KAR Auction Services

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1 G.research, LLC One Corporate Center Rye, NY Tel. (914) April 7, 2017 KAR Auction Services (KAR - $ NYSE) Source: KAR Auction Services Used Cars Galore: KAR Auction Services Primed for Bidders Initiate KAR with Buy, 2019 PMV $62 Per Share Matthew T. Paige Gabelli & Company 2017 (914) Please Refer To Important Disclosures On The Last Page Of This Report-

2 G.research, LLC. One Corporate Center Rye, NY Tel. (914) April 7, 2017 Investment Summary KAR Auction Services, Inc., based in Carmel, IN, is a leading vehicle auction platform specializing in both whole car and insurance salvage units. Additionally, KAR provides floorplan lending to its independent dealer customers. We are initiating coverage of KAR with a Buy recommendation and a 2019 PMV of $62 per share. We estimate KAR Auction will earn $2.15 per share and $830 million of EBITDA on $3.4 billion in revenues in We believe KAR is an attractive investment for the following reasons: KAR is primed to benefit from the impeding influx of offlease and trade- in vehicles as dealers, overwhelmed with excess trade-ins, look to KAR whole-car auctions to move inventory. After years of strong new sales, with a >20% lease penetration, dealers are likely to be inundated with a supply of used cars. Used vehicle prices logged consecutive decreases to begin 2016, and further deterioration is expected as off-lease and trade-in volumes increase used supply. Lower values, especially alongside increased repair costs (given higher technology content), boost odds that a car involved in an accident will be deemed a total loss, increasing the number of vehicles sent to auctions. KAR does not take ownership in auction units, insulating the company from falling residual values. An increase in miles driven pushed accident volume in line with 2003 peaks of 6.3 million following a dip to 5.3 million accidents in Despite active safety content increasing, distracted driving has offset many of those safety gains and elevated accident rates are likely to continue as long as humans remain in control of the vehicles on the road. These industry trends will mean increased volume directed to vehicle remarketers such as KAR Auction that provide both whole-car and salvage channels. We estimate revenues to grow from $3.2 billion in 2016, to $4.5 billion in 2021, a >7% CAGR. KAR s cost structure skews significantly towards fixed costs, additional units should drive strong incremental margins and ultimately $1.9 billion of free cash flow over the next five years. We project adjusted EPS to grow from $2.06 in 2016 to $3.25 in With a 2019 PMV of $62 per share, we believe a 30% margin of safety is sufficient for a Buy recommendation. Table 1 KAR Auction Services Earnings Summary E 2018P 2019P 2020P 2021P Revenue $ 3,150 $ 3,440 $ 3,740 $ 4,030 $ 4,270 $ 4,470 EBITDA ,020 1,105 1,180 EPS $ 2.06 $ 2.15 $ 2.70 $ 3.25 $ 3.80 $ 4.30 CapEx Source: Company Filings, Gabelli & Company Estimates -1- INITIAL REPORT BUY KAR Auction Services, Inc. KAR NYSE Current Price: $ Week Range: $ $35.68 Earnings Per Share (adj.): 2019P $ P E Price/Earnings Ratio: 2019P 12.8x 2018P E Dividend: $1.28 Current Return: 3.1% Capitalization (12/31/16): ($ billions) Net Debt $2.3 Common Stock (136.7 mil shares o/s) 5.7 Total Capitalization $8.0 Matthew T. Paige Gabelli & Company 2017

3 COMPANY HISTORY KAR Holdings, Inc was formed in 2006 by a consortium including Kelso & Company, Goldman Sachs (GS NYSE), Parthenon Capital and ValueAct Capital. KAR Holdings began operating in April 2007 through two concurrent acquisitions of IAA and ADESA. Insurance Auto Auctions (IAA) was formed in 1982 as a salvage vehicle auction business. IAA went public in 1992, before being acquired by Kelso & Company and Parthenon Capital in Meanwhile, ADESA began operating as a whole-vehicle auction company in 1989, going public in In 1994, ADESA acquired financing company Automotive Finance Company (AFC). In 1995, ALLETE (ALE-NYSE), a Minnesota utility provider, purchased a majority equity stake in ADESA, taking the company private later that year. This structure remained in place until June 2004 when ALLETE sold 20% of the business in public markets through an IPO, spinning off the remaining 80% in September of the same year. In April 2007, KAR Holdings acquired both ADESA and IAA from their respective holders, forming the company now known as KAR Auction Services (name change in November 2009). Kelso & Company, Goldman Sachs, Parthenon Capital and ValueAct Capital have since sold their equity ownership of the combined entity between December 2012 and November Exhibit 1 Date October 1982 N/A 1989 April 1992 January 1994 January 1995 June 2004 September 2004 June 2005 April 2007 November 2009 December 2009 Source: Company filings Company History Summary Event Insurance Auto Auctions begins operations ADESA begins operations ADESA is listed on the NYSE ADESA acquires Automotive Finance Company ALLETE acquires ADESA ALLETE IPO's 20% of ADESA ALLETE spins remaining ownership of ADESA to shareholders IAA acquired by private equity firms Kelso & Company and Parthenon Capital KAR Holdings acquires ADESA and IAA KAR Holdings changes name to KAR Auction Services KAR Auction Services listed on the NYSE James Hallett has served as the company s Chief Executive since September 2009 (and chairman since December 2014). Hallett previously served in various roles, including Chief Executive and President of ADESA from 1996 to He took a hiatus from the company, between May 2005 and April 2007 to serve as President of Columbus Fair Auto Auction, before returning to the company. VEHICLE REMARKETING OVERVIEW There are three major vehicle auction providers in North America: Copart, Inc (CPRT-NASDAQ), KAR Auction Services and Manheim (private, owned by Cox Enterprises). With only three major remarketers in the arena, KAR is set to benefit from a surge in supply driven by off-lease vehicles. Given the rate of vehicle sales growth in 2014 and 2015, lease returns could grow by as much as 500,000 units in both 2017 and 2018 to 4.7 million units annually. The industry will also see a higher rate of total loss and increasing frequency of accidents (salvage). KAR is in a prime position to benefit from these trends given its heavy exposure to whole-car auction. Exhibit Whole-Vehicle Auction Volume by Type Source: Manheim Consulting The North American used vehicle market typically encompasses ~40 million transactions per year, and unlike the cyclical new vehicle market, remains fairly consistent across the business cycle. Consumer-to-consumer deals comprise ~12 million units and wholesale auctions account for >10 million units. Additionally, approximately 13 million units are removed or scrapped from the car parc each year, with ~5 million of those cars being processed through a salvage auction. -2-

4 Whole-car vs. Salvage Whole-vehicle auctions, which total >10 million units annually, facilitates the transfer of used vehicles between dealerships and provides commercial fleets a means of disposing of retired vehicles. The auction provides an outlet for dealerships to sell (albeit at wholesale prices) vehicles that they either do not have space for, or have been unable to sell in their markets. Meanwhile, salvage auctions participate in a market size of >4 million units, and typically allow insurance companies to sell total loss vehicles to dismantlers, body shops and exporters (where repair costs are cheaper and safety standards lower). Salvage vehicles allow dismantlers to claim undamaged parts that can be used in repairing cars at less cost than new OEM replacement parts an attractive value proposition to insurance companies and consumers alike. BUSINESS OVERVIEW KAR Auction Services is a provider of auction services for both whole cars as well as salvage units in North America and salvage units in the United Kingdom. Additionally, through its AFC unit, KAR provides floorplan financing for the independent used vehicle dealers that utilize its auctions. ADESA ($1.8 billion, or 56% of 2016 total revenue): ADESA is the second-largest whole-vehicle auction provider in North America. ADESA s primary competitor, and the number one player in the North American market, is Manheim (owned by Cox Enterprises). ADESA maintains market share of ~27% vs Manheim s 40-45% of the market. These auctions, both online and at physical locations, consist of off-lease, repossessed, rental/other fleet, or dealer inventory vehicles that have either reached a mileage/age limit or do not have a readily apparent retail marketplace. Given this supply mix, customers tend to be entities that control large fleets of vehicles such as vehicle manufacturers, captive finance companies, rental fleets, financial institutions and dealer groups. Despite working with large customers, ADESA s customer mix remains fragmented with no customer accounting for more than 5% of segment revenues. On the other side of the equation, buyers of these vehicles are mostly vehicle dealer groups as vehicle auction buyers are required to have proper permitting, restricting the addressable market. ADESA is paid a fee from both the buyer and seller at auction; though the fee schedules vary. The fee charged to buyers is based on the auction price paid per unit, while institutional sellers typically pay a flat fee negotiated in advance based upon total volume brought through the ADESA network. In addition to providing the auction forum, ADESA generates revenue by providing transportation (for both buyers and sellers), administrative tasks (titling, repossession paperwork) and reconditioning work as requested. Additionally, ADESA acquired OpenLane in 2011 in order to provide private-label websites for automotive OEMs and captive finance companies to sell their vehicles to dealers. Exhibit 3 ADESA Sacremento Location Source: ADESA Exhibit 4 ADESA N. American Locations Source: ADESA -3-

5 INSURANCE AUTO AUCTIONS ($1.1 billion, or 35% of 2016 total revenue): In contrast to the whole vehicle auctions provided by ADESA, Insurance Auto Auctions (IAA) focuses on salvage vehicles. IAA is one of the two largest salvage auction operator, alongside Copart, Inc. Combined, these entities control ~80% of the salvage market in the United States, each accounting for about 40%. After years of consolidation, neither player believes there is a sizeable target remaining in the market to continue to acquire. Exhibit 5 IAA N. American Locations Historically operating in the United States and Canada, IAA expanded to the UK in June 2015 after acquiring salvage auction operator HBC. The primary customers for IAA are insurance companies, but sellers also include dealers, rental fleets and charitable organizations. IAA operates on an agency basis, conducting its auctions for its sellers (who retain ownership of the vehicle until the transaction is complete). The auctions are conducted in person as well as simultaneously on the internet, although it is unclear how many internet users are also physically at the auction. Source: Company filings The customers attending these auctions are automotive body shops, rebuilders, wholesalers, dismantlers and exporters. Given licensing requirements, only few non-professional buyers participate in IAA auctions. Similar to ADESA, IAA generates revenue through both buyer and seller fees, as well as fees from ancillary services such as document assistance, towing and storage. Additionally, the customer breakdown is very fragmented, with no seller accounting for more than 3% of IAA revenue, and no buyer accounting for more than 4%. Automotive Finance Company ($285 million, or 9% of 2016 total Exhibit 6 AFC Managed Receivables revenue): Automotive Finance Company (AFC) is a floorplan financing provider for independent vehicle dealers. Floorplan is a revolving financing that allows dealers to carry inventory they could not outright purchase. In AFC s situation, each loan is made against a specific VIN number or unit. While not all dealer customers participate in KAR s auctions, 84% of vehicles financed through the lender were purchased at a KAR auction. In all, AFC counts ~11,300 dealers with an average line of credit of $230,000 (for an average ~sixteen vehicles, or $9,100 per vehicle) as its customers, with no one dealer accounting for more than 1.2% of segment sales. Aggregate managed receivables are >$2 billion, and are typically paid within 60 days with a guidance for % loss Source: Company filings provision, in-line with Dealers typically use the financing to increase their purchasing power on auction vehicles that are found at mostly ADESA or IAA locations. These customers are largely low-quality credit customers using AFC as a method of last resort, however, given the close proximity to which its customer operate and stringent methods of legal recourse (including entire lot repossession and actions against the individual s other assets), AFC is able to sustain credit losses similar to the overall automotive finance industry. AFC maintains 118 locations, located nearby an auction site, in order to service its customers. -4-

6 REVENUE PER TRANSACTION DRIVING GROWTH ADESA: Revenue per-vehicle sold at physical auctions (excluding those sold as a principal) increased to $753 vs $701 in 2016, driven by an increase in ancillary services, such as pre-auction detailing and refurbishment work. In addition to those services, RPU also includes fees paid by both the buyer and seller. Given increased take rates on ancillary services, we expect these gains to more than offset any lower fees paid due to lower residual values. This trend will likely be amplified as more commercial volume (vs dealers) flows through ADESA, as these customers are less likely to be able to do the repair work themselves, as a dealer may. In internet only (private label) auctions, revenue per unit was $110 vs $102 given a better mix of vehicles sold through the auctions. We view these sites as a stable revenue source, and do not model in an increase given the lower volume associated with them as well as future residual pressure. IAA: RPUs at IAA meanwhile have remained flat, ~$500 in both 2016 and Salvage units do not carry many ancillary options purchased by the insurance company sellers, and instead, fees are determined by an (effectively) industry wide fee schedule published by Copart (Exhibit 7). Residual values only impact a small percentage of the units sold (higher value), and declining salvage prices have had a slight negative impact. While RPU will be under pressure this year until the second-half, if salvage prices remain at current levels, we believe overall IAA revenues will be boosted by industry volume increases. AFC: Given AFC s customer base consists of low-credit quality dealers that are mostly unable to secure floorplan financing elsewhere, it should come as no surprise that around half of the RPT comes in the form of various fees. In 2016, RPTs decreased slightly to $148 vs $150 given a slight uptick in provision for loan losses to 1.8%. This figure falls within KAR s guidance for 2017 loan loss provisions, and we therefore expect RPT to be about flat-to-up slightly with limited YoY pressure from loan losses. WHOLE-CAR AUCTION VOLUMES TO REMAIN STRONG Dealers/Consumer Volume to Boom from Lease Returns The primary method in that consumers dispose of old vehicles is through trade-in (or lease return) to a dealership when buying a new unit. Major franchise dealers benefit from this supply of used vehicles as it provides an inventory of used units. However, dealers are unable to retail all tradein vehicles that come to the dealership, and excess cars are sold through auction. This problem is amplified in the years following strong new retail sales as the US has experienced in recent years, with LV sales volumes in excess of 15 million units since While the first car owner typically keeps the vehicle for 3-5 years, the rising prevalence of leasing (25% of LV sales in 2016, vs 13% in 2009) will drive the average towards the low-end of that range. We predict the plethora of off-lease vehicles will lead franchised dealers to choose the best units to retail, putting the rest up for auction as the influx of off-lease vehicles overwhelms capacity. Exhibit 7 Copart Buyers Fee Schedule Sales Price Range Fee A Fee B Fee C $ $99.99 $ 1.00 $ $ $ , , , , , , , , , , , , , , , , $ , , % 7, , % 10, , % 15, , , % 20, , , % 25, , , % 30, , $ $ 1, % > $35, % 5% 15% Source: Copart, Inc. Exhibit 8 U.S. LV Sales & Leasing Rate Source: Ward s Automotive, Edmunds.com -5-

7 Given expectations that US LV sales continue in a plateau environment for about the next two years and leasing rates are expected to remain ~25% of total new volumes, strong whole-vehicle auction demand should be the new norm, at least in the short term. In light of a supply wave of used vehicles, many large dealers, including industry leaders AutoNation (AN NYSE) and Penske Automotive (PAG NYSE), have launched (or acquired) standalone used car centers. However, the top-five franchised dealers account for only 2.5% of total used car sales (according to Automotive News). This fragmentation demonstrates that regardless of these initiatives, the independent dealers that constitute much of the whole-car remarketing buyer base will continue to need to utilize auctions. Commercial Auction Volumes Growing Too However, dealers are not the only segment of the market that participates in auctions. Rental companies, financial institutions (lenders) and other managers of large fleets always look to auctions in order to move depreciating assets off their balance sheets quickly. Commercial volumes have a higher propensity to sell at auction than units from dealers, as these groups (despite recent efforts) do not have as many avenues of disposition as dealers, such as bringing back to their lots. To illustrate this point, of the 1.5 million repossessed vehicles annually, >80% are sold through auction, compared to 45% of dealer wholesale volume, according to Manheim Consulting. Vehicle loan delinquencies are just beginning to rise from historic (and near zero) lows, we believe this will propel industry repossessions volumes higher (volumes peaked at 1.9 million in 2009). In 2016, 2.1% of all loans were 30+ days delinquent, vs 2% in This volume will directly translate into increased remarketing volume given the high auction rate, as noted above. Additionally, while not providing specific mix figures, KAR maintains ADESA is overweight repo volumes vs the industry, meaning it should receive and outsized benefit. Table 2 Whole-Car Addressable Market Analysis P (millions of units) E 2018P 2019P 2020P 2021P Dealers Fleets/Leasing Factory Other Total Source: NAAA Survey and Gabelli & Company Estimates Off-rental vehicles add a further ~1 million units to the auction channel, though category volume peaked in 2006 at 2 million units, leaving plenty of runway for growth. More recently, rental powerhouses Hertz (HTZ NYSE) and Avis Budget (CAR NASDAQ) have refreshed their fleets, needing to remove small passenger cars that are not currently in vogue in the retail market, demonstrating the value that an auction channel can provide. The rental industry continues to talk about over-fleeting, which will augment the typical replacement cycle, driving auction volumes. (Table 2) -6-

8 SALVAGE SUPPLY NOT SLOWING DOWN Salvage vehicles primarily come from insurance companies attempting to sell vehicles that have been deemed an economic total loss. A total loss will be declared by the claims adjuster if it is found that the repair costs are greater than the pre-accident vehicle value, less the estimated salvage value. Salvage rates have trended up recently, a factor of both increased vehicle age and increased safety content per vehicle. Vehicles have remained on the road longer than ever before, and the average age of the car parc has surpassed 11.5 years. Despite being functional automobiles, these older cars have lower resale value and when they are involved in an accident are therefore more likely to be declared totaled. While values have recovered from 2009 and 2010 lows on positive supply/demand dynamics, we expect that trend to turn (as we have seen so far in 2016) as previously new cars are sold by their first owners. After selling 14.4 million vehicles in 2012 and 15.5 million in 2013, US auto sales, and thus trade-in volumes, have continued to grow. Vehicles tend to stay with their first owner for about three years before being traded in or sold. This sets up a tough pricing environment as the supply/demand mismatch will trickle down to impact older vehicles as well. With a lower value assigned to cars, more vehicles will be judged as a total loss following an accident, opening additional volume for salvage auctioneers like Copart and IAA. Even though active safety features work to prevent accidents, and are responsible (in part) for the decline in accident rates, they also add value to the vehicle in critical areas. These areas are more likely to be impacted by a collision; because of the fragile nature of the cameras and sensors, as well as the violent nature of a car crash, the repair costs are increased. These increased repair costs contribute to the likelihood that the car is salvaged rather than repaired. We believe that in an environment where miles driven and salvage rates are rising, both IAA and Copart are well positioned to drive sales and earnings. SALVAGE INDUSTRY VOLUME STRONG DESPITE SAFETY TECH We note that there remain market concerns regarding the risk that autonomous and semi-autonomous driving technologies pose to salvage operations in the future. The growth rate of the salvage business is subject to two major independent variables: accident rate and salvage rate. Accident rate is shown as a percentage of accidents occurring per million vehicle miles. Salvage rate is percentage of vehicles involved in an accident that are determined to be a total economic loss. An increase in miles driven increases the likelihood of a vehicle being involved in an accident, and as miles driven began to increase in 2012 (Exhibit 10), so have accidents. Exhibit 10 Vehicle Miles Traveled ( ) Exhibit 9 Scale: 2000= 100 Source: Manheim Consulting Manheim Used Vehicle Value Index Exhibit 11 Police Reported Crashes (U.S.) ( ) (miles in trillions) Source: Federal Reserve Bank of St. Louis -7- Source: National Highway Traffic Safety Administration

9 As seen in Exhibit 11, total accidents reported to police have rebounded from a low of 5.3 million in 2011 to 6.3 million in 2015, about flat with 2003 (these numbers are likely higher, closer to ~10 million according to NHTSA estimates on unreported accidents). We believe this recent increase is attributable to higher miles driven as well as more distracted drivers on the road (due to texting, internet usage, etc). This is not to say that recent technological advances have had no impact. Accident rates have declined, as active safety technology has improved the ability of drivers to avoid accidents. This sort of phenomenon is of course not new, as accident rates similarly declined after the mass introduction of anti-lock braking systems, or ABS. We have seen a boost in miles driven, which has been attributed to lower fuel prices, more vehicles on the road and a higher employment rate. As consumers pay lower prices at the pump, more drivers are choosing to take their vehicles on longer road-trips with their families, and the increasing size of the car parc inherently means more miles in aggregate. The highest percentage of miles driven in any given year for the typical American is spent commuting to and from work. As more people are employed, commuting becomes a part of their everyday routine, accounting for 10-15,000 miles per person. These factors have driven total miles driven in the United States above 3.1 trillion miles in 2016, up from 2.7 trillion miles in Further, increased wear and tear on a car will require replacement parts. Salvage parts can fill this void, especially for vehicles nearing the end of their useful lives (Table 3). Table 3 Salvage Addressable Market Analysis P (in millions) E 2018P 2019P CAGR Beginning Car parc New Vehicle Sales % Cars Scrapped (11.1) (11.1) (11.5) (11.8) (12.0) 2.0 Ending Car parc Accidents Total loss Accidents Non-Insurance (all sources Total Salvage units S o urc e : Ward's, Dept. o f T rans po rtatio n, N HTSA, C C C, Gabe lli & C o m pany Es tim ates ALTERNATIVE PARTS USAGE IS GROWING In the US, alternative parts comprise 36.7% of all parts used in repairs. Alternative parts encompass aftermarket, remanufactured and recycled parts. Given the similar reliability when compared to OE replacement parts, the figure continues to grow as insurance companies seek ways to reduce repair costs (in turn keeping consumer premiums in check). Parts are the largest cost of the average repair appraisal, accounting for 46% of the cost (vs 43% for labor), compared to 41% as recently as One of the reasons for this cost inflation has been vehicle complexity, further demonstrating the need for alternative parts to enable insurers to keep costs down. Exhibit 12 Source: Mitchell International US Alternative vs OEM Parts Usage in Repairs -8-

10 Globally, alternative parts make up just 10% of repaired parts, leaving a potential opportunity for both distributors and salvage auctioneers. That said, countries like Germany which are traditionally averse to alternative parts, and insurance systems would require radical changes in order to make the auction process, and therefore vehicle procurement process for dismantlers, feasible. So while all major auctions have plans to expand on continental Europe, we do not model in any benefits from foreign markets in the near term. FUTURE CHALLENGES AND OPPORTUNITIES LIE AHEAD We believe that autonomous driving technologies are still years away from mass adoption, but the potential impact they will have has been widely speculated upon and has resulted in multiple contraction for businesses such as Copart and IAA. To that end, there are key challenges that safety innovation will pose to the salvage industry, as well as potential offsetting opportunities that will arise due to shifts in the underlying markets. Autonomous Driving Poses Limited Current Risk to Revenues We believe that autonomous driving likely poses limited risk to operators like Copart and KAR in the near to midterm. Most active safety technologies on the horizon are only effective at low speeds, able to only mitigate incidents above 25 mph. Autonomous vehicle accidents, while less frequent due to reduction in low speed collisions, will involve more damage and require a higher cost to repair. More importantly, the timeline for autonomous vehicles remains too distant for the potential risk to be discounted into share prices. Even if autonomous vehicles begin to appear on roadways in 2025 as some predictions call for, it is at least years after that until the fleet can be turned over, meaning there will be non-autonomous vehicles remaining on the road. As we have witnessed with recent significant numbers of autonomous incidents, even self-driving vehicles can be involved in accidents, especially around their more traditional manually driven brethren. Car Sharing Would Create More Scrappage Another potential outcome is that car sharing surpasses individual ownership. Even assuming that the number of cars on the road can decrease under this situation (an assumption we do not necessarily agree with), those cars would need to inherently travel more miles each year (as vehicle utilization increases). As such, those (fleet) cars will need replacement parts at a more rapid pace than traditional vehicles and because of the increased wear there will be a higher likelihood of being declared a total loss if involved in an accident or when in need of serious repair. Additionally, due to the (theoretical) car share environment of the future, at the end of their fleet life, there will be limited resale opportunities outside of auction to salvage operations driving continued volume to salvage auctions. Aluminum is a Boon to Salvage Operators As OEMs search for ways to meet emission regulations around the world that rely, (in part) on lighter materials. For light vehicles, that means more body panels are being constructed from lighter alloys such as aluminum at the expense of steel. Aluminum is much more difficult to repair in the event of a crash than steel and needs to be replaced if it is damaged. Since insurers prefer the low cost of a salvage replacement part, this trend towards aluminum will drive more demand for salvage replacement parts, and should lead to increased business at salvage auctions. -9-

11 SCRAP PRICES ARE A REAL DRAG (ON THE WAY DOWN) Both Copart and IAA s revenues come from the fees collected from both sellers and buyers, and do not include the selling price of the vehicle (auctioneers act as agents). Those fees are determined by a schedule based on the sale price of the vehicle. An example of Copart s most recent Buyer s Fee schedule for US locations is shown in Exhibit 13. While not publically available, KAR can be assumed to utilize a similar methodology. From this table, one can see that a decrease in scrap prices (which would reduce the selling price of the vehicle) would negatively impact both sales and margins. The industry tracks scrap prices using the American Recycler Crushed Auto Body Index. The index has seen a steady decline since October 2012 due to weak demand from China and over-supply of precious metals. Scrap prices are not a pass-through input as they are for automotive suppliers. For a level of magnitude, 20-25% of vehicles are sold for scrap and even those that are sold to dismantlers (60-65% of units) have a portion of their value determined by scrap metal prices. There are three levels per-price range: Business Members using secure payment (Fee A), Business Members using nonsecure payment (Fee B), and Consumer Members (those without a business license, Fee C). While IAA does not publish their fee schedule, we believe them to be similar to Copart given our conversations with management. GOING DIGITAL: HIGH TECH DISPELS JUNKYARD NOTIONS Perhaps surprising to those outside of the industry, technology is an integral part of the vehicle remarketing business. KAR Auction has been one of the formative leaders in developing technologies on all sides of the business. Individual vehicles are tracked by VIN number, allowing auction management to know the status, quality and exact location of each unit as it arrives at the auction site. This technology allows KAR to suggest to sellers maintenance that may be needed prior to a successful sale, and can also be accessed by buyers who simply scan a sticker or VIN number on the car, and can be used to make a more informed purchasing decision. Autoniq, KAR s proprietary app allows dealers to access profitability guides in real time at any auction site (including ADESA s competitors). Autoniq costs dealers $50 per month, and has a potential market of over 18,000 independent car dealerships in the US. Exhibit 13 Copart Buyers Fee Schedule by Category Sales Price Range Fee A Fee B Fee C $ $99.99 $ 1.00 $ $ $ , , , , , , , , , , , , , , , , $ , , % 7, , % 10, , % 15, , , % 20, , , % 25, , , % 30, , $ $ 1, % > $35, % 5% 15% Source: Copart, Inc. Exhibit 14 Autoniq Screenshot Additionally, KAR has launched multiple mobile apps that allow prospective bidders to participate from anywhere with a connection. Looking forward, technology is an area that KAR is keen to focus on, with the potential to expand its data reach to help sellers make informed decisions. For example, future technologies could allow sellers to see how much of an increase in selling price a repair would cause, or to Source: Autoniq determine an accurate price floor in the auction. Many of these technologies are business-to-business focused, and would likely be included in the services offered to commercial sellers in an effort to gain market share and additional pricing in contracts. -10-

12 Competitors in the whole-car auction, Manheim s parent Cox Automotive, have launched or acquired a number of technological initiatives, such as Kelly Blue Book and more recently, DealerTrack that help dealers work with consumer customers. KAR have previously stated they are not focused on the business to consumer space. INTERNATIONAL EXPANSION POSSIBLE, THOUGH CHALLENGES REMAIN Of the $3.2 billion in 2016 revenues, $413 million was derived from foreign operations (primarily Canada and Mexico). While this figure also includes operations from ADESA and IAA in the UK, we believe these results to be currently nominal based upon conversations with management. However, as domestic expansion opportunities dwindle, expanding KAR s overall presence in Europe has become more of a priority, with the company showing a preference for acquisitions vs greenfield expansion in order to ensure customers from day 1. Following an acquisition into a market, KAR believe it can expand quickly, especially on the ADESA (whole-car) front given the global reach of its commercial customers (captive FinCo s and OEMs). On this front, there is one public whole-vehicle remarketer in Europe, BCA Marketplace (BCA-LSE), currently with a market capitalization of ~$1 billion (at current GBP/USD rates). While KAR feels this would be too large of an acquisition for them to make, especially given being at its leverage target of 3x EBITDA, we would not mark the idea of a BAC acquisition as impossible. The whole-sale auction market has a similar market structure as the US, with a notable exception: KAR s ancillary services are unlikely to be as prominent around the globe as higher levels of competition have compressed margins below an acceptable level to KAR at this time. Exhibit 15 Source: BCA Marketplace BCA Marketplace Locations Outside of the UK, where KAR already operates, we view the expansion into salvage remarketing as difficult. Industry practices in markets such as Germany function in a fundamentally different way from the US, making an auction business unsustainable without widespread change. For example, when a vehicle is determined to be a total loss in Germany, the consumer is responsible for disposing of the vehicle (due to legal requirements for the transfer of ownership). We believe that these regions will remain cash-negative businesses until required legal changes are made (insurance companies are likely to follow each other in order to boost customer satisfaction and lower costs once allowed). IAA is also not alone in pursuing Western European and Middle Eastern markets, as its largest competitor Copart has already launched similar operations in those countries. STRONG USD KEEPS FOREIGN BUYERS AT BAY 25-30% of salvage units are typically sold to foreign buyers, at both Copart and IAA/KAR, though both auctioneers have noted declines in this figure as the USD has strengthened against key currency pairs, notably the Mexican Peso (Mexico accounts for just under one-half of foreign buyers). This FX movement ( pesos per USD in Q vs in Q and in Q3 2015) has weakened the competitive position of these buyers, who look to export the salvage vehicles in order take advantage of cheaper labor and lower regulatory requirements and resell. Weakening financial positions of these buyers have not only removed some volume from the auction, but also weakened pricing, resulting in lower fees for both CPRT and IAA/KAR. -11-

13 BALANCE SHEET & CAPITAL ALLOCATION- DIVIDEND TOP PRIORITY KAR maintains a 3x EBITDA leverage target, driven by a management team that believes in fully utilizing its balance sheet. In doing so, KAR maintains a list of capital allocation priorities which include: 1) maintaining an above-average (among S&P500 peers) payout ratio; 2) making strategic acquisitions both in North America and Internationally; and 3) repurchasing shares based upon market conditions. Given that acquisitions are lumpy and hard to predict, we assume that if they occur, they will be at a discounted valuation to share repurchases and are therefore comfortable is assuming KAR s leverage target is maintained at 3x through share repurchases following 2017E. Table 4 Free Cash Flow and Leverage Analysis P (in millions, except per share) E 2018P 2019P 2020P 2021P ADESA EBITDA $ 385 $ 435 $ 505 $ 585 $ 650 $ 700 IAA EBITDA AFC EBITDA Corporate Cost (110) (90) (90) (90) (90) (90) EBITDA, total $ 715 $ 815 $ 900 $ 1,005 $ 1,090 $ 1,160 CAPEX (155) (150) (160) (170) (180) (190) FCF $ 90 $ 295 $ 325 $ 370 $ 430 $ 480 Net Debt $ 2,270 $ 2,165 $ 2,745 $ 3,095 $ 3,370 $ 3,560 Leverage Ratio 3.0x 2.6x 3.0x 3.0x 3.0x 3.0x Source: Company filings, Gabelli & Company Estimates SALES AND EARNINGS FORECAST KAR is set to benefit from a growing remarketing industry in both whole-car and salvage auctions and should continue to grow revenue per-transaction at both its ADESA and AFC divisions. Given a growing commercial customer base (at the expense of dealers) we estimate a higher take rate on services such as refurbishment. However, despite increases in volume at IAA, we estimate a weaker pricing environment given falling scrap prices and a weak foreign buyer unable to buoy bidding. Similarly, KAR is able to generate scale from many of its services, including auction lanes, by increasing volume. We estimate two points of margin expansion over our modeling period. Table 5 Sales and Earnings Summary P (in millions, except per share data) CAGR FYE 12/ E 2018P 2019P 2020P 2021P P Revenue $ 3,150 $ 3,440 $ 3,740 $ 4,030 $ 4,270 $ 4, % % Growth 17% 9% 9% 8% 6% 5% EBITDA $ 745 $ 830 $ 920 $ 1,020 $ 1,105 $ 1, % % Margin 24% 24% 25% 25% 26% 26% CapEx EPS $ 2.06 $ 2.15 $ 2.70 $ 3.25 $ 3.80 $ % EBITDA Multiple 10.7x 9.6x 8.7x 7.8x 7.2x 6.8x Source: Company filings, Gabelli & Company Estimates With regard to EPS, we are forecasting a significantly higher CAGR than that of either its revenue or EBITDA. Due to the variability of acquisitions, and their unpredictability we maintain KAR s balance sheet at its targeted 3x EBITDA leverage ratio, utilizing the additional debt for share purchases. Given the quality of management, we are comfortable in this assumption as we believe KAR will deploy cash in a method that generates a return that either meets or exceeds that of its common shares. Including this assumption, we estimate KAR to earn $2.15 per share in 2017, growing to $2.70 in 2018 and $3.25 in 2019 ($0.25 and $0.50 generated from share repurchases, respectively). -12-

14 INVESTMENT RECOMMENDATION - BUY Overall, KAR is slated to benefit from a surge in off-lease and trade-ins, as well as total-loss vehicles. Through its diverse collection of business segments, we believe that KAR is positioned to take advantage of this North American trend. Additionally, while we do not model in potential international impacts given their uncertainty (and likelihood of occurring outside our modeling period), these markets represent upside to our estimates should they come online faster than we predict. Although KAR maintains margins ~10% smaller than public peer Copart (primarily due to CPRT s online only dynamics), we do not believe this justifies the discount in KAR s trading multiple (CPRT trades at 14x our 2017E EBITDA vs 9x for KAR). Investors likely discount AFC due to its subprime credit spectrum, an unfair analysis in our opinion given the multiple methods of recovery at the unit s disposal. Utilizing a 10.0x multiple for each of the auction segments and 8.5x for AFC, we calculate a 2019 PMV of $62 per share, a 30% margin of safety. Although a strategic buyer is unlikely given anti-trust provisions, we believe the cash flow characteristics of the business would be attractive for a financial buyer. Additionally, although unlikely at 10.0x, should multiples contract, the potential for an LBO should not be forgotten given the financially savvy management team, despite high leverage. For reference, in 2008 KAR s total debt equal to 14.8x EBITDA. Putting it all together, we believe KAR is in a prime position to benefit from the surplus of used vehicles that will pressure others in the global automotive space, and recommend investors Buy shares. Table 6 KAR Auction Services, Inc. Private Market Value Calculation P (in millions, except per share data) E 2018P 2019P 2020P 2021P Revenue $ 1,765.0 $ 1,980.0 $ 2,220.0 $ 2,450.0 $ 2,620.0 $ 2,750.0 ADESA EBITDA (Car Auction) Valuation Multiple 10.0x 10.0x 10.0x 10.0x 10.0x 10.0x Segment Value $ 3,850.0 $ 4,350.0 $ 5,050.0 $ 5,850.0 $ 6,500.0 $ 7,000.0 Revenue $ 1,098.0 $ 1,150.0 $ 1,190.0 $ 1,220.0 $ 1,260.0 $ 1,300.0 IAA EBITDA (Salvage) Valuation Multiple 10.0x 10.0x 10.0x 10.0x 10.0x 10.0x Segment Value $ 2,900.0 $ 3,000.0 $ 3,050.0 $ 3,150.0 $ 3,250.0 $ 3,350.0 Revenue $ $ $ $ $ $ AFC EBITDA (Finco) Valuation Multiple 8.5x 8.5x 8.5x 8.5x 8.5x 8.5x Segment Value $ 1,275.0 $ 1,445.0 $ 1,530.0 $ 1,657.5 $ 1,742.5 $ 1,827.5 Corporate EBITDA $ (110.0) $ (90.0) $ (90.0) $ (90.0) $ (90.0) $ (90.0) Valuation Multiple 4.0x 4.0x 4.0x 4.0x 4.0x 4.0x Segment Value $ (440.0) $ (360.0) $ (360.0) $ (360.0) $ (360.0) $ (360.0) Total Private Market Value $ 7,585.0 $ 8,435.0 $ 9,270.0 $ 10,297.5 $ 11,132.5 $ 11,817.5 Less: Net Debt (2,268.5) (2,164.6) (2,743.5) (3,092.9) (3,368.4) (3,559.2) Less: Option Payments (13.0) (18.3) (23.1) (29.7) (35.9) (41.6) Equity Private Market Value $ 3,583.9 $ 3,583.9 $ 3,583.9 $ 3,583.9 $ 3,583.9 $ 3,583.9 Shares Outstanding PMV per share NM $46 $53 $62 $71 $79 Source: Company Filings, Gabelli & Company Estimates -13-

15 Other Companies Mentioned: ALLETE (ALE NYSE) AutoNation (AN " ) Avis Budget Group (CAR NASDAQ) BCA Marketplace (BCA London) Copart (CPRT NASDAQ) Goldman Sachs (GS NYSE) Hertz Global Holdings (HTZ " ) Penske Automotive Group (PAG " ) I, Matthew T. Paige, the Research Analyst who prepared this report, hereby certify that the views expressed in this report accurately reflect the analyst s personal views about the subject companies and their securities. The Research Analyst has not been, is not and will not be receiving direct or indirect compensation for expressing the specific recommendation or view in this report. Matthew Paige (914) Gabelli & Company 2017 Important Disclosures ONE CORPORATE CENTER RYE, NY GABELLI & COMPANY TEL (914) FAX (914) Gabelli & Company is the marketing name for the registered broker dealer G.research, LLC, which was formerly known as G.research, Inc., Gabelli & Company ("we" or "us") attempts to provide timely, value-added insights into companies or industry dynamics for institutional investors. Our research reports generally contain a recommendation of "buy," "hold," "sell" or "non-rated. We do not undertake to "upgrade" or "downgrade" ratings after publishing a report. We currently have reports on 608 companies, of which 48%, 35%, 3% and 14% have a recommendation of buy, hold, sell or non-rated, respectively. The percentage of companies so rated for which we provided investment banking services within the past 12 months is 0%, 0%, 0% and less than 1%. Ratings Analysts ratings are largely (but not always) determined by our private market value, or PMV methodology. Our basic goal is to understand in absolute terms what a rational, strategic buyer would pay for an asset in an open, arms-length transaction. At the same time, analysts also look for underlying catalysts that could encourage those private market values to surface. A Buy rated stock is one that in our view is trading at a meaningful discount to our estimated PMV. We could expect a more modest private market value to increase at an accelerated pace, the discount of the public stock price to PMV to narrow through the emergence of a catalyst, or some combination of the two to occur. A Hold is a stock that may be trading at or near our estimated private market value. We may not anticipate a large increase in the PMV, or see some other factors at work. A Sell is a stock that may be trading at or above our estimated PMV. There may be little upside to the value, or limited opportunity to realize the value. Economic or sector risk could also be increasing. We prepared this report as a matter of general information. We do not intend for this report to be a complete description of any security or company and it is not an offer or solicitation to buy or sell any security. All facts and statistics are from sources we believe to be reliable, but we do not guarantee their accuracy. We do not undertake to advise you of changes in our opinion or information. Unless otherwise noted, all stock prices reflect the closing price on the business day immediately prior to the date of this report. We do not use "price targets" predicting future stock performance. We do refer to "private market value" or PMV, which is the price that we believe an informed buyer would pay to acquire 100% of a company. There is no assurance that there are any willing buyers of a company at this price and we do not intend to suggest that any acquisition is likely. Additional information is available on request. As of February 28, 2017, our affiliates beneficially own on behalf of their investment advisory clients or otherwise approximately 6.17% of Hertz Global Holdings 1.81% of AutoNation and less than 1% of all companies mentioned in this report. Because the portfolio managers at our affiliates make individual investment decisions with respect to the client accounts they manage, these accounts may have transactions inconsistent with the recommendations in this report. These portfolio managers may know the substance of our research reports prior to their publication as a result of joint participation in research meetings or otherwise. The analyst who wrote this report may receive commissions from our customers' transactions in the securities mentioned in this report. Our affiliates may receive compensation from the companies referred to in this report for non-investment banking securities-related services, or may be soliciting these companies as clients for non-investment banking securities-related services. The analyst who wrote this report, or members of his household, owns no shares of any company mentioned. -14-