UNIVERSITY OF OREGON
INVESTMENT GROUP
10-29-2010
CONSUMER GOODS
KAR Auction Services
HOLD
Stock Data
Price (52 weeks)
Symbol/Exchange
Beta
Shares Outstanding
Average daily volume
(3 month average)
Current market cap
Current Price
Dividend
Valuation (per share)
DCF Analysis
Comparables Analysis
Target Price
Current Price
11.03 – 15.84
KAR / NYSE
1.51
134.6 M
158,409
1.744 B
$12.96
N/A
10.3 (60%)
17.9 (40%)
$13.31
$12.96
Summary Financials
Revenue
Net Income
Operating Cash Flow
2009A
1,730M
23M
312M
BUSINESS OVERVIEW
KAR Auction Services was organized on November 9, 2006 in the state of Delaware for the sole purpose of
consummating a purchase of ADESA, Inc. and combining Insurance Auto Auctions, Inc (IAAI) with ADESA. These
are two secondary vehicle auction companies. With these two companies, KAR is the only corporation with
significant market share in both the whole car auction and salvage car auction segments in North America. The
Covering Analyst: Bryceson Charlton
Email: bcharlto@uoregon.edu
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational.
Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be.
Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG’s portfolio. In
addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG’s portfolio.
KAR Auction Services Inc
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company completed its IPO on December 11, 2009 at $12 per share while this was below the expected $15-$17 range.
KAR operates in three business segments; ADESA, IAAI, and AFC.
Business Segments
ADESA - (63% of Revenue)
ADESA is the second largest provider of whole car auctions in North America. They run
auctions both live at their auction sites and online through their website. They have 62 auction
facilities, which are located to draw professional sellers and buyers together and allow the buyers
to inspect their targeted vehicles. The online auction allows even more buyers to look at the car
which is a benefit to the seller as more demand is generated. The type of vehicles sold through
ADESA auctions are from institutional customers, which include off-lease vehicles, repossessed vehicles, rental
vehicles, and others. Revenue generated from this segment is a fee basis on each car sold. This fee is usually around
330$ being split by the buyer and seller. ADESA also supplies ancillary services which account for around 200$ per
transaction if the customer decides to use it.
Insurance Auto Auctions, Inc - IAAI (32% of Revenue)
This is the salvage vehicle auctions segment for KAR where they currently have 152 auction
facilities. These include damaged vehicles designated as a total loss by its insurance company, stolen
vehicles where an insurance claim has already been settled, and older model vehicles which car
dealers no longer want. The buyers of these cars include body shops, rebuilders, used car dealers,
automotive wholesalers, dismantlers, and others. Auctions are usually held weekly and vehicles are
marketed at each auction site as well as online. The competitive market allows the vehicle to raise
its auction price which gives KAR more revenue as fees increase. The revenue generated from this
segment is by fixed fee and percentage of sale. Usually larger insurance companies obtain a fixed fee for each car sold
while individuals or dealers use a percentage of sales. Other fees KAR collects on include towing, title processing, and
other administrative services (ancillary services).
Automotive Finance Corporation - AFC (5% of Revenue)
AFC is a provider of floorplan financing to independent used vehicle dealers. This provides
customers of both ADESA and IAAI direct short term inventory-secured financing to independent
used vehicle dealers. AFC has 87 branches all located either in the auction facilities or close by. In
2009, AFC arranged 799,421 loan transactions at 110$ per transaction. The number of loans was
down from the previous year however rates were up.
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Initial Public Offering
ADESA entered the vehicle redistribution industry in 1989 and first became a public company in 1992. In 1994,
ADESA acquired Automotive Finance Corporation. Between 1995 and 2000, ADESA acquired Impact Auto
Auctions, Ltd., a salvage auction chain in Canada. ADESA remained a public company until 1996 when ADESA was
acquired by ALLETE, Inc. (“ALLETE”). Since then, ADESA has grown the business, organically and through
acquisitions, into a leading vehicle redistribution company in North America. In 2004 ADESA completed another
initial public offering and remained a public company until its merger with KAR Holdings in 2007. – 10k
IAAI was originally organized as a California corporation in 1982 under the name Los Angeles Auto Salvage, Inc. In
1990 all of the outstanding capital stock of the company was acquired in a leveraged buyout. In 1991 the company’s
name was changed to Insurance Auto Auctions, Inc. and the company completed an initial public offering. Since then,
IAAI has grown the business, organically and through acquisitions, into a leading provider of salvage vehicle auctions
and related services in North America. In 2005, IAAI was purchased by a group of private equity investors, some of
whom consummated the merger with ADESA, Inc. in 2007. – 10k
ADESA was taken private in 2007 by investors’ Kelso & Co, GS Capital Partners (affiliate of Goldman Sachs),
ValueACT Capital and Parthenon Capital. The purchase price from these investors was 3.7 billion which included the
contribution of IAAI and 700 million dollars of debt from these companies. As of June 2010 Goldman Sachs still
owns 20% of shares outstanding for KAR auction services.
BUSINESS AND GROWTH STRATEGIES
Dealer Consignment - The car auction industry is very mature. Therefore KAR Auction Services’ main goal is to
acquire market share. They hope to do this by first growing their dealer consignment business which is to obtain more
vehicles from car dealerships. KAR is having local auction representatives who are familiar and skilled in
communicating with local car dealers communicating to them the technology and live advantages you receive at
ADESA. They feel these services will be adequate to receive their business.
Increase Number of Salvage Vehicles - 12 million vehicles are de-registered every year, usually this means they are
not useable any longer. Only 3.5 million of these are run through the salvage auctions. IAAI is pursuing more of these
vehicles from the non insurance side (rental car, captive finance, and fleet companies). ADESA already has a good
client base of these companies and good relations. This can hopefully give IAAI the edge needed to receive some of
their business.
Revenue growth - ADESA and IAAI grew revenue annually by 5.1% and 3.1% respectively from 2004 through
2009. This is mainly due to the increased use of ancillary services, fee increases, and new product offerings. The
ADESA segment uses more of the ancillary services than IAAI because of the clientele. They plan to continue
growing revenue by increasing customer utilization of the existing ancillary products. They also plan to increase the
number of vehicles offered online and at their current physical auctions. IAAI is the only national salvage auction
company that offers its customers both live and online car auctions.
International – KAR feels they are in a good position to grow internationally, already having two ADESA auction
sites in Mexico City and Guadalajara. They have international customers already in their online bidding system which
is provided in multiple foreign languages. Buyers of KAR’s auctioned cars range from over 100 countries. The
company has only said they “will continue to assess acquisition and Greenfield expansion opportunities in selective
markets” for exploring the international market. I have not heard or read anything on them looking to expand outside
the North America market.
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ADESA – tends to be more cyclical with new car sales. This is due to if new cars are not being bought, there will be
less used car sales and leasing which is the main driver for ADESA. For the last two quarters, they are down 7% in
number of transactions; however because of the lack of supply, demand for these used cars rise. This leads to an
increase of 4% for company revenue since vehicles generate a higher sales price, giving ADESA higher margins. This
partially offsets the decrease of transactions.
Floorplanning loans - AFC intends to selectively grow by using ADESA and IAAI to capitalize on cross-selling
opportunities. They plan to tailor their services to individual car dealer’s needs. ADESA and IAAI locations provide
the expanding opportunities that AFC is looking for. There are currently 87 AFC branches, of that 55 are physically
located at auction sites while the rest are in close proximity. An addition of branches could be added to current
auction sites with no AFC services close by.
Services (KAR’s 10k)
The following are the extra service KAR is able to provide their customers at their auctions.
ADESA Ancillary services
 Marketing and advertising for vehicles to be auctioned
 Vehicle registration
 Condition report and detailing/body work
 Provide inbound and outbound transportation of vehicles
 Provide value-added market analysis to customers
IAAI Ancillary services
 Hybrid auction model which allows both live and online buyers to bid on a vehicle
 If a totaled vehicle is received by IAAI it will remain at their facility but cannot be auctioned until the title has
been submitted for transfer and processed by IAAI
 Provide inbound and outbound logistics
 Maintain vehicle inspection centers at most facilities which store and inspect vehicles
 Ability to streamline title process for vehicles, reducing processing time
Technology services
 ADESA LiveBlock – Allows registered buyers to participate in live auctions online against buyers at the
auction site.
 ADESA Market Guide - Provides wholesale auction prices, auction sales results, market data and vehicle
condition information.
 i-Bid LIVE – live auction internet bidding for salvage vehicles. Provides buyer with real-time streaming audio
from live auction and images of salvage vehicles.
 CSA Today – enables insurance company suppliers to enter vehicle data electronically and then track and
manage progress of salvage vehicles in terms of both time and recovery dollars. This provides them their
current total-loss data.
Risk Factors
Debt – KAR Auction Services has debt fair valued at 1.95 billion as of June 30, 2010. With a market cap of under 1.8
billion, this debt is a very substantial amount of this company. Management has already stated that reducing this debt
is one of their main priorities. Since 2008, they have paid off close to 500 million of it. Nonetheless, with their current
portion this can limit their ability to borrow additional funds for any reason including future acquisitions or capital
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expenditures. Also, free cash flow is reduced in paying off this debt. Some of their senior secured credit facilities are at
variable rates of interest which can negatively affect the company if there is an increase in interest rates. Moody’s has
currently upgraded the company’s credit rating to B2 which is in the junk bond rating. If economic downturn
continues this may affect KAR’s cash flow which could cause them trouble in making their debt payments.
Used Vehicles - During the recent economic downturn, demand for used and new vehicles was lessened by a
substantial amount. This caused the number of vehicles at an auction to decrease affecting their revenue. With lack of
availability of consumer credit, this minimizes the number of buyers and decreases the demand for used vehicles.
Salvage vehicles – If numbers of miles driven per car decreases this could also decrease the amount of salvage
vehicles for IAAI. Another factor is when commodities such as steel and platinum decrease, it can also decrease
vehicle values lowering KAR’s commission and the demand for these vehicles.
Peer to Peer – KAR Auction Services competes with Mayhem and Copart directly; however, other sources of
auctions including SmartAuction, OpenLane, and Ebay Motors also take away business. While they do not have any
meaningful physical presence, they are still a threat to KAR’s future business. Although these companies haven’t
grasped a sufficient market share of the type of vehicles sold in KAR’s auction; it is still a concern for investors going
forward.
MANAGEMENT AND EMPLOYEE RELATIONS
KAR – James Hallet is the CEO and director. Mr. Hallet started at the company in 1993 as president of ADESA
Canada. He served various roles included President and CEO in multiple terms. Except for a two year period he has
been with ADESA or KAR since 1993. Previously he was CEO for ADESA from 2007 to 2009.
ADESA – Thomas J. Caruso has been the President and CEO of ADESA since September of 2009. He has been
with the company since 1992 and was Chief Operating Officer of ADESA before he became the CEO.
IAAI – Thomas O’Brian has been the President and CEO since 2005. O’Brian recently sold around 250,000 shares in
September at 11.8 a share. He is also a director of First American Corp, a separate title insurance company.
AFC – Donald Gottwald is the current President and CEO of AFC. He was hired on December 10, 2008. Prior to
this he was the vice president at HSBC Auto Finance and before that he worked at GMAC Financial Services for 12
years.
RECENT NEWS
10-21-2010 – KAR Auction Services, to announce third quarter 2010 Earnings. The earnings will be released on
Wednesday, November 3rd. It will host its conference call the next day.
10-20-2010 - Moody’s Lifts KAR Auction outlook on expected debt reduction. Moody’s Investor Services lifted
its outlook on KAR to positive from negative, moving away from a possible downgrade because of “considerable
improvement” in key credit metrics and an expectation that the company will continue to lower debt near-term. Since
2008 KAR has cut outstanding debt by about 500 million.
9-1-2010 – KAR Auction Services, Inc. Announces Participation in Upcoming Investor Conference. KAR gave
a brief presentation on their company and how they generate revenue. They also informed investors of the market
share alignment and where their industry is compared to the past. A replay of this will be on their website.
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INDUSTRY
Auto Wholesaling/Leasing - The online and live car auction industry is a small and mature industry. KAR already
has 22% of the whole car market share and its 2009 sales were around 1 billion to give you a scope on the total market
size. The two main factors for these companies are automobile wholesaling and auto leasing. When more new cars are
bought it means more used cars are also sold which increases the vehicles ADESA has an opportunity to sell. As for
auto leasing, leasers will get rid of a certain vehicle when it reaches a general mileage. If leasing is up streaming then
KAR looks to have more business from these auto leasers. Positive Trends include: increase in number of households
with more than one vehicle, car manufacturing improvements which allow vehicle lifespan to be longer, giving auction
services a larger market. Affordability of used vehicles related to new vehicles. IBISWorld projects the wholesaling industry to
increase 3.5% annually until 2015. It also projects auto leasing to increase 3% annually in the same time period.
Salvage Auction Industry – Has increased at an estimated annual growth rate of 2%. New vehicles are becoming
more complex (airbags and electrical components) this causes them to be more costly when repairing. Therefore,
insurance companies should deem them a total loss and IAAI’s services should be in higher demand.
Market Share - The market share for used car auctions is consolidated. Manheim, a private competitor to ADESA,
represents 50% of the whole car auctions in North America. ADESA is second with 22% while no other competitor
is over 3%. ADESA has increased from 18% in 2006 to its current portion in 2010.
The salvage industry is just as compacted with Copart leading with 37% and IAAI having 35%. No other company
represents more than 10% of the market. IAAI has increased its market share by 2% since 2006.
Number of Vehicles (Image below) - There are currently around 270 million vehicles in operation in the US and
Canada. Of these, 10-15 million new vehicles are registered into the countries each year. Around 12 million lose
registration and around 3-4 million units are taken to salvage auctions from this 12 million. There are also around 40
million used vehicle transactions per year. Of these, 9 million units are auctioned off; however, this number does not
include online transactions (online auction).
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S.W.O.T. ANALYSIS
Strengths

Only vehicle auction company with large presence in both the whole car auction and salvage vehicle market

Leader of industry technology with its hybrid auction program
Weaknesses

Large amount of debt lessens the chance of expansion

They are in a mature industry which does not have high growth in future revenue
Opportunities

Opening two auction sites in Mexico could create an undiscovered market for KAR

Only 30% of de-registered vehicles are sold in auctions
Threats

If debt payments are not met, possible bankruptcy could occur

Peer to peer vehicle sales such as EBay Motors or Craigslist could lessen their transactions.

Auto industry could continue to decline
PORTER’S 5 FORCES ANALYSIS
Supplier Power – Low
Supplier power is limited as KAR does not have any one supplier who provides more than 5% of its vehicles.
Barriers to Entry - High
Investment in technology and infrastructure are the main barrier to industry. Companies must comply with regulatory
requirements that make it difficult for new entrants to build their operation. Larger companies also have existing
relationships with many of the suppliers and buyers.
Buyer Power – Low
No current customer provides more than 4% of KAR’s revenue. They have a very diverse base of buyers as previous
mentioned in the business segment. When lower numbers of vehicles are supplied, demand will go up giving KAR
increased margins.
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Threat of Substitutes – Medium
ADESA must provide a set of services or ease through their auctions to receive business from Auto Dealers who
could just continue to keep a vehicle on their lot. During the current economic downturn many car dealerships were
keeping older vehicles (usually the one’s they send to ADESA) and trying to sell them on their own. The reason for
this was the low vehicle turnover during the downturn made them try to get a commission on these cars where in a
normal economy they are not worried about them. EBay Motors and Craigslist could potentially become a substitute.
Degree of Rivalry – Medium
Manheim currently has a 50% market share in the whole car auction industry. Management feels that the customers
would like to see this gap shortened and have a more equal ratio. IAAI as has been stated is the only salvage auction
to provide live and online auctions of the same vehicle to customers. They feel this puts them ahead of their rival
Copart for the future.
CATALYSTS
Upside

Demand for New Cars and Leasing Vehicles goes up

If company continues to pay off outstanding debt credit rating will rise
Downside

New vehicle sales decrease, supply of vehicles at auctions will decrease

If company doesn’t continue to deleverage itself it could leave investors afraid of the stock
COMPARABLE ANALYSIS
Finding comparable companies for KAR was difficult as a result of its unique debt structure, future growth, and only
one true competitor that is public. I selected companies with a variety of traits I felt were comparable to KAR. All but
one of these companies are in the auto industry as they have equivalent risks and market exposure as KAR.
The metrics I used were EV/Revenue, EV/EBITDA, and EV/FCF. These metrics will proficiently measure KAR’s
ability to generate sales, margins, and free cash flow compared to that of the comparables. I took out GPI’s multiple
for FCF because I felt it was an outlier. With that said I decided to weight my Comparable Analysis only 40% because
of the difficulty of finding good comparables with similar growth outlook as KAR.
Copart, Inc – CPRT (25%) Copart is a provider of online auctions and vehicle remarketing services
in the United States, Canada and the United Kingdom. It provides vehicle sellers with a range of
services to process and sell vehicles over the Internet through its Virtual Bidding Second. - Reuters
Copart is IAAI’s main competitor with a 37% market share in the salvage vehicle business. They are
similar in market cap with KAR; however, they do not have any long term debt. This is why they have a similar
weighting to the other comparable companies, because of their difference in equity structure to KAR.
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AutoZone Inc – AZO (25%) AutoZone is a retailer and distributor of automotive
replacement parts and accessories. The Company also has a commercial sales program that
provides commercial credit and prompt delivery of parts and other products to local, regional
and national repair garages, dealers, service stations and public sector accounts. The Company also sells the
ALLDATA brand automotive diagnostic and repair software. Additionally, it sells automotive hard parts, maintenance
items, accessories and non-automotive products. – Reuters
AutoZone has the most similar future growth estimates as KAR, which is why they are rated so high. Its business also
targets technology for its products on its websites, which is a current and future focus of KAR.
Penske Automotive Group Inc – PAG (15%) Penske Automotive Group is an
automotive retailer. Each of its dealerships offers a range of new and used vehicles for sale.
In addition to selling new and used vehicles, the Company generates revenue at each of its
dealerships, through maintenance and repair services, and the sale and placement of
products, such as third party finance and insurance products, third-party extended service
contracts and replacement and aftermarket automotive products. – Reuters
PAG experiences the supply effects of used vehicles much like KAR. If credit is hard to obtain their business is likely
to suffer a lack of demand. They have a very similar enterprise value as KAR and even more debt which shows in
their beta of 1.98 the highest of the comparables.
LKQ Corporation - LKQX (10%) LKQ provides replacement systems, components, and parts
needed to repair vehicles (cars and trucks). The Company provides alternatives to original equipment
manufacturers collision products, and provides mechanical replacement parts used by collision and
mechanical automobile repair businesses. - Reuters
I picked LKQ as a comparable because of its placement in the vehicle repair industry, especially with
salvage parts and similar enterprise value to KAR. With its low debt and what seems to be a less risky investment I
decided to only weight LKQX at 10%.
Group 1 Automotive, Inc – GPI (10%) Group 1 Automotive, Inc. operates in the
automotive retail industry. The Company owned and operated 124 franchises at 95
dealership locations and 22 collision service centers in the United States. Through its
operating subsidiaries, the Company markets and sells a range of automotive products and services, including new and
used vehicles and related financing, vehicle maintenance and repair services.” – Reuters.
GPI was chosen because of its industry, similar debt to equity and enterprise value to KAR. It also deals with
financing vehicle loans and repair services.
HSN Inc – HSNI (10%) - is an interactive multi-channel retailer offering retail experiences
on television (TV), online, in catalogs and in retail and outlet stores through its two operating
segments, HSN and Cornerstone. HSN is a retailer and interactive lifestyle network offering an
assortment of products through television home shopping programming on the HSN
television network and through its business-to-consumer Internet commerce site HSN.com. Cornerstone comprises
home and lifestyle brands, distributes over 200 million catalogs annually, operates seven separate Internet sites, and
operates 23 retail and outlet stores.” - Reuters
HSNI is the one comparable that is not in the same industry as KAR. With that said I felt they were a good
comparable mostly because their products are bought via auction online as KAR’s are. Also it has the most
comparable Gross and Net Margins to KAR. Its downside of course being that it’s not affected by the auto industry,
although it is affected by disposal income not unlike KAR.
America’s Car-Mart, INC – CRMT (5%) “America’s Car-Mart, Inc. is an automotive
retailer in the United States focused exclusively on the Buy Here/Pay Here segment of the
used car market. The Company’s operations are principally conducted through its two
operating subsidiaries, America’s Car-Mart, Inc. (Car-Mart of Arkansas) and Colonial Auto
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Finance, Inc. (Colonial). The Company primarily sells older model used vehicles and provides financing for
substantially all of its customers. Each of the Company’s dealerships engage in the selling and financing of used
vehicles.” – Reuters
Car-Mart was chosen because of their exposure to both the auto dealership of older cars and auto financing much like
KAR’s segment AFC. They are the smallest in enterprise value and do not have a sufficient amount of debt which is
why I weighed them the least.
DISCOUNTED CASH FLOW ANALYSIS
For the discounted cash flow analysis I broke down revenue into the three business segments of KAR. I then
projected cost of sales as a percentage of revenue. Breaking down revenue into these segments allowed me to attribute
the different growth rates and gross margins each company has and was a more accurate assessment of revenue.
Management did not forecast very many items and I had to rely on analysts’ estimates as a range for my estimates in
the first few years. After 2010, I have year to year revenue growth at an average of 2%. This seems reasonable as
industry revenues appearing to be growing at least 3%. I wanted to estimate revenue conservatively as ADESA and
IAAI looked to be in a mature and slow growing market. I also used the 30-year Treasury bond for my risk-free rate
as this is the policy our group has adopted.
Revenue
ADESA - is in the most mature market and can only hope to improve sales through gaining market share, and when
the economy recovers they should have more vehicles to auction off. This will negatively affect their gross margins as
currently used vehicles are selling for a higher value giving them higher commissions. Management has given estimates
of single digit growth in the future. I have ADESA growing 2% in 2011 and then increasing that to 3% for two years
when the used vehicle market should be back to strength before decreasing that growth to 1% in the terminal year.
IAAI – this is the segment that KAR believes has growth potential as currently only 3.5 of the 12 deregistered vehicles
are being taken to auction. Management gives forecasting growth of 2-4% which I scale down from 4% to 1% in the
terminal year as there is no indication of how long this growth is sustainable.
AFC – Revenue for AFC has increased by 59% comparing the first two quarters to 2009’s first two quarters. This is
due to a 37% increase in revenue per loan transaction and 16% more loans processed. The company has stated a
growth initiative to create or add on to factories more AFC’s stores. I have them growing 6% in 2011 and scale that
down to 2% for 2018. While this may seem conservative, KAR has only stated a desire to offer AFC at all of their
auctions and no potential growth figures.
Cost of Services
ADESA - Cost of services increases as revenue does since commission margins will not be as strong as used vehicle’s
price should decrease when the market is normal unlike the present condition. Then I have it decreasing to 55% from
the current 56% because of more efficient practices and technology being implemented in their auction services.
IAAI – Increased their margin due to higher car prices. I have cost of services increasing to 62% in 2013 when the
market looks to be fully recovered and used vehicle prices will be lower. I then have it decreasing to 60% as
technology and more cohesion with ADESA should lower cost of services.
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AFC – Gross Profit for AFC increased 55% in the current 2010 quarters compared to the same time last year. This
was due to a decrease in cost of services and the company has said that there are not a lot of variable costs associated
with this segment. If revenue increases look for the gross margin to increase as well. I have these costs decreasing to
19% in the terminal year as guidance has said they should be fairly constant in a number basis and not a percentage of
revenue.
Selling, General and Administrative – I decided to project this out at 20% to the terminal year. In the past this
percentage has been relatively stable and I saw no reason to change it.
Depreciation and Amortization – Currently this is at the 9% to 10% range of revenue. However with capital
expenditures at 4%, this will affect depreciation in time and is why I have it gradually lowering to 7% in 2018.
Other Income Expense – This line item is mostly dominated by the currency rate fluctuation with Canada.
However, this figure is not substantial to the total revenue.
Interest Expense – This item has decreased to 8% in the 2010 quarters mainly because of prepayment of debt. While
there is a good chance of management continuing to pay off debt and keep the rate here I projected it at 10% a more
average of the past years and this current one. I have this gradually decreasing after 2013 when the maturity on the
main portion of their debt is due.
Tax Rate – Company guidance has said the tax rate will be 42% going forward. However, lower state taxes,
international operations, and discrete items have changed this. For example, in the first two quarters of this year, the
tax rate was 33.6% because of these items. Going forward, I start my projections at 42%. I forecast that this will
eventually lower towards 35% the maximum corporation tax. This is due to the company continuing to pay off its
Taxes Payable account. I have it at 37% in my terminal WACC as I felt this was a better representative of the future
value than 42%.
Net Working Capital – Projecting NWC was notably difficult as the line items varied over the history of KAR which
only goes back until 2007. Two line items that are completely new for 2010 are Obligations collateralized by finance
receivable and Finance receivables securitized, net of allowances. This is the result of a new guidance opposed by GAAP which
requires finance receivables after January 1, 2010 under KAR’s revolving sale agreement be included in the balance
sheet. With no future guidance on this subject I decided to use its current percentage of revenue and project this out
to the terminal year.
I see cash increasing after 2013 when most of their debt is paid off. Trade receivables have varied in the past and 19%
seemed reasonable for the short term future. I have this decreasing as a more appropriate figure compared to the past
two years. Accounts Payable was relatively constant from 2008 to 2009 with a jump in 2010 quarters and has no
details given about it in any SEC filings. I decided to trend it down from the current quarter to be closer to its figure
in the past. It is still above 08 and 09 because of the company’s plan to go after consignment vehicles which is the
main source of this account.
Capital Expenditures and Acquisitions – include investing in their core information technology capabilities and
expanding capacity in their auctions. For 2010, the company’s guidance is that it will be 75 million with $50 million of
this going to maintenance of facilities and the rest going to growth initiatives. Future CapEx will be used for
improvement or new auction facilities, improvements in technology systems, and new auction facilities. I decided to
trend Cap Ex and Acquisitions up to 7% in the terminal year as when they pay off their debt KAR will look to
improve or branch out new auction sites.
Beta – I first ran a weekly regression for less than a year (KAR went public last December) and received a beta of .77.
While this was comparable with CPRT (main competitor) and LKQH it seemed like it did not take into account the
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university of oregon investment group
http://uoig.uoregon.edu
debt of KAR. I then used a Hamada to calculate my beta and found a beta of 1.51 which I was comfortable with.
Companies used in the Hamada were in similar industry with a comparable market cap. I rated CPRT the highest
because it is my main competitor.
Cost of Debt – KAR has more debt than equity currently so this is a significant part of my implied price. In the most
recent 10k it stated that the weighted average interest rate on all borrowings was 5.5% in 2009 compared to that of
7.2% in 2008. I decided to use 7.78% which is a slight premium to KAR’s current bond YTM.
RECOMMENDATION
KAR Auction Services is a debt laden company with strong current and future projections of free cash flow. It
competes in a mature industry and has limited growth in the future. With that stated their high cost of debt brings my
DCF valuation to being overvalued. I received an implied price of $13.31, which if reached would give us a gain of
3.1%. I do not feel my comparable analysis is strong enough to push this stock into a buy. All but one comparable
company has faster growth than KAR. Although I see KAR deleveraging its debt as it has in the past year, the ability
to predict beta, cost of debt, and the debt/equity ratio in the terminal year is an item I am not yet confident to
estimate. I am recommending a HOLD for all portfolios.
12
KAR Auction Services Inc
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 1 – COMPARABLES ANALYSIS
The University of Oregon Investment Group
($ in millions, except per share data)
Stock Characteristics
Current Price
50 Day Moving Avg.
200 Day Moving Avg.
Beta
Size
ST Debt
LT Debt
Cash and Cash Equiv.
Diluted Share Count
Market Cap
Enterprise Value
Profitability Margins
Gross Margin
EBITDA Margin
Net Margin
Credit Metrics
Interest Expense (LTM)
Debt/Equity (MRQ)
Debt/EBITDA (LTM)
EBITDA/Interest Expense (LTM)
Operating Results
Revenue (LTM)
Gross Profit (LTM)
EBITDA (LTM)
Free Cash Flow (LTM)
Net Income (LTM)
Valuation
EV/Revenue
EV/EBITDA
EV/Free Cash Flow
KAR
Max
Min
Avg. Median
234.72 12.96 50.64 28.53
226.13 12.91 50.27 27.69
202.50 13.26 45.67 26.31
2.16
1
1.36
1.39
12.96
12.91
13.32
1.51
25%
CPRT
25%
AZO
15%
PAG
10%
LKQX
10%
GPI
10%
HSNI
5% Weighted Average
CRMT
33.49
34.19
35.27
0.64
234.72
226.13
202.5
1.27
13.25
12.95
13.26
1.61
21.53
20.61
19.89
0.95
32.1
29.62
28.48
2.16
30.62
39.97
28.37
1.63
26.44
25.76
24.25
1.11
79
77
70
1.25
1398
838
6
92.07
1220
3449
27
567
190.5
143.16
3082
3486
647
421
32.2
23.64
759
1795
13
321
279.9
57.54
1762
1816
0.4
44
0.3
10.87
287
332
278.3
986.0
142.8
69
4117
5238
1398
2909
289
143
10588
13398
0
44
0.3
11
759
1795
417
1017
146
74
2786
3791
27
567
144
71
1753
3014
2019
289
134.60
1744
3474
268.2
85.03
2848
2579
2909
98.3
45.11
10588
13398
52%
37%
20%
16%
3%
1%
36%
14%
7%
39%
11%
5%
34.8%
23.0%
2.8%
45.0%
36.6%
19.6%
52.2%
22.3%
10.0%
15.5%
2.7%
0.9%
45.4%
14.1%
7.2%
16.1%
3.3%
0.7%
34.9%
8.3%
3.4%
43.3%
5.2%
8.8%
38.4%
18.0%
9.1%
157
183%
7.83
10
3 72.19
0%
65%
0
3.37
2.7
6.3
37.5
23%
2.31
6.0
150
116%
4.9
2.7
0%
0.0
157.2
27%
1.8
10.4
93.5
183%
7.8
3.1
30.4
19%
1.9
10.4
37.5
141%
6.4
4.5
34.1
19%
1.4
6.9
2.7
16%
2.7
6.0
63.7
0.5
2.7
5.5
10396
3842
1638
1627
738
314
136
16
14
28
2546
901
284
158
98
1776
618
409
374
51
773
348
283
152
152
7362.6
3842
1638
1627
738
10396
1616
285
285
98
2239
1016
316
165
161
5007
807
168
59
37
2853
995
236
111
98
314
136
16
14
28
4619
1578
596
521
268
1.96 x
8.49 x
9.29 x
3.34 x
9.11 x
17.00 x
1.82 x
8.18 x
8.24 x
0.33 x
12.09 x
12.10 x
1.56 x
11.04 x
21.19 x
0.36 x
10.70 x
30.60 x
0.64 x
7.71 x
16.42 x
1.06 x
20.35 x
23.94 x
1.6
10.1
14.3
Implied Price
8.89
17.86
26.99
Weight
33%
33%
33%
3840
1172
419
348
170
Metric
EV/Revenue
EV/EBITDA
EV/FCF
Price Target
Current Price
Under Valued
17.90
12.96
38%
13
KAR Auction Services Inc
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
The University of Oregon Investment Group
($ in millions, except per share data)
Total Company Revenue
% Y/Y Growth
Cost of Revenue
% Revenue
Gross Profit
Gross Margin
Operating Expenses
SG&A
% Revenue
D&A
% Revenue
Total Operating Expenses
% Revenue
EBIT
% Revenue
Other (Expense) Income
% Revenue
Interest Expense
% Revenue
Pre-tax Income
% Revenue
Less Taxes (Benefit)
Tax Rate
Net Income
Net Margin
Add Back Depreciation and Ammortization
% Revenue
Add Back Interest Expense*(1-Tax Rate)
% Revenue
Operating Cash Flow
% Revenue
Current Assets
% Revenue
Current Liabilities
% Revenue
Net Working Capital
% Revenue
Change in Net Working Capital
Capital Expenditures+Acquistions
% Revenue
Unlevered Free Cash Flow
Discounted Unlevered Free Cash Flows
2007
1103
627
57%
475
43%
2008
1771
61%
1053
59%
718
41%
242
22%
127
11%
369
33%
106
10%
8
1%
162
15%
-48
-4%
-10
21%
-38
-3%
127
11%
129
12%
217
20%
902
82%
444
40%
457.7
42%
384
22%
183
10%
731
41%
-13
-1%
-20
-1%
215
12%
-248
-14%
-31
13%
-216
-12%
183
10%
188
11%
155
9%
753
42%
444
25%
309
17%
0%
217
129.6
7%
25
2009
2010AQ1-2
1730
928
-2%
997
508
58%
55%
732
421
42%
45%
365
21%
172
10%
537
31%
195
11%
12
1%
173
10%
34
2%
11
32%
23
1%
172
10%
117
7%
312
18%
942
54%
417
24%
525.1
30%
216.3
69
4%
27
0.5
2010Q3-4E
2010A+E
897
1825
6%
494
1002
55%
55%
403
823
45%
45%
186
20%
85
9%
271
29%
150
16%
2
0.2%
71
8%
55
6%
19
34%
37
4%
85
9%
47
5%
169
18%
1417
179
20%
81
9%
260
29%
143
16%
1
0.1%
72
8%
72
8%
30
42%
42
5%
81
9%
42
5%
164
18%
1512
942
1025
475
51%
-50.1
24.6
3%
194
486.5
54%
11.5
48.7
2%
104
100
365
20%
166
9%
531
29%
292
16%
2
0.1%
143
8%
127
7%
49
38%
78
4%
166
9%
88
5%
332
18%
1512
83%
1025
56%
487
27%
-39
75
4%
296
1.5
2011 E
1879
3%
1032
55%
847
45%
2.5
2012 E
1944
3%
1092
56%
852
44%
366
20%
180
10%
546
29%
301
16%
3
0.2%
188
10%
116
6%
48
41%
68
4%
180
10%
110
5%
358
19%
1625
87%
1074
57%
552
29%
65
87
4%
205
185
389
20%
185
10%
574
30%
278
14%
2
0.1%
194
10%
86
4%
35
41%
51
3%
185
10%
115
5%
350
18%
1722
89%
1087
56%
635
33%
83
97
5%
170
142
3.5
4.5
2013 E
2014 E
2005
2056
3%
3%
1119
1139
56%
55%
886
917
44%
45%
401
20%
180
9%
581
29%
304
15%
2
0.1%
200
10%
106
5%
50
40%
56
3%
180
9%
120
5%
357
18%
1746
87%
1120
56%
626
31%
-9
108
5%
257
201
411
20%
185
9%
596
29%
321
16%
2
0.1%
164
8%
158
8%
67
39%
91
4%
185
9%
100
5%
377
18%
1832
89%
1126
55%
705
34%
79
111
5%
187
136
5.5
2015 E
2107
2%
1166
55%
940
45%
6.5
2016 E
2139
2%
1162
54%
977
46%
7.5
2017 E
2171
1%
1179
54%
992
46%
8.5
2018 E
2194
1%
1191
54%
1004
46%
421
20%
169
8%
590
28%
350
17%
2
0.1%
147
7%
205
10%
83
39%
122
6%
169
8%
90
5%
380
18%
1877
89%
1154
55%
723
34%
17
135
6%
228
155
428
20%
160
8%
588
28%
389
18%
2
0.1%
150
7%
241
11%
94
39%
147
7%
160
8%
91
5%
399
19%
1906
89%
1172
55%
734
34%
11
137
6%
251
158
426
20%
152
7%
578
27%
414
19%
2
0.1%
130
6%
286
13%
105
38%
181
8%
152
7%
80
5%
413
19%
1934
89%
1190
55%
745
34%
11
161
7%
241
142
442
20%
154
7%
596
27%
408
19%
2
0.1%
132
6%
278
13%
102
37%
177
8%
154
7%
84
5%
414
19%
1955
89%
1202
55%
753
34%
8
158
7%
248
136
14
KAR Auction Services Inc
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 3 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
The University of Oregon Investment Group
Assumptions for Discounted Free Cash Flows Model
Tax Rate
42% Terminal Growth Rate
Terminal Tax Rate
37% Terminal Value
Risk-Free Rate
2.6% PV of Terminal Value
Terminal Risk-Free Rate 3.91% Sum of PV Free Cash Flows
Beta
1.51 Firm Value
Market Risk Premium
7% LT Debt
% Equity
42% Cash
% Debt
58% Equity Value
Cost of Debt
7.78% Diluted Share Count
CAPM
13.19%
Terminal CAPM
14.48% Implied Price
WACC
8.15% Current Price
Terminal WACC
8.91% Under (Over) Valued
3%
4320
2091
1309
3400
2019
289.4
1381
135
10.3
12.96
-21%
APPENDIX 4 – HAMADA BETA
Auction Services Ticker
Weighting
30%
CPRT
15%
LKQX
15.0%
PAG
15.0%
GPI
12.5%
KMX
12.5%
AN
Mean
Median
Tax Rate
KAR D/E
Unlevered Business Beta
KAR Levered Beta
Beta
SE
0.67
1.14
1.61
2.16
1.31
1.33
0.17
0.23
0.24
0.38
0.28
0.29
1.27
1.32
0.25
0.28
Price Shares Out.
33.49
21.53
13.25
32.10
29.54
23.82
85.03
143.16
92.07
23.84
224.85
146.39
Debt
0.00
594.40
2235.50
1068.30
4037.00
2855.70
D/E
2847.55
0%
3082.23
19%
1219.93 183%
765.26 140%
6642.07
61%
3487.01
82%
69%
71%
42%
116%
0.90
1.51
15
KAR Auction Services Inc
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 5 – BETA SENSITIVITY ANALYSIS
The University of Oregon Investment Group
Beta
2.01
1.88
1.76
1.63
1.51
1.39
1.26
1.14
1.01
St. Deviation Implied Price Under (Over) Valued
2.00
10.32
-20.10%
1.50
10.98
-15.00%
1.00
11.65
-9.80%
0.50
12.47
-3.50%
0.00
13.31
3.10%
-0.50
14.27
10.40%
-1.00
15.44
19.50%
-1.50
16.67
29.20%
-2.00
18.27
41.40%
APPENDIX 6 – WORKING CAPITAL MODEL
The University of Oregon Investment Group
($ in millions, except per share data)
2007
Net Revenues
1103
Current Assets
Cash and Cash Equivalents
204.1
% of Revenues
19%
Restricted cash
16.9
% of Revenues
1.5%
Trade receivable
278
% of Revenues
25%
Finance receivable
247
% of Revenues
22%
Finance receivables securitized, net of allowances
% of Revenues
Retained interests in finance receivables sold
71.5
% of Revenues
6%
Deferred income tax assets
29.3
% of Revenues
3%
Other current assets
54.8
% of Revenues
5%
Totla current assets
901.8
% of Revenues
82%
Current Liabilities
A/P
292.8
% of Revenues
27%
Accrued employee benefits and compensation
55
% of Revenues
5%
Accrued interest
16.4
% of Revenues
1%
Other accrued expenses
80.1
% of Revenues
7%
Income taxes payable
% of Revenues
Obligations collateralized by finance receivables
% of Revenues
Total Current Liabilities
444.1
% of Revenues
40%
2008
1771
2009
1730
2010 E
1825
2011 E
1879
2012 E
1944
2013 E
2005
2014 E
2056
2015 E
2107
2016 E
2139
2017 E
2171
2018 E
2194
158.4
9%
15.9
0.9%
286
16%
159
9%
363.9
21%
9.3
0.5%
250
14%
150
9%
43.4
2%
43.2
2%
47.2
3%
752.7
42%
89.8
5%
37.3
2%
40.9
2%
941.9
54%
289.4
16%
8.3
0.5%
346
19%
113
6%
571.2
31%
95
5%
42.6
2%
46.4
3%
1511.9
83%
346
18%
11
0.6%
357
19%
150
8%
582
31%
94
5%
38
2%
47
3%
1625
87%
398
20%
12
0.6%
369
19%
156
8%
603
31%
97
5%
39
2%
49
3%
1722
89%
401
20%
12
0.6%
361
18%
160
8%
621
31%
100
5%
40
2%
50
3%
1746
87%
452
22%
12
0.6%
370
18%
164
8%
637
31%
103
5%
41
2%
51
3%
1832
89%
463
22%
13
0.6%
379
18%
169
8%
653
31%
105
5%
42
2%
53
3%
1877
89%
492
23%
13
0.6%
364
17%
171
8%
663
31%
107
5%
43
2%
53
3%
1906
89%
499
23%
13
0.6%
369.07
17%
174
8%
673
31%
109
5%
43
2%
54
3%
1934
89%
505
23%
13
0.6%
373
17%
176
8%
680
31%
110
5%
44
2%
55
3%
1955
89%
283.4
16%
42
2%
15.4
1%
102.7
6%
262.7
15%
56
3%
14.8
1%
80.2
5%
2.7
0.2%
443.9
25%
417
24%
408.3
22%
51
3%
11.6
1%
77.6
4%
3.1
0.2%
473.4
26%
1025
56%
413
22%
75
4%
15
1%
79
4%
3
0.2%
488
26%
1074
57%
389
20%
78
4%
16
1%
97
5%
2
0.1%
505
26%
1087
56%
401
20%
80
4%
16
1%
100
5%
1
0.1%
521
26%
1120
56%
391
19%
82
4%
16
1%
103
5%
0
0%
534
26%
1126
55%
400
19%
84
4%
17
1%
105
5%
0
0%
548
26%
1154
55%
406
19%
86
4%
17
1%
107
5%
0
0%
556
26%
1172
55%
412
19%
87
4%
17
1%
109
5%
0
0%
564
26%
1190
1655%
417
19%
88
4%
18
1%
110
5%
0
0%
570
26%
1202
55%
KAR Auction Services Inc
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 7 – COST OF DEBT ANALYSIS
Cost
Cost of Debt
9.28%
9.03%
8.78%
8.53%
8.28%
8.03%
7.78%
7.66%
7.53%
7.28%
5.50%
of Debt Sensitivity
Price Under (Over) Valued
12.05
-6.8%
12.24
-5.2%
12.44
-3.7%
12.65
-2.1%
12.92
-0.4%
13.09
1.3%
13.31
3.1%
13.43
3.9%
13.55
4.9%
13.79
6.7%
15.77
22%
APPENDIX 8– REVENUE MODEL
The University of Oregon Investment Group
($ in millions, except per share data)
2007 2008 2009 2010Q1-2 2010 E 2010A+E 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E
Total Rev
1102.8 1771.4 1729.6 928.4 897.0 1825.4 1878.8 1943.9 2004.7 2055.6 2106.5 2139.2 2171.0 2194.2
Total Cost of services
627
ADESA
Growth%
Cost of services
% of Revenue
IAAI
Growth%
Cost of services
% of Revenue
AFC
Growth%
Cost of services
% of Revenue
678
386
57%
330
219
66%
95
22.3
23%
61%
1053
59%
1123
66%
655
58%
550
67%
362.9
66%
97.7
3%
35.2
36%
-2%
997
58%
1089
-3%
615
57%
553
1%
352.1
64%
88
-10%
29.8
34%
508
55%
554
494
55%
540
309
56%
316
-43%
185.3
59%
58.6
302
56%
305
179.95
59%
52
13.6
23%
11.96
23%
6%
1002
55%
1094
0%
611
56%
621
12%
365.25
59%
111
26%
26
23%
3%
1032
55%
1116
2%
625
56%
646
4%
381
59%
117
6%
26
22%
3%
1092
56%
1149
3%
655
57%
672
4%
410
61%
123
5%
27
22%
3%
1119
56%
1184
3%
663
56%
692
3%
429
62%
129
5%
27
21%
3%
1139
55%
1207
2%
676
56%
713
3%
435
61%
136
5%
28
21%
2%
1166
55%
1231
2%
690
56%
734
3%
448
61%
141
4%
29
21%
2%
1162
54%
1244
1%
684
55%
749
2%
449
60%
147
4%
29
20%
1%
1179
54%
1256
1%
691
55%
764
2%
458
60%
151
3%
30
20%
APPENDIX 9 – SOURCES
www.reuters.com
www.sec.gov
KAR Auction Services Inc 10k
www.karauctionservices.com
Ibisworld
Google Fiannce
Yahoo Finance
Factset
17
1%
1191
54%
1269
1%
698
55%
771
1%
463
60%
154
2%
30
19%