Description

RB Global

Situation Overview

Ritchie Brothers (RBA, or RB Global) is no stranger to the investment community. The business has been written up three times on VIC as a short and over the last twelve months, has been continuously in the headlines, for i) the contentious acquisition of IAA, an adjacent salvage auto auction business, ii) activists emerging for/against the company on this contentious acquisition, iii) a dilutive financing for this contentious acquisition, iv) firing of the CEO (and CFO) responsible for this contentious acquisition and v) a loss of the contentious acquisition’s major customer. Literally you can not make this stuff up. Without full context, any of these headlines would make a thoughtful investor run away from RBA as quickly as possible. However, despite this negative fact pattern and high degree of business disruption, RBA’s profitability has been inflecting sharply. I expect this inflection to continue to over the next 18 months and see RBA’s earnings power exiting 2025 approaching $5 / share. Not only is this well above street numbers (where analysts are anchoring to management’s guidance from the proxy for the IAA acquisition), but compares very favorably to a share price in the $60s. Once the noise around RBA dissipates, I believe the market will begin appreciating the earnings power of this countercyclical business. I can see the stock approaching ~$100 / share (20x $5 normalize EPS) over the next 18-months. Coincidentally, I believe within this time frame RBA will be included in the S&P 400 mid-cap index which could further catalyze RBA towards fair value.

At its core, legacy RBA is the dominant construction and commercial transportation equipment auction house. Auction networks are demonstrably high barrier-to-entry businesses, which requires significant time and capital investment (largely in the form of land) to attract buyers and sellers. Once established as the go-to venue, it’s very difficult to cede this position. RBA holds the #1 position in the used equipment auction markets, with an estimated 20% market share and a competitive position that appears to be only strengthening.

In recent years, the earnings power of the used equipment business has been constrained due to the ongoing supply chain challenges. Supply chain challenges have finally been easing and RBA’s used equipment auction business is now finally realizing the benefits. For context, legacy-RBA’s gross transaction value (GTV) grew 22% YoY in Q3. I believe GTV can grow another ~20% from current levels as used equipment volumes have yet to normalize (see chart below). GTV growth combined with the operating leverage inherent in the business should punctuate the overall earnings power of RBA.

Similarly, IAA’s results have been constrained by lower than normal salvage volumes as higher used car prices have crowded out accident vehicles being deemed a total loss. Constrained volumes coupled with market share losses have led many market participants to perceive IAA as being a broken business. Fortunately, like legacy RBA, IAA’s volumes are normalizing. Moreover, I believe a turnaround in the IAA acquisition is well underway. Specifically, in our discussion with customers, underlying customer KPIs are improving. Assuming IAA’s execution continues to improve on the same trajectory, I believe there is a shot we will be talking about IAA stabilizing market share and potentially even gaining share. 10-years ago, IAA / Copart shared the market 50/50. Today, it’s closer to 75/25, a dynamic no customer really wants.

Ultimately, the combination of overall RBA earnings inflecting, IAA stabilizing and the ongoing noise from the IAA acquisition dissipating, should turn the broader market back on to this high quality, countercyclical business trading at a very reasonable price. Better, if we can get some share shift on the IAA side, the market will stop fretting about IAA and focus on the strong tangible underlying results. Dare I even say it, but RBA can easily regain “compounder” status.

Lastly, if someone reading this knows Todd at Berkshire can they please pass him this write up. Not only is RBA a business that has a lot of characteristics that Berkshire seeks, but more importantly, Berkshire can create a lot of value here. Berkshire should buy a stake and then give IAA a second chance to manage GEICO salvage volumes. I believe many of GEICO’s issues with IAA have been resolved with RBA’s incremental yard capacity. Moreover, IAA is now being managed by a competent team with Jim Kessler at the helm. He understands service and what it takes to satisfy customers. If RBA were to announce that they recaptured some GEICO volumes, the overall perception issue with the business would immediately disappear. Not only would this give the market some confidence that IAA is not a broken business (and value RBA appropriately), but the customer win could be used by RBA as a propeller to gain further share with other customers. Berkshire makes money and IAA’s franchise strengthens. Win-win.

RBA Overview

RBA’s business is nearly evenly split, in both revenue and GTV terms, between Legacy RBA and IAA.

Legacy RBA

Legacy RBA primarily makes money by collecting fees for acting as an agent for consigned used equipment and by selling additional services supporting the overall transaction (financing, appraisals, inspections, logistics, etc.). Approximately ~45% of the fees RBA receives are tied to sellers commission, ~30% are largely related to buyer fees and the remaining ~25% are tied to marketplace services. Seller commissions are a function of price and volume, buyer fees are more volume driven and marketplace services are largely volume driven.

Construction and commercial transportation assets comprise the majority of the equipment sold by GTV dollar value, though RBA sells a wide variety of assets, including agriculture, energy and mining capital goods.

Customers selling equipment through RBA’s auction channels include end users (such as construction companies), equipment dealers, original equipment manufacturers and other equipment owners (such as rental companies). The buyer base is highly fragmented and ranges from individuals looking to buy a one off piece of equipment to equipment dealers looking to retail equipment sourced from Ritchie. 

From 2017 to 2022, RBA’s organic GTV growth has been 5% (combination of price and volume). This level of normalized growth should be expected to continue. Moreover, given RBA’s #1 position for used equipment and the customer fragmentation, RBA has incredible pricing power and has seen its take-rate increase over time. The underlying GTV growth combined with pricing power (RBA utilizes) should support mid-to-high single-digit organic revenue growth for legacy RBA over-time. In turn, operating profit at RBA should grow at a normalized low-double digit level. 

IAA

IAA is the second largest U.S. auto salvage auctioneers/marketplaces and primarily serves as a disposition channel (mainly on a consignment basis) for insurance companies looking to sell vehicles that have been in a collision. The U.S. auto salvage industry can be characterized as a duopoly between IAA/ Copart, and this industry is driven by the number of vehicles that get salvaged annually. The key inputs that dictate this are miles driven, collision frequency, and salvage rates, which have historically combined to provide a favorable tailwind for the industry over the long-term.

Unlike legacy RBA, which has a relatively diverse source of revenues, 80% of IAA’s revenues are derived from buyer fees. Buyer fees have a large fixed component and therefore largely volume driven. I emphasize this point given the historic move in used car pricing. IAA showed little leverage to used car pricing on the way up and the same will hold true on the way down. Moreover, salvage values have proven to be less volatile than whole car used values.

IAA auction customers broadly fall into three categories: i) scrap buyers (i.e. people looking to liquidate salvage vehicles for commodity / part value); ii) refurbishers (i.e. people that think the insurers have it wrong and that the value of the repaired vehicle after repairment is higher than the salvage vehicle); and iii) international buyers (largely into emerging markets like Africa where driving safety standards are lower than North America).

From the time of IAA emerging as a public company (spun out of KAR in 2019) through 2022, IAA compounded EBITDA at ~10%. IAA was able to achieve this growth despite the challenging industry volume conditions; less cars were deemed salvaged due to the inflated used car pricing environment. This headwind is now turning into a tailwind, which should punctuate industry volume growth over the next two years (discussed further below).

Recent History

There have been several discrete events over the past twelve months that have negatively impacted the perception of RBA amongst public investors. As these concerns dissipate, investors will begin to appreciate the solid underlying earnings power of the business.

Contentious acquisition

To say RBA’s acquisition of IAA has been contentious is an understatement. The acquisition was announced in November 2022, but between the initial acquisition announcement (November 2022) and the final transaction close (March 2023), Luxor and a handful of other investors came out against the deal. Similarly, Ancora and Starboard came out supporting the deal, albeit Starboard’s support came with a dilutive preferred share that was not broadly offered to investors.

Ultimately, in the end, RBA investors were split on the transaction, with 46% of shareholders voting against the deal. Based on the sheer number of “no votes”, it’s clear that investors are not willing to place any potential value creation surrounding IAA, creating an opportunity for a patient investor.  

Firing of the CEO

In August 2023, Ann Fandozzi, the CEO who spearheaded the acquisition of RBA was let go over a compensation dispute with the board. Our diligence found nothing nefarious. Our checks indicated that Ann was demanding a significant option package. Based on anecdotes, it sounds like she ultimately overplayed her hand, thinking she had a captive board, while the board ultimately stood up against her demands. CEO turnover after such a transformative acquisition does not screen particularly well for investors and I don’t expect the market to be giving RBA any benefit of the doubt. This creates an opportunity for a patient investor.

Moreover, part of my reason for pitching this idea on VIC is the checks on the new CEO, Kessler, who was the previous COO, have come back incredibly strong. It’s clear not only did the board see issues with Ann’s compensation demands, but they also identified someone strong in Kessler who could lead RBA. Paragon Intelligence put out a good report summarizing a bunch of checks on Kessler, the vast majority ofwhich were a screaming endorsement. If you’re interested in this idea, that report is worth getting your hands on.

Announcement of a Loss of a Major Customer

So far, the event pattern for RBA should read horribly to you. A contentious acquisition and the CEO behind the acquisition fired within six months of closing the transaction. Unfortunately….it gets worse. Less than three weeks ago, on RBA’s Q3-23 earnings call, the company announced a loss of an IAA customer that represents 3% of consolidated RBA revenues. Right when the company was beginning to make inroads with investors and the market was warming up to Kessler, this news completely soured all goodwill brewing, tanking the stock more than 10%. 

It’s no secret now that the lost customer was USAA. While a lost customer will not inspire any confidence of an IAA turnaround, I think this customer loss is a one-off and does not foreshadow how many remaining IAA customers will behave.

The story we pieced together on USAA is relatively consistent with what HonkeyRed shared in a recent short Copart VIC pitch. Specifically, IAA underperformed title procurement KPIs for USAA. This is noteworthy as outside of USAA, IAA only does title procurement for 16 customers, which account for approximately ~2% of IAA’s total automotive volumes. Also important, is that IAA started hitting their title procurement KPIs in the third quarter, but this was too little too late. Lastly, we understand the new decision maker at USAA came from Nationwide, which is a Copart exclusive account. Therefore, I’m not trying to make excuses, but the combination of legacy underperformance of a specific KPI, a weak relationship with IAA, sprinkled with the aforementioned top of the house disruptions was enough for USAA to shift. My checks with carriers indicate that IAA’s performance continues to improve (discussed further below) and this loss of USAA appears like an isolated incident.

IAA Idea

In order for investors to value consolidated RBA appropriately, IAA must show stabilizing to improving market share trends. Ultimately our diligence leads us to conclude that not only should IAA’s market share stabilize, but there is a strong possibility that IAA will start gaining share over the next 18-months.

Most importantly, our diligence has led us to conclude that IAA does not have a structural disadvantage versus Copart. Our view is IAA’s legacy share loss is attributable to poor execution / operational missteps which have largely been addressed or are currently being addressed by RBA in the acquisition. Specifically, RBA brings two crucial elements to IAA:

• Capacity. The underinvestment in capacity has been one of the main culprits of IAA falling behind. The RBA-IAA combination doubles each other’s yard footprint. As RBA auction yards are fully utilized less than 50% of the time, this provides ample additional capacity for IAA, especially useful during catastrophic (CAT) events.
• Competent management team. We think the new CEO, Jim Kessler, is well-suited to execute a turnaround given his track record at ABRA (collision repair business; same customers but more complex operations).

We spoke to 10+ insurance carriers during our channel checks, the overwhelming consensus was that there was no meaningful difference in performance levels between IAA and Copart:

• IAA and Copart have comparable performances across pickup time, cycle time, ASPs, and ultimately net returns.
• Copart has higher average ASPs because they sell whole cars while IAA historically could not because of its non-compete with ADESA. If you adjust for whole cars, ASPs are in the same ballpark. This makes intuitive sense because if you’re a buyer, you will most definitely visit the two largest salvage auction sites to bid / compare prices.
• Copart has clearly played the long game and made better decisions that paid off in the long-term whether that be investing in overflow capacity to service CAT events, aggressively expanding their real estate footprint, operating larger yards, and bringing tow trucks in-house.
• Copart is the better operator with better service quality. We have heard they have more responsive sales reps, have quicker decision making from senior execs, and runs with a much leaner cost structurer than IAA.
• Insurance carriers want to maintain a two-player market for all the commonsense business reasons. It is not the case where Copart delivers significantly better returns so that there is no need for a second player.

If IAA’s performance is comparable with Copart, then why did they lose all this share?

• The market share loss over the last 2-3 years was primarily driven by one customer, Geico, shifting most of its volume to Copart. Our sense is that the decision to leave was driven by IAA dropping the ball during one specific CAT event 5+ years ago.
• Notably, Geico was the only customer that cited there was a clear difference in net returns between Copart and IAA. Even then, we have heard this was not a huge difference and that they have seen an improvement in IAA’s service levels over time.
• No other carrier we spoke to complained about IAA’s CAT response. This checks out with what RBA management has been saying – data from insurance carriers show similar performance levels between IAA and Copart.
• Allstate and Travelers are exclusive Copart accounts. Interestingly, the main reason they went exclusive with Copart was not because of performance, but because of the online offering, which IAA was clearly behind at the time (7-10 years ago). We now understand that IAA’s online offering is comparable to Coparts which could open the possibility of some share shift as customers may want to diversify for vendor risk management purposes.

IAA growth?

IAA’s growth drivers are truly independent of economic factors. The key drivers of growth are miles driven, accident rates and total loss rates (i.e. salvage rates). Furthermore, there’s an argument to be made that IAA is even countercyclical. The reason being is that salvage volumes tend to increase when used vehicle pricing decreases. When used car prices are lower, a car is more likely to be deemed total, as the salvage value will exceed the value of the repaired vehicle, net of repair costs. Case in point, in 2007-2009, IAA’s revenue grew 7% / year and EBITDA grew >20% / year.

There are underlying secular tailwinds that support higher salvage rates.

• Growing fleet and age of the car parc: Today the average vehicle on the road exceeds 12 years and there are 285 million vehicles on the road. This compares only 250 million vehicles registered a decade ago with an average age of 11 years. As vehicles become older, the likelihood of salvage increases.
• Vehicle complexity / repair costs: Average repair costs per vehicle are up >50% versus a decade ago. This is due to increase vehicle complexity (EVs, ADAS, composites, etc.). Rising repair costs relative to used car values have contributed to increasing units sent to salvage

In 2010, total loss rates were 15% (i.e. 1 in 8 vehicles in an accident were deemed totaled). Pre-COVID rates reached nearly 22%. Total loss frequency troughed near 17% about 18 months ago and today we’re at 19%. As supply chains and used car prices normalize, we should see a reversion towards historical total loss levels. Eventually loss levels will exceed pre-COVID levels given the aforementioned secular tailwinds. Simple reversion in the total loss ratio suggests 15% growth (22%/19%-1) in IAA volumes and should provide a cyclical tailwind over the next 18-24 months.

RBA Idea

RBA growth?

RBA is experiencing a normalization in volumes. Today, used inventories in its two largest categories, construction equipment and commercial vehicles are ~50% and ~20%, respectively, below 2019 levels. While used prices will likely soften, RBA benefits from volumes in a similar fashion as price, as there are marketplace service revenues associated with volumes. It’s not unreasonable to believe that just a reversion in volumes to pre-COVID levels, offset by some price, can drive 20% growth in GTV / revenues. This is very similar to the dynamic we saw in the most recent quarter (see chart from Q3-23 deck below).

Synergies

All of our checks around Jim Kessler have been extremely positive. He gets investing for growth, being a leader but is still described as incredibly cost-conscious. Most importantly, he takes ownership for the synergies laid out at the time of the acquisition in the December 2022 proxy. Based on the proxy, there are still about $70 million of synergies to be realized, all of which sounds very reasonable (executive overhead, back office, procurement and real estate).

Valuation

Current run-rate

Consolidated RBA in Q2-23 earned $308 million, Q3-23 earned $286 million and in Q4-23, the company is guiding to an implied >$300 million in EBITDA. Therefore, consolidated RBA is currently run-rating at $1.2 billion in EBITDA. 

Volume reversion

As discussed above, volume reversion tailwinds in both legacy RBA and IAA should drive 20% and 15% growth, respectively. This gets us to 18% growth in service revenues. Let's assume it takes two years for this revision to play out.

The loss of USAA represents 3% of consolidated revenues

18% - 3% = 15% growth in service revenues

2023e service revenue = $3.15bn

$3.15bn x 15% = $500 million in incremental revenues

$500 million @ 50% incremental EBITDA margins  = $250 million in EBITDA in 2025e vs. 2023e

Synergies

$70 million remaining, as spelled out by the company in their December 2022 acquisition proxy materials

Consolidated EBITDA

$1.2 billion + $250 million + $70 million = $1.5 billion in 2025e EBITDA

Equity valuation

• Current net debt of $3bn. Assume all capital generation goes to deleveraging. Capex cycle over the next two years to realize synergies will reduce FCF generation below normal levels. Average debt balance in 2025 should be $2.4 billion
• Legacy RBA and legacy IAA have historically traded at 15x NTM EBITDA. Appears fair not only versus history but also in the current market
• $1.5bn x 15x = $22.5bn enterprise value. Less $2.4bn in net debt equates to $20 billion equity value
• Assume Starboard prefs are fully converted, so total shares outstanding is 190 million
• $20bn / 190 million shares = ~$100 stock

Normalized FCF per share

• $2.4bn average debt balance. Assume expensive acquisition financing is refi’d to an appropriate level so cost of debt is 6.5%. So normalized interest of $160 million
• Maintenance capex of $150 million
• SBC of $50 million
• $1.5bn - $160 million - $150mm - $50mm = $1.14bn EBT
• 23% effective tax rate
• Normalized FCF of $880 million
• RBA should be in a position to buyback stock in 2025. If we assume the company maintains its leverage target of 2.0x, we see that on my 2025 numbers, average leverage will be in the 1.6x area ($2.4bn net debt vs. $1.5bn EBITDA). This means RBA can buy back ~$500 million in stock (0.4x $1.5bn). For conservatism, lets assume this offsets Starboard’s pref ($73 / share conversion price). That means total shares outstanding will be approximately 183 million.
• Interest headwind of $500mm x 5% (6.5% interest expense, tax effected) = $25 million
• $855 million in adjusted net income / 183 million share = $4.70 in FCF per share in 2025
• A counter-cyclical business that has historically been able to grow double-digits before capital allocation should be worth ~20x. Again, that gets us to fair value in the $100 area.
• 20x is where the street currently has RBA trading, so this effectively assumes no multiple expansion. I do note that over the last 10-years, RBA has traded on average closer to 30x earnings, suggesting a decent margin of safety if I’m in the right ballpark on numbers. 

All in all, I believe RBA is an attractive risk/reward for a high-quality, countercyclical business. Again, if someone knows Todd, could you flag this opportunity to him?

Catalyst

- IAA market share stabilization/gains

- Index inclusions 

- More than 12 weeks without anything insane happening at the company?