KAR Auction Services, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

A leading digital marketplace for wholesale used vehicles, connecting buyers and sellers across North America and Europe, also offering ancillary services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

KAR Auction Services, Inc., now known as OPENLANE, is undergoing a strategic transformation from a pure auction platform into a full digital marketplace. This shift is essential to understanding the company’s current business model.

Business Overview

OPENLANE (formerly KAR Auction Services) operates a digital marketplace for wholesale used vehicles, connecting buyers and sellers across North America and Europe. The company operates through two major reportable segments: Marketplace and Finance.

Marketplace: The marketplace segment provides a digital platform for sellers and buyers to transact used vehicles. This segment handles physical auctions with digital capabilities as well as digital marketplaces for whole vehicles. This includes ADESA U.S. and Canada, OPENLANE Canada, and ADESA Europe. OPENLANE primarily earns fees based on total transaction volume.
Finance: The finance segment focuses on providing floor plan financing solutions to its auction clients, including both commercial banks and other financial institutions. These are primarily provided through AFC, Automotive Finance Corporation. The segment earns revenue from interest and fees charged to borrowers.

OPENLANE has shifted focus to digitalizing its marketplace. The goal is to create a more robust digital ecosystem, and streamline operations by enhancing the user experience for buyers and sellers. This includes a focus on data and analytics, and leveraging technology.

Industry Trends

The wholesale used vehicle market is a large and fragmented one, with different participants like physical auctions, digital marketplaces, remarketing services, and captive finance companies.

Digital Shift: There is a clear industry-wide movement towards online platforms and digital transactions, which has only intensified with the global adoption of technology, but has also been accelerated by Covid. This shift allows the industry to reach a wider geographic area, increase efficiency, and make the market more accessible to new buyers and sellers.
Increased Use of Data: The reliance on data and analytics in the market is steadily growing. Buyers and sellers use data to make pricing and purchase decisions. Transparency, pricing accuracy, and improved forecasting all come from this growing trend.
Evolving Business Models: The business model continues to evolve, and the emergence of new players is changing the dynamics of the industry. There has been increased M&A activity, more partnerships and other forms of integration between business operating in the same sector.

Competitive Landscape

OPENLANE faces intense competition from both established players and new entrants in the online vehicle market.

Traditional Auction Houses: Competitors in this area include Manheim, the largest provider of automotive auctions globally. These are the most directly comparable as a direct competitor to the ADESA branded auctions.
Online Auction Platforms: The internet has seen new and emerging businesses like ACV auctions and Carvana, who operate exclusively online as a digital marketplace. The key differentiation here is the lack of physical locations and purely online operations.
Ancillary Services Providers: There are numerous competitors that provide ancillary services, such as transportation, inspection, and data analytics. This includes companies that are part of larger groups like Cox Automotive, or specific small to medium-sized companies.

OPENLANE is attempting to differentiate itself by providing an integrated marketplace platform that provides solutions for buyers and sellers, combining both physical auctions with online capabilities. The company is leveraging data and tech solutions to enhance efficiency.

Financial Analysis

Revenue Distribution: OPENLANE’s revenue comes from two sources: transaction fees and interest and financing income. Both of these segments are very sensitive to volumes and transaction prices. Market conditions can greatly affect both the financing and trading aspect of the business. In the Marketplace Segment, revenue is derived from the sale of vehicles at auction, and from providing a variety of ancillary services such as title services, transportation, and inspection. This segment is the primary source of income for the business, and has higher revenue compared to the Finance segment. The Finance Segment provides a variety of financing options, primarily to dealers, and they receive interest income and various fees in exchange.
Profitability: The company’s margins are quite complex to analyze as several aspects of the business affect it. Operating costs are highly dependent on personnel, technology, marketing, and business integration costs. The gross profit margin on vehicle sales is high, but the operating expenses are considerable, reducing the overall profitability of the marketplace segment. The finance segment has a lower gross margin, but also lower expenses as the business is very capital intensive. The net profits and EBITDA show that margins are volatile and they are dependent on the general economic environment, as well as management decisions to streamline and lower costs. In previous years the net margin has been as high as 30 percent and as low as -12 percent, which shows just how volatile profitability is.
Growth: The last year has been challenging for OPENLANE because, despite strong growth from the marketplace segment, its financial segment has been heavily impacted from the general industry slowdown. That being said, they are showing strong growth year-over-year from the core business segments of the marketplace. The company is shifting away from physical auctions and toward its fully digital platform. This is evident in its last report from the three months ended Sept 30, where their Marketplace revenues increased by 24%, while their Finance segment revenue decreased by 35%, showing the overall direction of the company.
Latest Earnings: The last report shows a positive turn to the company profitability despite the revenue fluctuations. The company produced earnings per share at 0.08 which beats analysts expectation by 0.04 cents a share, and they also reported a positive net income of 18.5 million. They also reported adjusted EBITDA as 169 million. However, this positive trend was solely a factor of improvements and cost-cutting measures, as the revenues are not growing at the same pace that their overall profits are, highlighting their overall business risk.

OPENLANE is a complex business with revenues tied to volatile auctions and the macro economy, while also being highly capital intensive due to its finance business.

Moat Assessment

OPENLANE’s business is not highly differentiated as it has multiple direct and indirect competitors with large brand recognition and long operating experience. The core business model is quite easy to replicate given the technological advances and other alternatives like other financing options from competitors. Therefore, the barriers to entry in the industry are not insurmountable, and there is low defensibility against new entrants.

Network Effects: While network effects do play a part in the business (buyers are attracted by the variety of available sellers and vice versa), they are not incredibly strong and easy to replicate, because this is an issue that the competitor can easily solve via its own network. This lowers the magnitude of the network effect, and the moat that it creates.
Intangible Assets: OPENLANE has some degree of brand recognition for ADESA, but the business is still mostly just a middleman and doesn’t focus on brands that create specific lock-in, therefore it does not constitute a strong enough moat, and is easy to erode. Also, their software itself, can be easily replicated or used as an offering by another company.
Switching Costs: It’s not incredibly difficult for buyers and sellers to move to other platforms. The cost and effort involved are minimal and easy to overcome by competitor companies. Furthermore, the customers are always looking for better deals and it is easy for competitors to use pricing power to capture the client base.
Cost Advantage: The company, with all of its operations being large, is not able to generate any sort of a true cost advantage over its competitors. The business model itself is not that unique and new businesses can follow same strategies while operating their own network and leveraging their infrastructure in better ways.

Moat rating justification: The overall business does not have a strong moat, and the company faces many competitors. This means that the business does not possess the pricing power it needs to establish an impressive position, and thus a lot of its returns are at risk. This gives it a relatively weak moat, therefore meriting only a 2 out of 5 rating.

Risks to the Moat

Technological Disruption: Newer technological platforms from competitors can offer superior services and features, potentially eroding OPENLANE’s market share. With the shift to complete digital marketplaces, a company can easily disrupt the business by offering better services or low fees.
Increased Competition: The rise of other specialized and large players could increase pressure on margins and profitability. Forcing it to lower prices or innovate more in order to keep its market share. Also, a lot of smaller players in the industry might make the company vulnerable to them in very specific areas of expertise.
Economic Sensitivity: The used vehicle market is directly tied to macroeconomic conditions, a prolonged economic downturn or increase in interest rates will make consumers reduce their purchase power, which may result in decreased prices of used vehicles and make financing costs much higher.
Operational Challenges: Integrating newly acquired businesses, or scaling of newer and faster growing segments of the company can cause disruptions to normal operational levels and processes, resulting in missed timelines and targets, and increased costs and overheads.
Credit Risk: Default risks by their financing clients can lead to losses in their finance segment, and could directly affect profits and revenues. This especially applies to smaller or non-investment grade clients that operate in a more difficult financial environment.

Business Resilience

The company’s resilience stems from its long-standing position as a significant player in the automotive industry, with existing relationships in both the buyer and seller sides, and an extensive client base across North America and Europe. The company has been focused on digital innovations, as such, is actively looking for ways to make the business less cyclical or vulnerable to industry headwinds. The long term vision of the business is to be a more data-driven technology and analytics company. This, if successful, may make it more valuable in the longer run.

Understandability

The business is not very hard to understand. However, the combination of a physical auction business with a large financing segment makes it slightly more complex. Also, the way the company is evolving into an almost exclusively online market presence can make some of its operations less intuitive to those who are new to the business. Overall, the business model is a bit more complex than average, therefore meriting a 3 out of 5 rating.

Balance Sheet Health

OPENLANE’s balance sheet shows solid liquidity, with a good amount of cash available for operations and future investments. The current assets ratio is above 1 and there are no major upcoming debt repayments. While there has been a steady increase in debt, it is primarily for strategic acquisitions and to fund operations rather than used for covering a decline in revenues. Therefore, the company’s balance sheet appears to be quite healthy, meriting a rating of 4 out of 5.