Ancora Holdings Group, LLC today released the below letter that has been sent to IAA Inc.’s Board of Directors:
March 15, 2022
Members of the Board of Directors,
Ancora Holdings Group, LLC (together with its affiliates, “Ancora” or “we”) is a meaningful stockholder of IAA, Inc. (NYSE: IAA) (“IAA” or the “Company”), beneficially owning approximately 2% of the Company’s outstanding common stock. We invested in IAA because it appears to be a fundamentally sound business that operates in an attractive and growing market with duopolistic characteristics. IAA and Copart, Inc. (“Copart”), which is the Company’s closest competitor, control the vast majority of the market for lightly damaged, salvaged and clear-title automobiles, parts and heavy equipment. Unfortunately, despite strong industry tailwinds, IAA’s share price is -38.3% over the past year and -0.7% since going public in June 2019.1
IAA’s share price performance is even more disappointing on a relative basis. Since being spun off from KAR Auction Services, Inc. (“KAR”) in 2019, IAA has dramatically underperformed the broader market, relevant peers and Copart. In our view, this underperformance can be attributed to a multi-year period of market share loss, poor capital allocation decisions related to acquisitions and issues pertaining to guidance and investor expectations. In our view, Chief Executive Officer John Kett bears significant responsibility for these unacceptable missteps and results.
Given IAA’s underperformance and the fact that the Company’s market capitalization has plummeted by roughly 40% since reporting third-quarter earnings in November 2021, the status quo cannot persist. We believe there are two strategic actions for the Board of Directors (the “Board”) to consider at this point:
- Replace Mr. Kett with a new CEO who is more dynamic and equipped to reinvigorate the organization. In our view, IAA needs a leader with a vision for achieving organic market share growth, improved margins and effective capital allocation.
- If the Board is unwilling to act with urgency to improve leadership, it should run a formal sale process to sell the Company.
As noted, the industry is a duopoly market dominated by IAA and Copart. Collectively, these two companies hold an estimated 80% of the North American market share. We suspect, based on estimates and our own analysis, that IAA could have roughly 40% of the market. These businesses are very desirable assets given the high barriers to entry, counter cyclical and recession resistant characteristics, strong market share, secular growth and high cash flow generation.
Copart currently trades at roughly 17.5x forward EBITDA and has an approximately $27.5 billion market capitalization. In contrast, IAA trades at 11.2x forward EBITDA and has a $4.9 billion market capitalization. This disparity is quite puzzling considering the businesses have very similar models with comparable operating tailwinds. We believe this massive valuation disconnect stems, in part, from investors’ lack of confidence in IAA’s leadership following recent customer departures and deteriorating EBITDA margins.
In light of IAA’s attractive attributes and business model, we anticipate the Company would obtain a significant premium relative to its current share price if taken private by one of the many well-capitalized potential acquirers in the marketplace. We estimate a takeout price of $55 or more is achievable based on a trailing 12-month EBITDA of 15.5x and an analysis of peers’ valuations and precedent transactions.2 At this point, a sale seems like the best risk-adjusted path forward for stockholders.
A CLOSER LOOK AT IAA’S ISSUES UNDER MR. KETT
Sustained market share loss from major insurance customer.
One of IAA’s largest insurance customers has been shifting vehicle supply to Copart since the third quarter of 2019. We have heard this issue was due to the service levels IAA provided during Hurricane Harvey, during which the Company was not able to meet the supply needs of this particular customer.
The share loss has been a consistent issue that has plagued IAA for years and reached its pinnacle on the fourth quarter earnings call. Management’s organic revenue growth guidance of 1.5% to 7.0% implies one of two things: either this particular customer completely shifts its entire vehicle volume away from IAA (at the low end of revenue growth) or it continues to shift volume in a more measured approach and still remains a customer of IAA (high end of revenue growth). Despite guiding to positive revenue growth in 2022, the Company’s EBITDA outlook suggests organic growth of -8.0% to 1.5%. This is despite the Company’s previously announced $80 million of margin improvements. The combination of positive revenue growth and $80 million of margin improvement potentially resulting in negative EBITDA growth suggests a lack of expense control and inefficient operations. We contend these issues are now causing investors to question the viability of IAA sustaining its market share in the salvage industry.
Poor capital allocation.
One of the largest growth avenues for the salvage auction industry is the international market. Growth can be realized by driving more international salvage buyers to the digital auction platforms, but also through a physical business presence in foreign locations. IAA and Copart have both expanded their overseas buyer bases over the last several years, providing each organization the benefit of having more buyers bidding on vehicles at their respective auctions and driving higher average sale prices on a per vehicle basis.
We are critical of IAA when it comes to the capital allocation decisions associated with expanding the Company’s actual physical footprint internationally. For example, IAA made the acquisition of U.K.-based SYNETIQ Ltd. (“SYNETIQ”) in October 2021 for $310 million. The business provides salvage auction services for insurance companies, accident management companies and other public and private sellers across 14 locations in the U.K., but the business model is a significant divergence from how IAA’s domestic operations work. IAA’s U.S. operations operate on a consignment basis whereby IAA does not take ownership of the salvaged vehicles and simply collects fees from both buyers and sellers in transactions. SYNETIQ relies on a purchased vehicle model where it purchases the vehicles and then sells them at auction. The vehicle purchase model, like the one run by SYNETIQ, has inferior margins compared to IAA’s domestic business. At the time of the transaction, SYNETIQ was reported to have low-teens EBITDA margins compared to IAA’s domestic operations, which have low-30% EBITDA margins.
We support the international expansion efforts but question the rationale behind paying a purchase multiple of roughly 13x EBITDA for a business that has a materially different operating model and is also significantly margin dilutive to IAA’s consolidated margin profile. We believe IAA can partner with a leasing specialist to assist in procuring international real estate with a much more capital efficient outcome.
Unreliable guidance and limited institutional credibility.
The Company’s shares sold off significantly following the fourth quarter earnings release on February 11, 2022. We believe the sell-off was related to continued market share loss, missing analysts’ estimates for EBITDA and initiating lower forward EBITDA guidance than the market was forecasting. The midpoint of IAA’s 2022 EBITDA guidance implies the lowest EBITDA margin over the past five years despite a material margin enhancement plan that was initiated in March 2020. Perhaps even worse is that 2022 EBITDA margins will be lower than 2017 despite the fact that revenue has increased 70% since 2017. This again raises the issue of a lack of cost control as the business should have much more operating leverage and scale.
Additionally, the analyst community appears to have reached its tipping point with IAA as the fourth quarter EBITDA miss coincided with a series of downgrades. Many analysts had already indicated frustration with IAA’s poor communications and investor relations after its prior miss in the third quarter of 2021.
THE TIME FOR DECISIVE ACTION HAS COME
We believe stockholders are fed up with the status quo at IAA. If the Board wants to continue to run the Company in the public market, we believe it needs to appoint a new CEO. If the Board is not prepared to initiate a succession plan for Mr. Kett, the Board should explore a sale and secure meaningful value for stockholders.
We are evaluating whether we need to take action at the upcoming Annual Meeting of Stockholders and would appreciate a prompt response from the Board.
Frederick D. DiSanto James Chadwick
Chief Executive Officer and Executive Chairman President
Ancora Holdings Group, LLC Ancora Alternatives LLC
Founded in 2003, Ancora Holdings Group, LLC offers integrated investment advisory, wealth management and retirement plan services to individuals and institutions across the United States. The firm’s comprehensive service offering is complemented by a dedicated team that has the breadth of expertise and operational structure of a global institution, with the responsiveness and flexibility of a boutique firm. For more information about Ancora, please visit https://ancora.net.
1 Total stockholder returns run through March 14, 2022.
2 Copart’s shares trade at a trailing 12-month EBITDA and next 12-month estimated EBITDA multiple of 18.9x and 17.5x, respectively – significantly higher than the EBITDA multiple IAA currently trades at in the public market. Carvana Co., IAA and TDR Capital LLP have each made acquisitions in the sector and paid between approximately 13x EBITDA and approximately 22x EBITDA in precedent transactions.
In reaction to this announcement, shares of IAA Inc. IAA, 8.02% surged 5.3% toward a fifth-straight gain in morning trading Tuesday (March 15).