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On April 1, 2019, KAR Auction Services, Inc. (NYSE: KAR, $55.98, Market Capitalization: $7.5 billion), a leading provider of whole car & salvage vehicle auction services and technology-enabled solutions, announced that it has received a favorable private letter ruling from the Internal Revenue Service with respect to the tax-free status of its previously announced spin-off of its Insurance Auto Auctions salvage auction business. On February 27, 2018, KAR had announced a plan to separate its Insurance Auto Auctions (IAA) salvage auction business unit into an independent, publicly traded company. The receipt of Private Letter ruling (PLR) has reduced the regulatory uncertainty regarding the spin and it is quite likely that KAR will be able complete the IAA spin-off in 2Q19; not withstanding any major external factors. During 4Q18 earnings call, KAR had sounded a bit cautious about the spin timing and had guided that the spin could be completed in 2019. The market had reacted negatively to the uncertainty regarding the spin timing and had fallen 13% on 2/20.

KAR Auctions Services and Price Performance

Furthermore, according to the Bloomberg article dated 4/16, an activist investor Starboard Value has built a stake in KAR. As per Starboard, a potential valuation re-rating for its salvage business (post spin) and performance improvement in its remaining business; can deliver considerable value to KAR shareholders. KAR stock has delivered returns of 20.9% since 2/20 and 7.7% since the spin announcement on 2/27/18. KAR is expected to declare its 1Q19 results on 5/7 and additional details could be provided during the earnings release.

Spin-Off Details and Top 5 Shareholders

Spin-Off Update

On 4/1, KAR received a favorable Private Letter ruling (PLR) related to the spin of its salvage business. IAA Spinco also released an amendment to Form 10 on 3/5, which has provided details regarding 4Q18 and FY18 results for IAA. As per the latest Form 10, IAA’s debt is pegged at approximately $1,330.0 million upon completion of the separation. As KAR has received the favorable private letter ruling from IRS, the company’s management has said that they expect to complete the spin as fast as possible with a goal of 2Q19, however external factors could delay the process.

Valuation and Recommendation

We value KAR Auction Services (KAR) using 2020e EV/EBITDA methodology by assessing KAR (Stub) and IAA Spinco (Spin-Off) separately. Our average intrinsic value of $31.00 per share (Previously: $30.00) for KAR (Stub) is based on 2020e EV/EBITDA multiple of 9.5x. Our average fair value estimate for IAA (Spin-Off) stands at $33.00 (Previously: $27.00) per KAR share is based on 2020e EV/EBITDA multiple of 13.2x. We arrive at a target price of $64.00 per share (Previously: $57.00) for KAR Auctions, which implies a potential upside of 14.3% from the current market price of $55.98 as of 4/22. The target price factors in higher EV/EBITDA multiple for its salvage business. Given the potential upside and its growth prospects, we remain constructive on the stock and maintain our ‘Buy’ rating.

FY19 Outlook

As disclosed during 4Q18 results on 2/19, KAR expects EBITDA in the range of $953- $988 million and Adjusted EBITDA in the range of $935-$970 million in 2019. Net Income is expected in the range of $330-$355 million, and Diluted EPS is expected to be in the range of $2.90-$3.09 per share.

Other Updates

Insurance Auto Auctions, Inc. makes Strategic Investments in Expansions at Key Locations – Insurance Auto Auctions, Inc. (IAA), a business unit of KAR, has announced expansions at branches in five states to augment its growth prospects. The expansions have added more than 110 acres to IAA’s footprint in Alabama, Arkansas, Minnesota, New York, and Texas…