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Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong
Thesis Summary – 60 Second Version
KAR, an auto auction company, is spinning off IAA, its salvage auto division into a separate entity.
CPRT KAR
Recommendation Most Important!
Price (11/26) $57.15 • Long IAA during when-issued trading
Shares out. 134.3 • Alternatively, long KAR pre-spin for an anticipated 1:1 distribution of shares in
Market cap $7.6bn Q1 2019 – KAR is, as of market close 11/26/2018, trading at $57.15
P/E (LTM) 2.7x • Blended price target = $29.76. represents 43.3% upside from current implied
EV/EBITDA (LTM) 11.5x
market value of $20.77 (giving KAR RemainCo an implied value of $36.38)
• Catalysts: announcement of the spin date, amendments to IAA’s Form 10,
Net Debt/EBITDA 2.8x
initiation of the spin
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 2
Business Model
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 3
Business Model – Overview of KAR and Its Operating Segments
IAA is an intermediary for sellers (insurance companies) trying to reach buyers (rebuilders and recyclers).
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 4
Business Model – What IAA Does Best
IAA sells total loss vehicles and demonstrates an ability to throttle supply.
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 5
Industry and Competitor Overview
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 6
Industry and Competitor Overview
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 7
Industry and Competitor Overview
A Natural Moat New Light Vehicle SAAR (Millions, FRED Data) Manheim Used Vehicle Value Index (Oct 2018)
20.000
• New auto has, for the past 3 years, hit
18.000
pricing and volume highs
• Leading indicators show a potential reversal 16.000
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 8
Why the Discount?
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 9
Why the Discount?
Rare Copart Earnings Miss Non-NA Exposure? KAR’s non-NA exposure (mostly UK) is
KAR and CPRT Post-Q3 Performance (USD) due to ADESA, which is following market
NA v. non-NA Exposure
70 leader Cox (Manheim) into international
97%
65 100% 80% 87% markets after Cox’s early foray
80%
60
60%
55 40% 20% 13%
20% 3%
50 0% • But IAA beat guidance with 12% YoY
Copart KAR IAA
45 revenue growth and 6% YoY volume
40
NA Europe growth
8/14/201 8 9/14/201 8 10 /14 /20 18 11 /14 /20 18
• And IAA hardly has international
CPRT KAR
Copart failed to deliver largely exposure
• Weakened end-market volumes in because:
Europe and China caused Copart to • EBITDA margins in Europe are Something doesn’t add up…
miss Q3 earnings ~9% lower than NA margin • Copart fell ~25%, KAR fell ~12%
• Copart’s aggressive European expansion • Vehicle sales and revenue growth due to its high correlation
introduced a large short-term SG&A dropped off after: • IAA was simply collateral damage
drag to the business • Tailwinds from Hurricane due to its consolidation under KAR
• Copart’s weakness weighed on KAR Harvey • Artificial price deflation provides a
shares – somewhat corroborated when • Aggressive M&A activity, potential buying opportunity for KAR
ADESA posted on low end of which fueled inorganic shares ahead of the spin and
guidance… revenue growth distribution
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 10
Thesis Overview
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 11
Thesis 1 – Steel and Aluminum Tariffs
Trump’s Tariffs Spread per Vehicle Sold (USD)
550.0
• 25% on steel imports 540.0 537.9
• 10% on aluminum imports 530.0 528.2
534.8
524.6
• Enacted in March 2018 520.0
515.0
511.9
• Domestic HRC steel, metal scrap, 510.0
504.9 506.3 505.8 502.4
500.0
and steel rebar prices have already 490.0
496.1
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 12
Thesis 2 – Structural Tailwinds
The light vehicle fleet is growing and miles driven are increasing, bolstering the total addressable market.
Seasonally-Adjusted Miles Driven
Vehicles in Operation 297mm
(NA, Thousands)
280,000
Used Vehicle Transactions 42mm 270,000
260,000
Vehicles Removed 250,000
from Operation 13mm
240,000
230,000
Salvage Auction
Vehicles 4-5mm 220,000
210,000
IAA’s 200,000
2.4mm
Mar-2014
Jan-2000
Jan-2017
Dec-2009
Feb-2007
Oct-2012
Jul-2008
Aug-2015
Apr-2004
Sep-2005
Nov-2002
May-2011
Jun-2001
Jun-2018
Share
Source: KAR Auction Services Q3
Corporate Update
• 4-5mm change hands at salvage grown at a ~1% CAGR since 2002 900,000
800,000
auctions per year. At $500+/vehicle per • 15-year trend of decreasing accidents per
700,000
transaction, this represented a market million miles driven brought on by improving 600,000
opportunity of $2.3bn in FY2017. IAA safety standards has been reversed by 500,000
sold 2.37mm vehicles in 2017 and will increases in on-the-road distractions like 400,000
Q1Q3Q1Q3Q1Q3Q1Q3Q1Q3Q1Q3Q1Q3Q1Q3
likely exceed 2.5mm by EOY 2018. texting and mobile phone use (~25%)
2016 2017 2018 2019 2020 2021 2022 2023
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 13
Thesis 2 – Structural Tailwinds
The light vehicle fleet is aging, resulting in an increase the proportion of total loss vehicles.
• Average vehicle age on the road in NA Total Loss % of Total Claims Salvage Rate by Vehicle Age
has grown at a 1.6% CAGR from 8.4 18.0% 25.0% 22.6%
years to 12 years since 1995 18.0%
17.5%
• Aging of the vehicle fleet is a byproduct 17.0%
16.9% 20.0%
of higher quality auto engineering 16.5%
15.0%
16.0% 15.6%
• Increase in longevity is coupled with the 15.5% 9.2%
increasing complexity of auto 15.0%
10.0%
14.2% 14.3% 5.0%
manufacturing 14.5% 14.0% 13.9% 13.9%
14.1% 14.1%
5.0% 3.3%
14.0%
• As more complex vehicles necessitate 13.5%
0.0%
parts particular to a make/model, the 13.0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0 Years 1-3 Years 4-6 Years 7+ Years
replacement of parts becomes costlier
• Manufacturers continue to add Revisiting an earlier point
Average Light Vehicle Age (2002-2016)
equipment, even to lower-end models • Ability to limit supply is crucial
12
• After an accident, vehicle repair is more • Because IAA operates far below
11.5 11.511.6
likely to be deemed a total loss 11.3 11.4 11.4
11 11.1 supply capacity, boons to supply:
• Over time, total loss cases as a 10.5 10.5
10.8
1. Boost volume and margins
10.3 10.4
proportion of insurance claims have 10 10.0 10.1
10.2
2. Allow IAA to preserve its
9.8 9.9
hovered around 14% – but between 2014 9.5 supply-side transaction fee
and 2018, that proportion has 9
due to supplier relationships
consistently increased to 18.8% 8.5
20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 16 and warehousing practices
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 14
Thesis 2 – Structural Tailwinds
• A rise in the drivers with gap insurance leads to a rise in total loss cases
The cyclical cherry on top: more rental car lease terms have been expiring.
• The proportion of off-lease volumes has increased to 30% since 2010 at a ~16% CAGR
• When a fleet vehicle’s lease term ends, it’s returned to the captive finance company, and
a portion of those are transacted through salvage auctions
• While the rental fleet phenomenon reflects new auto cyclicality, it moves on a 3-year time
lag, since that’s the average rental car lease term
• Should continue to boost IAA’s non-total loss volume for at least 3 years
Source: U.S. News & World Report
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 15
Thesis 3 – Is Copart’s Premium Warranted?
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 16
Thesis 3 – Is Copart’s Premium Warranted?
Copart still trades at 40% premium to KAR despite the many similarities. What are the differences, then?
• 28.3% EBITDA margin • 37.2% EBITDA margin
• 37.3% EBITDAR margin • Volume is 100% online,
• 60% online, 40% physical no physical presence
• 40% market share in NA • 40% market share in NA
Qualities Unique to IAA Qualities Unique to CPRT
• Leases the majority of its auction sites; decided in 2002 to • Owns the majority of its operating yards
not spend capex on land • Rent expense is ~2-3% of CPRT revenue
• Rent expense is ~9-12% of IAA revenue • However: SG&A margin is ~10% due mostly to the
• 20-year lock-up with 6 contractual rent bumps depreciation on its lots – larger than that of IAA
• However: SG&A margin is ~9% once excluding its vestigial • Runs a pure online model, which means there are no
amortization of goodwill from its 2007 buyout auction sites. Copart’s real estate is exclusively for yard
• Runs a hybrid model of in-person and online auctions operations – this has given Copart its “cold and callous”
• Creates stalwart-like niche in salvage auto reputation with consumers
• Live auctions give buyers the chance to see running • Copart has made an aggressive international expansion
cars, which may be a concern for older vehicles centered around Europe and other underserved markets
• Older buyers like the free coffee, pizza, donuts, etc. • Growing pains in the way of SG&A drag
• Model is very high-touch, which serves as a • Tighter regulation in Europe
differentiator in product offering to customers in the • Margin pressure in European markets is higher due to
NA market higher land density (NA is relatively sparse)
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 17
Thesis 3 – Is Copart’s Premium Warranted? Possible Explanations
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 18
Thesis 3 – Is Copart’s Premium Warranted? Possible Explanations
Maybe it’s because Copart’s capital structure is more debt-free than IAA’s?
But how informative is cap structure?
• Copart only runs 0.25x Net Debt/EBITDA while KAR runs 2.8x in the form of term loans, revolver, and capital leases
• ~34% of KAR’s total debt is attributable to its AFC, which runs debt in the form of receivable-collateralized obligations
• IAA’s post-spin cap structure is set to be 3.5x Net Debt/EBITDA, but without refi or new debt issuance
• Historically, KAR levers up almost exclusively in anticipation of acquisitions (like ADESA’s $432mm acquisition spree in 2016)
ADESA acquires Brashers Conclusion: IAA’s debt is likely healthy, and anticipated to be paid down
KAR Leverage Over Time (2012-Present) ADESA acquires Sanford quickly since the 3.5x leverage is simply a hand-me-down from KAR
(Debt Value in Millions of USD)
ADESA acquires GRS UK
• Management has a history of being excellent capital allocators
4.2x 3,000.0
ADESA acquires Flint
• Debt is only taken on for growth purposes
4.0x
2,500.0
• Otherwise, it’s paid down quickly – if IAA has capital deployment
3.8x opportunities, management will put capital to work
2,000.0
3.6x
• Revolver remains undrawn
3.4x 1,500.0
• No debt in recent memory has
3.2x been issued for IAA-specific
1,000.0
3.0x purposes, which means either an
500.0
2.8x
expedient paydown or
2.6x 0.0 utilization for growth endeavors
Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2
2012 2013 2014 2015 2016 2017 2018
like international expansion
Net Debt/EBITDA Net Debt Debt and Capital Leases
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 19
Thesis 4 – Opportunities for Improved Capital Allocation
Jim Hallett – CEO and Chairman of the Board of KAR Auction Services IAA executive management
• Joined company in 1993 as president of ADESA Canada have steered a successful
• Has served as CEO of KAR Auction Services since 2009 turnaround of the company
• Has received numerous industry awards, including the Ring of Honor from from its 2004-era distress
the National Independent Dealers Association • Previous management were
• EY Entrepreneur of the Year 2014 for the Services category poor allocators
• Tom O’Brien (now retired),
John Kett – CEO and President of Insurance Auto Auctions (IAA) John Kett, and other
• Joined company in 2001 as SVP of planning and business development founding members of the
• Has served as CEO of Insurance Auto Auctions since 2014 team helped steer IAA’s
• Has nearly tripled the number of corporate-owned auction facilities since turnaround
assuming the CEO role • Current management cohort
• On SkillsUSA’s Youth Development Foundation Committee started together at an auto-
glass company in Chicago
John Hammer – President of ADESA • Tight-knit group
• Joined company in 2009 in a leadership role in the AFC business • Bureaucracy is weighing
• Held leadership roles as CEO, President, and COO of AFC IAA down, as KAR’s first
• 25-year track record of successful results in whole, retail, financing priority is ADESA
• Spent 17 years in roles at Ally Financial, AutoNation, and Mercedes-Benz • Hence the lack of
Financial investment in IAA
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 20
Thesis 4 – Opportunities for Improved Capital Allocation
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 21
Thesis 4 – Opportunities for Improved Capital Allocation
Whether or not we think the premium is warranted, IAA’s spin into a pure play will bring the business model
more in-line with Copart’s and make it more operationally efficient, helping IAA close the gap with Copart.
KAR’s Current Capital Allocation Policy IAA’s Potential New Capital Allocation Policy
The difference?
• Each of IAA’s capital deployment opportunities align its
operating model more closely with Copart’s.
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 22
Thesis 4 – Opportunities for Improved Capital Allocation
Each area of capital deployment serves to close the last remaining gaps between IAA and Copart.
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 23
Thesis 4 – Opportunities for Improved Capital Allocation
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 24
Key Drivers and Valuation
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 25
Key Drivers Projections
Do these drivers look familiar?
• Secular tailwinds mentioned in ‘Thesis 2’ contribute directly to IAA’s revenue trajectory
• The 5-7% industry volume CAGR assumption lies at the heart of the following calculations
• Some conservative assumptions:
• Revenue per vehicle sold is flat-lined beyond EOY 2018 despite strong upward trend
• Demand among scrap recyclers, repair shops, and international buyers are all likely to
increase – buyers of running vehicles especially in the event of a recession
Miles • Assumes scenario in which lease buyouts slowly and gradually increase capex
Vehicle Driven
Fleet • Note: this build represents IAA’s standalone business before applying an appropriate and
Age
proportional amount of corporate overhead
Buyer
Case
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 26
Valuation – Multiples Approach
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 27
Valuation – Upside-Downside Profile (and DCF Sanity Check)
Blended
Upside:
43.3%
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 28
Debunking Common Concerns
What About Gas Prices? Financial Crisis Supply Shock Autonomous Vehicles?
• Fluctuations in gas prices most • The recession era created an unfavorable • Has the potential reduce rate of
prominently affect trucks and hybrids, car buyers market which has had a accidents to near-zero levels in the
not so much light vehicles residual impact on salvage auto supply in distant future
• Distinction between discretionary 2009-2011 • No foreseeability, and current efforts
driving and mandatory driving • The Obama administration introduced a have led to significant controversy and
• Miles driven relatively inelastic Cash for Clunkers program to mitigate headline risk
due to mandatory driving this trough • Highly unlikely for affordable
• Modification in behavior is actually • Policy allowed drivers to swap their used autonomous vehicles to reach and
the #1 driver of changes in miles cars for new vehicles during the period penetrate the market in next 5-10 years
driven, not gas prices of 2009-2012 • Highly unlikely for the autonomous
• Significant modification in • According to industry experts, impact is vehicle market to materialize and drive
behavior is mostly likely during immaterial and idiosyncratic down accidents rates substantially in any
financial shocks or deep reasonable frame of time
recessions Number of Listings on IAA Website • For now, the salvage auto auction
by Model Year
• Even then, IAA and smaller business remains unchallenged
3000
competitors within used auto
2500
saw pricing power and volumes
2000
increase in these environments
1500
• Negative impact is mostly
1000
negated by positive tailwinds
500
brought on by the same
0
environment
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 29
Catalysts
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 30
Thank You!
Sohn London Idea Contest – KAR US Equity (IAA Spinoff) – Nelson Dong 31