How Spac magic took Cazoo from nought to £5 billion in 17 months

The chances are, not only do you recognise the name, but you also know it as the nation’s biggest online-only second hand car dealer.

So ever-present is its blitz of advertising, it feels like Cazoo has been here forever.

In fact, it’s only been running little over a year.

In that time, the company run by London tech tycoon Alex Chesterman has become valued on Wall Street at a staggering £5 billion.

That means Chesterman’s 25% stake is worth something in the region of £1.5 billion.

It must be one of the most rapid accumulations of wealth ever, made all the more incredible by the fact that this fortune stems from the same line of work as Arthur Daley.

For some in the City, Cazoo’s valuation marks one of the most outrageous bubbles in internet history.

For others, it highlights how digital technology and private equity billions have changed the world for good.

To understand the tale, we must first understand the man.

In the old days, most seriously successful entrepreneurs only had one really big hit. Think Stelios Haji-Iaonnou: having trousered outstandingly from easyJet, he has spent the decades since struggling to find anything remotely as lucrative.

But, in these digital times, a player like Elon Musk can make a fortune from PayPal, then another from SpaceX, then another from Tesla.

Chesterman, rather eccentric looking, with a pointy beard and slightly transatlantic, gravelly drawl, first struck gold with LoveFilm - the DVDs-by-post service he founded then sold to Amazon for £200 million. Then came the property site Zoopla, which floated on the stock market in 2014 before being sold on for £2.2 billion, leaving Chesterman a personal profit of more than £100 million.

Only then did he come up with Cazoo, perhaps his biggest payday yet.

But even by his standards, Cazoo’s value has accelerated with suspicious speed.

After all, many established car dealerships sell way more cars than Cazoo. Pendragon, one of the UK’s biggest dealerships, has 16,000 used cars listed on its website compared with Cazoo at around 3400.

Yet Pendragon is only valued at £265 million. How can Chesterman’s business be worth 18 times more?

For many City fund managers, the answer’s simple. It isn’t.

As one of the biggest, who has shares in traditional dealers, puts it: “Cazoo is a bubble. Pure and simple.  Possibly one of the biggest ever. And when it pops, a lot of people are going to feel it.”

A reknowned short-selling hedge fund investor with a nose for such things agrees: “He’s a clever guy, no doubt, Chesterman. But I’m afraid this one is heading for a nasty fall.”

According to him, the tycoon has created his business just as technology company valuations have gone berserk.

Pretty much all tech stocks went into orbit last year as big money went chasing The Next Big Thing after Covid left interest rates at zero or lower.

Spac Magic

But that wasn’t the only bit of market timing Chesterman got right.

When he was looking at where and how to float his business, one corner of Wall Street had entered an even higher stratosphere - the Spac.

Short for Special Purpose Acquisition Company, Spacs are tech speculation on steroids.

Rather than a conventional stock market flotation, where a fast growing company looking to raise money sells shares to new investors, a Spac does it in reverse.

That is, a bunch of investors, known as sponsors, stick a few hundred millions of dollars into an empty-shell company on the stock market and go hunt for a business to buy with it.

Generally, they’ll then top-up their warchest of cash by selling shares in the Spac to new investors to fund the takeover.

When the sponsors find a target, the newer shareholders can either vote in favour of the deal or, if they don’t like it, walk away and redeem their shares for no less than $10 each.

If they decide it’s a winner, the merger goes ahead, the Spac changes its name to the newly-acquired company and becomes like any other plc.

The sponsors are heavily incentivised to find and buy a takeover target. So much so that they can make a fortune even if they hideously overpay. Often, they do just that.

Their fee comes in the form of whacking 20% of the shares of the company after the takeover is complete.

As Professor Michael Klausner, a Spac expert at Stanford Law School puts it: “The darned things are crazy.”

Deliveroo avoidance

That’s not how entrepreneurs like Alex Chesterman see them.

For them, a Spac offers a fast, guaranteed amount of cash that doesn’t risk disappearing if the markets have a wobble just before the float date. Darktrace, a long-established tech company, recently had to slash its IPO price purely because market sentiment had been soured by the disastrous float of Deliveroo a few weeks earlier. That wouldn’t have happened with a Spac.

Little wonder Chesterman agreed to be merged into a New York Spac with the anonymous sounding Ajax I.

Cazoo won’t actually complete its deal with Ajax until July, but the extraordinary valuation put on the business already guarantees him a minimum of $800 million from his sponsors.

If the other shareholders approve the deal, he gets a further $800 million.

Spac attacked

But there’s trouble in Spacland.

Having seen many Spac shares plunge, the market is currently having a major wobble, with valuations collapsing from their highs. Sir Richard Branson’s space business Virgin Galactic, whose shares soared from their Spac launchpad to hit $59 in February have crashed back down to $18 today.

Prof Klausner predicts we’re only seeing the start of it. “Spacs have been good for the target companies [like Cazoo] because in general they have made excess valuations for themselves. But they are generally speaking a bad investment for shareholders.”

Some target companies have had to renegotiate downwards the valuations struck with their Spac sponsors because shareholders are balking at the price.

There is no suggestion that is happening yet with Cazoo, but it could.

Even if it does, though, the $800 million guaranteed to come Chesterman’s way means he can keep spending astronomical amounts of cash building up his business.

Go big, go early

And that’s the real key to how Cazoo has achieved such a massive valuation. To build the foundations of his business, Chesterman has hurled a fortune at it.

Thanks to his contacts and track record, even before the Spac was announced, he had raised $400 million to set the company up.

It has

:: meant he could pump his advertising up to the max, with its brand recognised by more than 60% of the country in record time.

:: funded the building of five giant warehouses spanning 130 acres, where the used cars it buys are spruced up before going on sale.

:: paid for 17 customer service centres across the UK with another 10 in the pipeline, and 200 car transporters to get the vehicles to the customer’s front door.

:: funded a push into Europe and allowed him to hire 2000 people.

And, for those who like such baubles (clue: this writer doesn’t), it has attracted glitzy non-executive directors to the board such as the former Labour, Change UK and LibDem MP Luciana Berger.

Against such turbocharged spending, Cazoo’s old-fashioned peers just can’t compete.

In the race to sell more cars to more people than his rivals, Chesterman has a headstart that could prove unassailable.

According to those who have seen Cazoo’s presentation to potential investors, the infrastructure and marketing machine Chesterman has built makes him confident of making £700 million in sales this year.

But there’s a phrase in the business world that some say will come back to haunt Chesterman: turnover is vanity, profit is sanity.

You can sell all the product you like, but if you’re selling it for less than it’s costing, you’ll eventually run out of road.

Profit margins on selling cars aren’t that great at the best of times. Pendragon’s Car Store second hand business made a gross profit margin of 4% in 2019 (8% the year before).

Investors who saw Cazoo’s investor presentation say Chesterman is predicting a margin of 13% by 2024 - unprecedented by industry standards, even if you throw in the extras like finance plans.

How can that be? Chesterman’s allies say through the Amazon-like efficiency of his modern set-up and the vast volumes he will be able to push through it.

Cazoo also told investors it will be making £5.9 billion in sales by 2024, the Evening Standard understands.

For those in the motor trade, such forecasts are just unfathomable.

(Note to money nerds - in a conventional IPO, financial predictions like these would also be illegal, but not for Spacs - in Spacland, people can and do make all the projections they want. Wall Street regulators are now reviewing whether that’s a good idea.)

Similarly, show a man in the motor trade Cazoo’s forecasts on the average selling price of a car and he’ll choke.

From this year’s £12,000 odd, I’m told it reckons by 2024 it will be £14,500.

Even if we weren’t expecting a time of historically low inflation and high unemployment, that looks optimistic.

Blockbuster Video vs Netflix

For tech investors, though, such growth rates are achievable when a well-capitalised digital company sets out to rip a new exhaust in a sleepy industry.

As Chesterman once teased me after I doubted Cazoo’s valuation: “If you want to back Blockbuster against Netflix and Love Film, be my guest.”

For him, so calmly self-confident that it makes you feel absurd to cast doubts, the well-funded digital trampler always wins against the puny shrubs who populated the landscape before him.

“The European used car market is worth $700 billion but only 2% is currently online,” he said recently, declaring he only wants a small slice of the pie - perhaps 3%. Even if he “only” grabs that, he’s looking at £19 billion of sales, he says.

Besides, he’ll point out, even at a value of £5 billion, his empire is still worth a fraction of the US online car giant Carvana relative to its sales (he’s right; at the time of its pricing, Cazoo was valued at 1.8 times its expected 2022 revenue against Carvana’s 11.2 times).

Buying books, clothes, music, furniture, houses, all went digital long ago, he reasons. Only cars haven’t made the shift.

“It is ripe for disruption,” he says.

He could be right about that. Many old school players in the business are small fry, sleepy outfits with a hard-to-shake reputation for grim car lots and shiny-suited sales lizards many people really don’t want to deal with.

Even the most professional incumbents can seem in a world of their own when it comes to marketing. Vertu’s “Bristol Street Motors” is apparently considered the powerbrand in the sector, but you have to wonder how many ordinary Joes could name it if asked.

Certainly, when you run it through the analytic gizmos that measure which brands are getting searched on Google, it performs like a dusty Trabant to Cazoo’s Aston Martin (albeit Autotrader leaves them both eating its dirt like a Lamborghini).

When I challenged one of the biggest CEOs in the sector that he was lagging Cazoo in the ways of modern marketing, he boasted how his brands sponsored the football, the cricket and the rugby.

And what percentage of family car buying decisions are made by women, I asked? More than 70%.

Cazoo has hired some of the brightest sparks in marketing who are taking a different tack (setting aside its £10 million a year for Everton).

But even so, to extrapolate a value of £5 billion from a company which, as I write, has less than 3000 cars available still seems a massive stretch. Profits to justify such a sum seem even more absurd.

I like Chesterman a lot. He talks straight and makes me laugh. But would I buy a used car site off him? At this price, no way.

Test drive

Marketing techniques, business models and share prices are one thing, but which online dealer actually offers the best choice of cars?

As a city dweller, I did a quick search online for a Toyota Prius. Nothing older than three years.

Here were my options:

Cazoo had four, ranging from £16,000 to £19,000.

Vertu, whose website featured an image of a slightly frightening looking salesman, didn’t offer the Prius as an option

Cargiant found me five, ranging from £10,499 to £12,299

Autotrader’s search tool autofill somehow knew I’d been dreaming of a mustard yellow 1970s Porsche 911 (thanks, Google) but fetched me 467 Priuses within 30 miles. They ranged from one with a mere 235,000 miles on the clock for £1890 to a nearly new job for £29,995.