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One-of-a-Kind Insurance Auctions Biz Receives New Valuations After Recent Filings

KAR Auction Services, Inc. (KAR) has submitted updated filings for its Spin of Insurance Auto Auctions, Inc. (IAA), which is expected for Q1 or early Q2 2019. With these new numbers, we've updated our valuations for the pre- and post-Spin entities ahead of the separation. Following the Spinoff, KAR will focus on its niche used vehicle auction services (comprised of ADESA and AFC segments), while IAA will be the first publicly traded insurance auction company on the market.

The Edge View...
KAR Auction Services, Inc. (KAR, Parent), a niche player in the field of online auto auctions, announced the Spinoff of Insurance Auto Auctions, Inc. (IAA, Spinoff), which is the first ever separation in the field of salvaged auto auctions. IAA is a higher margin business (FY20E EBITDA margin of 26.3%) compared to KAR’s ADESA segment (FY20E EBITDA margin of 17.8%). As this is the first Spinoff in the insurance auto auction services, we expect IAA will command a higher FY20E trading multiple of 10.5x (compared to blended KAR (ex-Spin)’s 9.1x) owing to its superior margin profile and stable cash flow generation post-Spin.

KAR (Parent, ex-Spinoff) will focus on its niche used vehicle auction services business, with a lower EBITDA margin profile of 17.8% in FY20E, compared to the combined company’s EBITDA margin of 23.1% in the same period. Following the Spinoff, KAR will have two primary business segments: ADESA (Automotive Dealer Exchange Service America) and AFC (Automotive Finance Corp.), out of which we believe AFC is the next divestiture/sale candidate, as it is a floorplan vehicle finance business with a higher risk profile. We expect AFC’s potential divestiture/sale will reduce KAR’s overall credit risk and thereby boost its trading multiple, improving the company’s overall valuation.

The Spinoff announcement did not help KAR’s credit rating, as Moody’s credit rating agency put KAR (Parent, pre-Spinoff) under review for downgrade due to the increased stress on the company’s financials after the Spinoff of IAA. However, on May 22, 2018, Moody’s announced that KAR’s credit rating remains unaffected and the further review for downgrade is ongoing. We expect that Moody’s will keep the credit rating of KAR unchanged due to the higher debt transfer ($1.3bn) to IAA that will decrease the leverage on KAR (ex-Spinoff) to 2.2x from the current 2.6x.

IAA (Spinoff) will be the first publicly traded insurance auction company that offers a superior FY20E EBITDA margin profile of 26.3% compared to ADESA’s margin profile of 17.8% in the same period. Therefore, we believe this business demands a premium to its peers based on its sole insurance auction positioning and superior margin profile. Moreover, the current veteran CEO and President of the IAA segment (John Kett) will remain as Chairman and CEO of IAA after the Spin, which we view as a positive for the company.