
information available on a more timely basis, and we have been able to
achieve some operating efficiencies from the system itself. We think
we're going to continue to be able to capitalize on improvements in
technology and our systems as we move forward. So we think that's a big
advantage for us. People who come in and see our systems are amazed,
because they're better than any new car dealership system they've seen,
and better than normal finance company systems because it's got
everything. And we're continuing to improve it.
TWST: How have you found hiring high-quality people for the company? Is
that a challenge?
Mr. Sullivan: Of course. It always is. Fortunately for us, we offer kind
of a unique operation in the car business. We get a lot of people who
come in from the new or used car business to us because we offer a
career approach that they're not used to seeing in this business. It's
not a burn them up, burn them out approach. We want to keep our
employees for the long term. We offer training, development and all the
things that result in a career versus a job, in an industry that
typically has been very short-term oriented. We also offer stronger
benefits than they are used to seeing. Our employees like our approach
with our customers. It is very straightforward. We don't play games to
sell cars to our customers. We tell them the truth and make sure they
understand. Since we are financing the customers and will be their
partner for the term of the loan, we believe this is the best approach.
So we generally do very, very well with retaining good employees,
particularly at the manager level and above.
TWST: What should long-term investors look at or focus on in reading
your financial reports?
Mr. Sullivan: The most important one is our growing interest income. We
went off gain-on-sale income in the fourth quarter of 1998. For those
folks unfamiliar with gain-on-sale, this practice allows finance
companies to recognize their future interest income at one time when
they originate the loan, versus waiting to earn the income over time. It
is a very legitimate and appropriate accounting practice still used by
many in the finance business. But we decided that too many finance
companies had made aggressive assumptions regarding future events in
their gain-on-sale transactions, and it is so difficult for investors to
track the assumptions. As a result, we thought our attraction to the
investment community would be better if we went to traditional portfolio
accounting, where our interest income is recognized over the life of the
loans. Since that time, we've been building the portfolio, our interest
income. Our portfolio carries an average yield of over 26%, so you can
see that our portfolio can really generate a large return. Most of the
income growth you're seeing out of the company over the last five
quarters has been driven off the growth in our portfolio. And from the
growth in dealerships that we have added over the past couple of years,
even without more new dealerships, our portfolio is going to continue to
grow. That's number one. Second, investors should look at our operating
efficiencies. For example, our corporate expense per car sold has gone
from over $630 per car in 1997 to $420 per car in 1999, and it's going
to continue to drop in 2000. We're in a relatively high-growth mode, yet
we're dropping even more income to the bottom line proportionally, and
this efficiency is very important. We're able to grow this business and
produce increasing profits at a proportionally higher rate.
TWST: How do you feel about your current stock price?
Mr. Sullivan: Like many, we feel we're undervalued. But I think we're
even more undervalued than most. Our book value is over $11.75. At this
very moment [May 2000], our stock is around 7.5. That's 70% of book
value. You might expect to see that in a company that wasn't a growth
company, but we are a growth company. The analysts are predicting
earnings in the $1.20 range for this year. That's a pretty good increase
versus our earnings last year of $0.57. The earnings multiple doesn't
make sense to me, particularly in relation to our growth and our book
value. I believe that if we continue to post positive results over the
coming quarters, which we fully expect to do, investors will have to
take notice of the value that we present. I think we have been hurt a
little through association with sub-prime finance, where some companies
in the past have not performed to expectations, and through association
with car retailers, as investors have shown some concern over margin
competition in that area that doesn't really apply to us. So we really
think we're different from both those sectors, and as investors see our
results and learn more about our business, we will overcome this.
TWST: What two or three reasons would you give potential long-term
investors to buy stock in Ugly Duckling now?
Mr. Sullivan: I would give you the very reasons I just went through I
think that we're trading at a very good value relative to our book value
and relative to our earnings. There is the growth in our income you can
basically see coming. The portfolio will grow from existing dealerships
that will throw off increasing interest income. We have enormous
potential for more growth. We are the largest player in a huge industry,
and yet we are only one-half of one percent of the market. So we are in
excellent position. We just need to continue to execute our business
plan, and the market will recognize our success. Our business is not the
easiest to understand. It takes a little effort. It is not the easiest
to relate to. Stock investors typically haven't had the credit issues
that our customers have. But once you understand the business and our
approach, we think investors will be very impressed with the investment
opportunity we present.
TWST: Thank you. |
