KAR AUCTION SERVICES INC KAR
November 20, 2019 - 8:39pm EST by
Fletch
2019 2020
Price: 21.92 EPS 1.19 1.48
Shares Out. (in M): 129 P/E 18.5 14.9
Market Cap (in $M): 2,823 P/FCF 13.5 11.9
Net Debt (in $M): 1,547 EBIT 327 358
TEV ($): 4,339 TEV/EBIT 13.3 12.1

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Description

America and Europe. KAR facilitate an efficient marketplace by providing auction services for sellers of used, or "whole
car," vehicles and salvage vehicles through our 254 North American physical auction locations at December 31, 2018, and
multiple proprietary Internet venues. KAR is broken down into two segments: (1) ADESA, the whole car auction services
business, and is the second largest provider of used vehicle auction services in North America; (2) AFC is an important
provides floorplan financing to auction buyers, primarily to independent used vehicle dealers. Revenues are generated
through auction fees from both vehicle buyers and sellers, as well as by providing value-added ancillary services, including
transportation, reconditioning, inspections, marshalling, titling and floorplan financing.
 
Capital Structure & Relevant Financial Metrics
 
 
 
 
Recent History & Current Situation
â–ª In October of 2017, KAR acquired the remaining 50% in Traderev, a digital dealer- to- dealer vehicle appraisal and
auctioning system where dealers can launch and participate in real time auctions at any time
- Since its acquisition, Traderev has been intentionally unprofitable to penetrate the market
- FY:18 lost $53 million; FY 19 expected to lose $60 million; 2020 the loss is expected to moderate and
expected to break even in 2021
- Breakeven will require sales of 350k-400k cars on TradeRev, which would be at least double the 2019 sales
rate
- Analysts believe profitability can take longer than expected, due to competition in dealer to dealer channel
and operating expense pressures (Stephens Report, 5/9/19)
- TradRev EBITDA margins expected to be 25%, and margins on physical and other online businesses to be
50%
â–ª On 1/31/19, KAR completed the acquisition of CarsOnTheWeb (COTW), an online auction company serving the
wholesale vehicle sector in Continental Europe that seamlessly connects OEMs, fleet owners, wholesalers and
dealers
- The acquisition advances KAR’s international strategy and extends its strong North American and U.K.-
based portfolio of physical, online, and digital auction marketplaces
- This acquisition caused revenue to increase $30 million in 1Q:19 , along with incentives KAR has offered to
dealers
- Asia and Australia markets are potential long term expansions
â–ª The separation of IAA was announced in February 2018, and was completed on 6/28/19, making KAR a pureplay car
auction company
 
Business Trends
â–ª ADESA Revenue Drivers
- ADESA and AFC’s main source of revenue are auction fees and added service fees from both the buyer and
seller. These fees are being turned into free cash flow
- ADESA main sources of product are vehicles coming off lease; 15% are repossessions; 10% are from fleets;
and approximately 10% are from car rentals
- Physical auction volumes closely track leasing activity on a 3 year lag, which should give revenue stability
for at least the next 2 years
â–ª Revenue per auction vehicle has been increasing steadily for the past few years due to the increase in the services
- In 2007, ADESA was generating $465 per car sold from auction revenues. In 3Q of 2019, KAR generated
$893 at physical auctions. Of which, approximately $600 comes from additional “service fees”
â–ª TradeRev has strong and visible organic growth
- KAR leverages technology and data analytics for long term growth
 
- Even though Traderev has been a burden and losing money, KAR strongly believes it will be highly profitable
down the road
- KAR used the same strategy in 2011 with OpenLane, which is now the world leader in private label sales of
off-lease vehicles for the captive finance companies and any other source of leasing vehicles
- In Q3 2019, TradRev volumes slowed as KAR is putting profitable sales ahead of volume
â–ª Pulling back on incentives to drive profitable transactions
â–ª Company still expects a $60 million loss at TradeRev in 2019 and for that loss to moderate
â–ª Recent purchase of CarsOnTheWeb, gives KAR a toehold in Europe, which is another source of organic growth
â–ª Most CapEx is for technology. KAR is embracing more of digital technology in order to fend off any risks of
cannibalization of its physical auction services business
 
 
Why Does This Opportunity Exist?
â–ª With much time focused on the spin, the business suffered and KAR missed their 2019 targets
- Inventory loss due to fraud at High Tech Locksmiths while KAR expects to retrieve much of what was lost,
it impacted 2Q margins
- Softness of bidding by Independent Dealers in the 3Q of 2019
â–ª Volumes declined, as dealers were disciplined with their bidding, leaving many cars going unsold
in the 3Q
â–ª ADESA gross margins have declined
- Increased spend on TradeRev which is an investment into the future resulting in losses today.
TradeRev losses have hit their peak and should now be declining
Investors have assigned negative value to TradeRev while their largest competitor, ACV
(private) burns cash but was recently valued at over $600 million
TradeRev should be generating positive free cash flow on a run rate basis in 2021
- Channel shift away from physical and increase from online. Online sales (like COTW and Openlane) do not
come with the added “services” of the physical auction and therefore have a lower margin
- While this should continue in 2019, it is expected that managements new focus on margins will result in
improvements in 2020
Worries about Cyclical Headwinds
- Declining off lease vehicles, new vehicle retail sales, and dealers keeping more used vehicle trade-ins for
retail have investors nervous that it will eventually result in weaker industry whole car volumes
- While this will eventually be true, there are a few things that will counteract the cyclical headwinds
â–ª 3 year lag of leasing trends allows KAR to adjust their business before a slowdown actually hits
â–ª Secular growth from market share gains in Europe through COTW
â–ª Growth of large new markets through TradeRev. Management believes that TradeRev’s TAM is
9 million units, which includes some displacement from physical auctions as well as
approximately 5 million of new units
 
Valuation
Believe KAR’s shares are worth $28 share with upside to over $30 if they can execute and increase margins
- 8.5x 2020 EBITDA estimates (ex TradeRev)
- 13x 2020 FCF (ex TradeRev)
- $250 million value on TradeRev
â–ª Expect KAR to continue using FCF to buy back shares
 
 
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Progress from TradeRev

Stabilizing and growing margins

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