Ritchie Bros.: Why Acquiring IAA? (NYSE:RBA)

In February of this year, I concluded that shares of Ritchie Bros. Auctioneers Incorporated (NYSE:RBA) were getting auctioned, as I was not a buyer yet. This came as the business had seen tougher operating performance in the second half of 2021 with prices of equipment being rapidly on the increase, while availability was low.

Slower momentum was worrying as the company announced a larger deal for Euro Auctions at the time, creating some small leverage concerns, as the overall earnings power was not compelling enough to see appeal arrive just yet.

A Quick Recap

Ritchie Bros. buys and auctions industrial equipment, a large and fragmented market, for industrial equipment and related items. The company takes multiples roles in this market, sometimes acting as broker and sometimes actually buying the goods outright itself both in North America and the European region.

The company posted a modest 4% increase in sales in the pandemic year 2020, with revenues up to $1.38 billion. Most of these revenues were generated from commissions and fees, with inventory sales totaling roughly half a billion. Operating margins rose to 19%, or a little over a quarter of a billion, with GAAP earnings just surpassing the $1.50 per share mark.

With shares trading around the $75 mark in the autumn of 2020, valuations were sky high even if earnings power had improved to a run rate around $2 per share at the time. I picked up coverage again in August 2021, as the company has been growing sales, yet earnings growth was hampered.

With a $7.0 billion enterprise valuation at $60 in August 2021, the company announced a larger $1.1 billion deal to acquire UK-based Euro Auctions. With availability of auctioned goods hurting the results, the company even saw year-over-year earnings declines in the third quarter as financing costs on the deal were quite expensive, creating a tough set-up.

As it turned out, 2021 sales rose just 3% to $1.42 billion as full year adjusted earnings rose just five pennies to $1.94 per share, with realistic earnings trending around $1.75 per share. With shares trading around the $50-mark, valuation remained high at 25-30 times earnings as net debt of $1.4 billion translated into a high leverage ratio based on $385 million in adjusted EBITDA (ahead of the Euro Auctions contribution).

Stabilization – And Pullback

After shares traded in the low $50s in the spring of this year, shares rallied to the $70 mark this past summer and shares are now down to $50 again. In April the company terminated the pending deal with Euro Actions as the UK Competition and Markets authority not want to give approval for the deal.

In May the company announced solid first quarter results with revenues up 19% to $394 million as adjusted earnings rose twelve cents to $0.46 per share. Second quarter revenues rose as much as 22% to $484 million on the back of accelerated pricing efforts with non-GAAP earnings up seven cents to $0.74 per share.

Early in November, third quarter sales growth was reported at 25%, with revenues up to $411 million, with adjusted earnings up eight cents to $0.53 per share. Hence, earnings now trend at $2.25 per share for the year. This comes as trailing adjusted EBITDA has improved to $442 million. With net debt down to $200 million following deleveraging and the cancelled deal earlier this year, leverage ratios come in at less than 0.5 times.

The 112 million shares traded at $62 ahead of the report, for a $6.9 billion equity valuation and $7.1 billion enterprise valuation at those levels. With earnings power trending at $2.25 per share, the company traded at high valuations of 27-28 times earnings on about $1.7 billion in sales.

A Huge Deal

Alongside the third quarter results, Ritchie Bros. announced a huge deal for IAA, Inc. (IAA) in a transaction valued at $7.3 billion, virtually the same as the valuation of its own firm ahead of the deal. With a $10 per share cash component, out of a $46.88 per share valuation, a great portion of the deal will be paid for in stock even as the deal includes a billion in net debt assumption. With Ritchie reporting $200 million in net debt ahead of the deal, net debt will come to around $2.5 billion upon consummation of the deal, as the company claims that this is equivalent to about 3 times leverage.

IAA generates some $2.1 billion in sales on which it reports EBITDA of $540 million, indicating that it is slightly larger and more profitable compared to Ritchie, as both firms have a similar dollar valuation here.

Of course, the businesses are not alike, as Ritchie Bros. focuses mostly on equipment and equipment vehicle, while IAA is focused on cars. With synergies seen at $100-$120 million in 2025, earnings accretion is seen in the years to come, as the question is where these come from with little overlap seen between both businesses.

Investors do not like the lack of strategic rationale, as the deal seems to be simply driven by larger scale and diversification. Shares fell to $50 overnight while third quarter results were in line with expectations. This means that the value of the equity fell some $1.3 billion on the deal announcement, only based on the outstanding shares currently. Including the to-be-issued shares, the valuation fell by $2.2 billion upon the announcement of the deal.

And Now?

The truth is that a $2.2 billion decline in the valuation of the company on the back of a $7.3 billion deal is large, yet here are few reasons to be upbeat. Valuations were high from the get-go, and the rationale behind the deal can be questioned, as leverage will increase quite a bit at a tough point in the economic cycle, as debt is tricky in this interest rate environment.

Amidst all of his, and an already very cautious stance ahead of the deal, I am even more cautious now, despite the pullback in Ritchie Bros. seen to the $50 mark here. At these valuations, and given the many question marks around this deal, I find it very easy to avoid Ritchie Bros. shares here.