|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|
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”).