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Carsales Takes Korea, Brokers Applaud

Australia | Nov 21 2017

Brokers see Carsales’ full takeover of Korea’s leading equivalent as providing a new lease of life for a maturing business.

– Carsales lifts Encar stake to 100%
– Upside potential in growing business
– Attractive price
– Carsales' valuation debatable

By Greg Peel

Leading Australian online vehicle classifieds company ((CAR)) has signed a memorandum of understanding to lift its stake in South Korea’s number one equivalent business, SKEncar, to 100% from 49.9%.

Carsales acquired 49.9% of Encar in 2014 and since that time it has become the company’s best performing segment, growing revenue and earnings by compound rates of 27% and 28% respectively compared to 16% and 8% for the group as a whole, Citi notes. Encar is the leader in a market that sees around 10-15% more used cars sold each year than in Australia, Credit Suisse points out.

Carsales is still dominated by a domestic market providing around 87% of earnings, but as that business matures, the company is looking offshore for growth. Carsales otherwise currently owns 30% of Brazil’s WebMotors as well as controlling interests in leading portals in Mexico, Argentina and Chile.

Calling the Shots

Brokers are in agreement that a full takeover provides the opportunity to exploit successful strategies implemented in Australia to the Korean business in order to enhance upside potential. Deutsche Bank suggests Carsales’ pay-per-lead model may not have been popular with Encar’s owner SKGroup given its previous operation of used car dealerships. Encar’s earnings uplift over the past year has been driven by inspections/display growth, so implementing new initiatives has the potential to significantly improve the core business.

The question for UBS is will Carsales monetise leads? However the broker believes there is still material upside available from driving penetration alone. Having crunched the Korean industry numbers, UBS calculates that despite its number one position, Encar may still only be responsible for 15-30% of Korea’s used car transactions.

The acquisition will be funded with a new debt facility. While this will lift Carsales’ debt to equity ratio it is not a concern, Deutsche suggests, given the company’s strong cash flow growth. It will mean, nevertheless, that near term earnings accretion will be offset by a higher interest expense. But brokers are not that fussed about the near term numbers.

Credit Suisse sums up the mood in suggesting SKE has many years of double-digit earnings potential ahead and the price paid for 100% will in time be seen to be a great deal.

Value Discount

That price paid, being $370m, represents a discount to Carsales’ own current valuation. Estimations vary slightly among brokers but by so much that Deutsche’s calculation cannot be used as indicative, being an FY18 enterprise value to earnings multiple of 14.6x and a PE of 21.9x for Encar compared to 15.6x and 25x currently for Carsales.

Expansion in Korea is not without its hurdles. Credit Suisse expects growth to be driven by higher dealer penetration and higher yield, both of which are currently well below Australian levels. But the dealer customer base in Korea is highly fragmented, making monetisation more difficult than in a highly sophisticated market like Australia’s, the broker concedes. Display advertising should be a key growth driver, however the private seller market may be harder to address.

Nor is the acquisition any sort of game-changer for Carsales. Citi expects, despite growth potential, Encar will still only be contributing 10% of group earnings in FY19 and international businesses in total will add up to 13%. By comparison, online peer Seek ((SEK)) generates 46% of earnings internationally.

But brokers all agree international expansion is the way to go, given the potential on offer.

As to just how much potential then becomes a matter of disagreement vis a vis forecast domestic performance. In Citi’s opinion, Carsales needs to rely on international expansion to justify a current FY18 PE of 25x against a long term average of 21x if the existing domestic business cannot further accelerate. Citi still sees growth opportunities at home but suggests the company will want to continue looking offshore.

Citi is hence one of the four brokers in the FNArena database with a Hold or equivalent rating on Carsales, while the other four all have Buy or equivalent ratings. There is little disagreement Carsales has entered into a great deal, but varying views on the local business with respect to current valuation.

The valuation impact of the deal is evident in brokers not making material upgrades to earnings forecasts but lifting their consensus target price to $13.83 from a prior $13.40.

The deal is still in an MOU phase and remains subject to possible scrutiny by Korea’s regulator, if deemed necessary, and a confirmation of due diligence from Carsales. The company expects completion by January and brokers are happy to assume success.

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