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KAR Auction Services riding the wave of auto recovery

October 5, 2013

In retrospect, it was an amazing feat that Carmel-based KAR Auction Services, one of the nation’s biggest operators of used-car auctions, was able to pull off an initial public offering in December 2009.

Back then, the auto industry—on whose health the company depends—was a wreck. The Great Recession had sent new-car sales into a free fall. U.S. sales in 2009 were a mere 10.4 million, down from 16 million in 2007.

To get investors to bite, KAR had to slash the offering price to $12, far below the $15 to $17 range it had estimated in filings with the Securities and Exchange Commission.

Fast forward four years, and those early investors are looking savvy and sitting on hefty returns. Since November 2012, KAR shares have marched steadily higher, rising from $12.25 to nearly $29.

The good times might not be over, according to analysts and company executives. KAR executives in recent weeks have been telling investors that their strong second-quarter results—with sales rising 11 percent, to $541 million, and earnings soaring 40 percent, to $33 million—were just the start.

“We said that volume would get stronger in the second half of 2013. It would get stronger again in 2014 and then get stronger again in 2015,” KAR CEO Jim Hallett said at a Goldman Sachs investor conference last month. “That’s not just our opinion, but this is an opinion that is shared by our customers.”

To be sure, the fundamentals of all three of KAR’s business lines—whole-car auctions, salvage-car auctions, and inventory financing for used-car dealers—are on the upswing nationwide. New-car sales are on track to surpass 16 million this year, fueled in part by the strongest leasing market ever.

Leasing now accounts for 28 percent of car sales, and that number might reach 50 percent by 2017, Hallett said at the investor conference. He said that after drying up during the financial crisis, leasing came back in 2010. Because many leases run three years, those cars are now beginning to reach KAR’s auctions.

“We remain of the view that each of KAR’s three business segments are well positioned for solid growth for the foreseeable future,” wrote Northcoast Research’s John Healy, one of several analysts high on the stock.

Getting to this point has been an adventure for the private equity firms that acquired the business, then known as Adesa Inc., in April 2007, just before the global financial crisis hit. The deal, which also included the acquisition of a major salvage-auction operator, was valued at $3.7 billion.

KAR survived the crisis, even though the buyers—New York-based Kelso & Co., New York-based GS Capital Partners, San Francisco-based ValueAct Capital and Boston-based Parthenon Capital—had ratcheted up debt.

By last fall, the private equity owners were ready to pocket their profits and began negotiating KAR’s sale. But “advanced talks” to sell to the New York-based private equity firm Clayton Dubilier & Rice broke off in November, Reuters reported at the time.

Now, Clayton Dubilier might wish it had sealed the deal. Back then, KAR shares were trading for around $18, 38 percent below what they now fetch.

After the deal unraveled, the private equity firms settled on a plan to get their money out more gradually. Last December, KAR paid its first quarterly dividend—19 cents a share. And in March and September, the firms cast off some off their shares in secondary offerings.

The owners still have plenty of skin in the game. And if analysts are right in predicting KAR’s bright future, they’re probably not done racking up profits.

Finish Line gets downgrade

Sept. 27 was a sweet day for Finish Line Inc. execs. After they announced better-than-expected results before the market opened, the company’s shares zoomed higher, closing up 9 percent on the day.

But the investment firm Goldman Sachs isn’t joining the party. Days later, it issued a “sell” recommendation, suggesting shareholders should capitalize on the runup to lock in profits before shares fall.

Goldman said it is bearish because athletic footwear distribution is broadening, hurting retailers like Finish Line and Foot Locker. In addition, the firm is concerned that a new deal to operate Finish Line outposts inside Macy’s department stores will cannibalize existing stores.•

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