|Shares Out. (in M):||107||P/E||0||0|
|Market Cap (in $M):||4,119||P/FCF||0||0|
|Net Debt (in $M):||636||EBIT||0||0|
|Borrow Cost:||General Collateral|
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Recommend shorting shares of RBA at the current price of $39. This write-up will focus mainly on things that are incremental to the two previous write-ups on VIC.
For those that don’t know RBA, it basically hosts live unreserved auctions for selling used equipment (construction, agricultural, transportation, etc.) at its 44 auction sites globally. The company sold $4.25bn of equipment in 2015 and did $516mm of revenues. For more background on RBA, their investor presentation does a good job outlining the business and can be found here https://s2.q4cdn.com/965716280/files/doc_presentations/2016/sept/RBA-Q2-16-Updated-Overview-Presentation-September-4-2016-Final.pdf.
Iron Planet Deal
On August 29, 2016, RBA announced that it was going take its pristine net cash balance sheet and lever up 3x to acquire privately held Iron Planet (“IP”) for $760mm in cash. IP is RBA’s largest competitor in the used equipment auction market. IP sold just under $1bn of equipment over the twelve month period ended 6/30/16 and had $126mm in revenue.
IP is different than RBA in that most of its auctions are conducted online (mostly in an unreserved format). As the auctions are done online, equipment does not need to be moved to and from an auction site. The company provides buyers an ”IronClad” guarantee with detailed inspections to protect buyers and incent them to transact. Additional background on IP and the deal can be found here https://s2.q4cdn.com/965716280/files/doc_presentations/2016/aug/RB-IronPlanet-Acq-INVESTOR-DECK-FINAL-Aug-29-16-145.pdf..
Market (Over) Reaction
The market is excited about the IP deal. The stock has rocketed up from $27 pre-deal to $39 today. While some of this is based on a strong Q3 16 (which pulled forward some auctions from Q4) and Trump, the vast majority of the run has been due to the deal, in our view.
Excitement for the deal includes: 1) the takeout of RBA’s largest competitor, 2) the addition of a scaled online auction platform to complement RBA’s physical sites and 3) a strategic alliance signed with CAT in conjunction with deal, making RBA/IP the “preferred” but non-exclusive auction channel for CAT dealers. Note that IP bought Caterpillar Auction Services (“CAS”) in April of 2015. CAS was formed in 2008 by CAT and select CAT dealers as a captive liquidation channel for used equipment.
At the time of the IP deal announcement, RBA only disclosed historical gross merchandise (“GMV,” also referred to as "GAP" or gross auction proceeds) value and revenue for IP. They notably, did not disclose any detailed information below the sales line. That said, RBA management cast the purchase price as 13x 2017E pro forma IP EBITDA. The 13x includes credit for $100mm NPV of tax assets and $20mm of expected operating synergies. This implies pre-synergy 2017E IP EBITDA of $30mm ($760mm purchase price - $100mm tax assets = $660mm of EV divided by 13x implies $50mm of pro forma EBITDA less $20mm of synergies = $30mm of underlying 2017E IP EBITDA).
Behind the Curtains
IP tried to go public in 2011 and failed. The old IP prospectus is on file and can be found on Bloomberg (ticker: IRON). Looking at the prospectus, plus the limited RBA financial disclosures at the time of announcement, reveals two things:
IP’s GMV and revenue were roughly flat from 2011 to 2014 (IP 6/30/11 LTM GMV was $544mm and 2014 GMV was $524mm), and
IP’s EBITDA in 2011 was negligible, which would suggest 2014 EBITDA was also negligible given revenues were roughly the same.
In fact, all of our conversations with the channel about IP over the years we have followed the industry, have suggested that the company wasn’t very profitable and wasn’t gaining much traction in the marketplace. That begs the question – how did IP go from a flat-lined, little-to-no EBITDA business to a 45-50% growth one with $30mm in projected 2017E EBITDA? This was mostly unanswerable until 11/30, when RBA filed IP’s historical financial information through 9/30/16. The financials were disclosed as part of RBA’s debt financing and can be found here https://www.sec.gov/Archives/edgar/data/1046102/000127956916004753/0001279569-16-004753-index.htm. The financials paint a much less rosy picture than management did when they announced the deal. Shockingly, only two sell side firms have taken the time to look at the IP financial disclosures (and really only one of those firms did any analysis). Discussions with the sell-side reveal that not many people have even looked at the IP financials and most market participants may not even be aware of the filing as the IP financials were an exhibit to an 8K containing a press release.
Key red flags from the filing are as follows:
IP’s massive 58% revenue growth in 2015 was flattered by two acquisitions and a large 1x government contract win; backing these out, 2015 organic growth was likely much less robust and potentially negative, per IP’s own calculation provided in the filing
Growth in both 2015 and 2016 was flattered by “customer equity incentives,” whereby IP was incenting CAT dealers to transact through them by issuing them equity based on the amount of GMV they sold through IP; the “customer equity incentives” are taken as deductions from gross sales on IP’s income statement, but RBA management has added them back and only contemplates “gross revenues” when discussing the deal
IP’s revenue growth rate in Q3 16 has slowed to only 9%; this compares to the 1H revenue growth of 47%; while only one quarter, and subject to noise, it suggests the business could be losing momentum (note that RBA’s core business is also slowing)
IP did only $11mm in LTM adjusted EBITDA through 9/30/16, which is a far cry from the $30mm of EBITDA required in 2017E to hit the 13x 2017E multiple advertised by RBA management; the $11mm in LTM IP adjusted EBITDA adds back $20mm of “customer equity incentives” discussed above, which is highly suspect, as it is a real cost of business that drove outsized growth; including the cost of these incentives, IP’s EBITDA LTM EBITDA would be -$10mm on a standalone business
The deal is not that accretive to RBA’s baseline earnings or growth; the disclosures show that over the LTM ended 9/30/16, IP would have only been 12% accretive to RBA’s EBITDA including $14mm of synergies and generously adding back the customer equity incentives; interest costs for the 3x leverage will be ~$35mm alone, wiping out all of the incremental $25mm in IP EBITDA plus synergies ($11mm in adjusted EBITDA + $14mm in synergies); D&A including intangible amortization are another $9mm
The full $20mm in synergies is a whopping 16% of IP’s gross revenues; the $20mm in synergies is also 100% of IP’s G&A; RBA’s standalone opex is growing, and presumably IP’s opex will also need to grow to support the massive ramp from $11mm to $30mm in EBITDA, making the $20mm synergy target appear aggressive
IP has been described by RBA management as a “technology platform,“ yet R&D is not broken out and IP spends almost zero on software/capex
IP generated no cash in 2014, 2015 or LTM ending 9/30/16
Before agreeing to be acquired by RBA, IP was also pursuing a parallel path for an IPO in 2016. From the looks of IP’s financials, the IPO seems like it would have been a tough sell. It also makes the $760mm price tag RBA paid look sky high, thus making the run in RBA’s shares post the deal look very overheated. IP was juiced for a sale and RBA took the bait.
In addition to the market’s misperception of IP’s true underlying growth and profitability, standalone RBA has also been slowing as of late. RBA’s LTM GMV as of 9/30/16 is up only 2% y/y. The fourth quarter is off to a slow start as well, with October and November auction GMV declining -8% y/y in total, and two benchmark auctions in December also being down y/y, setting up RBA to potentially miss Q4 16. RBA has undoubtedly benefitted from the upheaval in the energy sector over the last two years as many companies in the sector right sized or liquidated their assets. Based on discussions with people in the field, this equipment surplus from energy customers is in the late innings.
At $39 per share RBA is trading at 20x LTM pro forma adjusted EBITDA that includes $14mm of synergies and adds back all of the customer equity incentives. The 20x multiple is for a company that would have grown combined pro forma adjusted EBITDA 5% from 2015 through LTM 2016 when normalizing both periods for $14mm of synergies. This seems steep for a combined company that may be slowing, and also levered up to pursue an overpriced acquisition at what may be the peak of the cycle. Risk/reward seems excellent at current levels, with downside to $25-30 based on 13-14x pro forma EBITDA and giving credit for $100mm in tax synergies (roughly $1/share). Conversely, if RBA hits its $300mm EBITDA target that it has discussed with the rating agencies (business is currently at ~$245mm including synergies LTM 9/30/16), the stock is will still be trading at a cool 16x EBITDA.
IP 2015 Revenue Growth
As mentioned, 2015’s meteoric revenue growth is being bolstered by three distinct things. Two M&A deals, the acquisition of Kruse Energy on 10/31/14 and Cat Auction Services on 4/1/15. IP also won the Department of Defense rolling stock contract from LQDT mid-2014 and we believe that contract began to hit the IP PNL in late 2014 based on LQDT commentary. While we don’t have exact figures for the two deals, based on our channel checks and information in the IP filing, a rough cut of IP’s 2014-2015 organic growth is shown below (note: Cat Auction Services financials are included at the end of the IP filing as “Associated Auction Services”).
Customer Equity Incentives
Another factor to take into consideration when evaluating IP’s topline growth is that post the Cat Auction Services deal, IP started a program to issue equity to all CAT dealers for transacting with them. In short, the more GMV a dealer transacted, the more equity in IP that dealer would receive.
It’s probably fair to assume that post the Cat Auction Services deal, IP had made it clear to all CAT dealers, that IP intended to either go public or sell itself, which meant these dealers had visibility into a monetization event. This program got traction as IP paid out $13mm in incentives in 2015 and $21mm in the LTM period ending 9/30/16. IP’s financials treat these customer equity incentives as a deduction to gross revenues. Note that the deductions on the P&L are based on the fair value of IP at the end of the GMV measurement period for earning equity awards. This suggests that the amounts on the P&L potentially understate the value of the equity as the dealers were eyeing a premium in the event of a sale or public offering.
This incentive program has not been discussed by RBA management, and has only been disclosed in the IP filing. Interestingly, RBA management adds these incentives back when calculating revenues and adjusted IP EBITDA. In fact, IP’s EBITDA would be negative if we include the full cost of the incentives. RBA’s logic behind adding back these costs is that they are an “earnout” from the CAS deal and will no longer be a cost past their 12/31/16 expiry. This is disingenuous as the equity awards are a real cost of business that drove outsized growth and were offered to CAT dealers that owned CAS as well as independent CAT dealers that had nothing to do with CAS. One cannot boast about growth, without deducting the full cost of that growth. If one does want to add-back the cost, then you would also need to reduce the growth driven by those incentives. RBA management wants to have its cake and eat too.
Management may also contend that the CAT partnership alliance signed in conjunction with the deal will also make up for the lack of equity awards going forward. The issue is that the CAT alliance 1) was already in place at IP, 2) is non-exclusive so CAT dealers can transact where they wish and 3) includes a “preferential rate” (i.e, instead of equity, they will get a fee break). The idea of the partnership agreement is that CAT dealers will transact with RBA/IP in exchange for software/analytics and data. RBA has agreed to affix telematics applications to all equipment sold so that CAT and dealers can benefit from data such as usage, location, etc. While these are all great things, we don’t believe they will be as great as the up to $40mm in equity that has been granted when all is said and done in a company at a pre-IPO/takeout valuation.
We do have one example to see the power of these incentives in action. IP conducts a large live auction in Florida every February (in addition to its core online business). We know through various press releases that IP generated $50mm of GMV at this auction in 2012. In February 2015 (before the Cat Auction Services deal closed), IP again sold $50mm of equipment. Then in 2016, when the deal was closed, and when a view into IP’s sale or IPO was evident, Ring Power, a large CAT dealer in FL pumped GMV through IP in anticipation of receiving equity. This took GMV at the same FL auction to $94mm in 2016, effectively doubling the historical run rate at this auction. While RBA may argue that without the equity incentives RBA would have gotten that volume (instead of IP), the fact remains that RBA paid a huge multiple based on the accelerated growth at IP, which has an economic cost they are ignoring.
Lack of EBITDA
As mentioned above, RBA management has outlined $30mm of EBITDA in 2017E for IP. The filings show that IP is nowhere near that level of EBITDA currently, posting $11mm of adjusted EBITDA LTM as of 9/30/16. This is up from almost no EBITDA in 2015 (despite 58% revenue growth that year) and includes the addback of $20mm of customer equity incentives discussed above. Even keeping IP’s opex flat (unrealistic) and treating COGS as variable, IP will need to grow revenues some 25-30% again next year to hit the $30mm. Given that the equity incentives are ending, IP just grew 9% in Q3 16, and RBA is also slowing, this seems unlikely.
In the IP financial filing, RBA gives pro forma combined financial information and for 2015 and LTM 9/30/16 gives credit for achieving $14mm of the $20mm of expected synergies. RBA standalone EBITDA for LTM 9/30/16 was $214mm. After adding $11mm of IP EBITDA and $14mm of synergies, total adjusted pro forma EBITDA is $239mm. This suggests the IP deal only increases RBA pro forma EBITDA by 12%. BUT, interest expense alone is $35mm effectively erasing any accretion. While RBA will benefit from a lower tax rate from the NOLs, these earnings cannot be capitalized at RBA’s 30x EPS multiple as they are finite in length (10 years) and value. The proper treatment of the $100mm of value is to look at the value per share which is ~$1 and use that for valuation purposes.
RBA Slowing and Set up to Miss Q4 16
RBA itself is slowing. LTM GAP through Q3 16 was only up 2% - well below the HSD/LDD evergreen model. So far in Q4 16, October/November GAP is down 8% which puts Q4 16 estimates at risk. As mentioned, RBA has benefitted greatly from the turmoil in the energy market. That said, RBA’s energy exposed Alberta and TX auctions are starting to slow. Note that the Edmonton site alone was close to 15% of total RBA Gap in 2015.
*December 16 Edmonton auction was -30% y/y….$50mm of GMV in 16 vs. $71mm in 15
Lastly, RBA’s “sweet spot” is 3-5 year old equipment. This equipment fetches the highest prices/value and is a draw for buyers. As OEM equipment producers have been severely depressed over the last couple years, there will be a dearth of 3-5 year equipment in the not too distant future.
While not in the base case, the RBA/IP deal is under FTC/DOJ review. The definition of the used equipment market can be as large as $350bn+ depending on how one defines it. That said, if the regulators decide to view the auction market as separate from other forms of disposition (brokers, dealers, listing services, etc.) then the combined RBA/IP will have ~50% market share. This is based on disclosure in IP’s 2011 prospectus measuring the the auction channel specifically at $10 billion in sales annually (as of 2008).
RBA management is also very promotional and relatively new. CEO Ravi S. came from OMX and Aramark before that. The CFO came from a retail background. It’s interesting that RBA operated successfully with a clean balance sheet for years, and in short order, a new CEO and CFO who are both new to the industry and have a lack of deal experience, decided to embark on a game changing acquisition. In fact, the previous management team at RBA disliked IP and had zero desire to own the asset.
Q4 16 results
Review of IP financials
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