TIP845: Copart Stock (CPRT): Is Copart Now a Buy? w/ Daniel Mahncke & Shawn O'Malley

19:04Shawn O’Malley:And as we'll see later when we talk about the financials a bit more, that is a major factor. There's also a limited amount of land that still can be turned into a massive salvage yard. And since Cobalt owns 250 of such locations globally, the majority of them obviously in the US, it's increasingly hard to get the same sort of expansion in terms of yards for any competitor.

19:25Daniel Mahncke:Yeah, the good old NIMBY movement, not in my backyard. Look, last time we recorded this episode, I was not yet a homeowner, and now I am. And I can tell you, I'm probably more Team NIMBY than I was just a year ago. Like I could imagine really only a few things that are probably worse than getting one of those massive salvage yards anywhere near my house. I'm sure really everybody feels that way.

19:49Shawn O’Malley:Up until now, I only have seen photos, but in about, what is it, a month from now, I will actually visit you. So I'll see the backyard in real life. And I can say that I think if I would have a backyard like that, I wouldn't want a salvage yard anywhere near that either. Because every homeowner thinks that way, obviously the permits to get for those yards, It's incredibly difficult and it's only getting more difficult in the future. And obviously also you can sell that land at a much better price when it's for housing or for office spaces. So there's just not really an incentive to still, you know, give a lot of permits for land that is then turned into a junkyard.

20:23Shawn O’Malley:So to some extent, again, this is a competitive advantage that IA can no longer attack. And that's true today, but it will also be even more true in five years time. And I should mention, and this is kind of bullish in my opinion, that Jay Adair said in his first callback as a CEO, which has happened about a month and a half ago, that Copart now has enough land and no longer needs to spend at least this half a billion dollars, which they currently are spending, to acquire more land. So I think that's a pretty good sign, because if you just look at the financials,$500 million is quite a significant amount, even for a company the size of Copart.

20:56Shawn O’Malley:So for example, last year, Copart generated free cash flow of 1.2 to 1.3 billion. So even if the spend is just cut in half, which means$250 million of savings, that's quite a meaningful chunk for Cobalt.

21:09Daniel Mahncke:And the second moat is something that we've seen in many businesses that we looked at. And it's just about the marketplace dynamic. They launched a website and auctions in the mid-90s and just a couple of years after eBay is when they did that. And at that point, it's safe to say that most salvage yards were still running auctions in person with a guy in a clipboard, probably overseeing things. And that's why Copart had a major advantage in onboarding customers. It was sort of a digital first mover.

21:38Shawn O’Malley:I still remember when I first looked at Copart and I kind of asked myself why no one even tried copying them. Even IAA, which again is their main competitor, only started really getting into online auctions during the pandemic. So we're literally talking 25, almost 30 years later. And I think that's just a pretty good example of how mismanaged that company has been for a very long time. And anyway, the website and also the virtual bidding system, which has sort of been this innovation that Copart had, turned into a massive advantage because more bidders, and that's sort of the dynamic that you just described, more bidders mean the winning bid goes higher than if you have fewer people bidding on an auction And higher prices mean the insurance company recovers more money, which means Copart becomes the most profitable place for an insurer to dispose of a car, which is what we talked about earlier.

22:27Shawn O’Malley:And that brings in more insurers, which in turn brings in more and better inventory for Copart's side. And if you can get better cars and maybe not the most wrecked ones, you'll obviously also get more buyers. And that's sort of the flywheel that we're always looking for in all the companies that we cover. And I think it's safe to say that Copart is one of the strongest flywheels that we've ever seen in all of the companies we covered, which by now is close to 100, by the way.

22:50Daniel Mahncke:And last but not least, as we think about Copart's moats and the advantages that insulate them from competition, we have economies of scale to consider, especially thanks to the density of their yard network. Basically, the denser the network, the shorter the distance to the next yard when you have to pick up and tow a car. And it's sort of like the dominoes model of trying to have as many locations as possible in population-dense areas so that it's as close as you can possibly be. The delivery time is less than a few minutes. That sort of accessibility is an advantage. Yeah.

23:28Shawn O’Malley:And in this case, it's actually both. It's a cost advantage, but it's also about reliability. I mean, last time, I think we talked about Hurricane Katrina, which was a game changer for Copart. It basically left hundreds of thousands of vehicles in salvage condition. And while salvage vehicles are usually a good thing for Copod, too much volume at once, which tends to happen in these catastrophe events, is not that good for them because you have to handle it. And that means you have to lease extra yards, you have to hire third-party services, and work many overtime hours. And obviously, all of that comes at a time when the costs for yards, for third-party services, and so on, are much higher than usual.

24:05Shawn O’Malley:And then in the short term, that means that all of these vehicles, they are unprofitable volume for Copod. And that's why competitors and especially IAA didn't want to go the extra mile to help back then. And Copart, they chose to absorb the losses and help as much as they could and as fast as they could. And actually, I found a quote by Willis Johnson, who is the founder of Copart. And he said that they wanted to prove they're not only the best operator, but also the most reliable partner. And I actually think if you look at how many customers Copart still has and how they stick with them, You can still see that credit that it gave to them 20 years later, because again, the hurricane happened in 2005.

24:45Shawn O’Malley:This was also just a year or two after Copart shifted the entire business to online auctions. So it was also a huge test for the new system. And it worked out well with tens of thousands of flood damaged cars pouring into the market and Copart's digital infrastructure allowed buyers globally to bid on cars, which as you said before, was basically a national operation, right? Now, suddenly you have the entire world. Internationally, you have buyers for those costs and all of that helped bypassing the logistical bottleneck of physical auction lots. And after that, Copart established what they call a CAT response team.

25:22Shawn O’Malley:So a catastrophe team, basically, that can help further and faster when these hurricanes come up.

25:28Daniel Mahncke:Preston Pysh And so this was a major part of why Copart was able to win market share for almost two decades after that. Insurers trusted CoParty and knew it was not only the best place to sell volume, but also a reliable company in times of crisis. And it's really important for insurance companies to get quick help in those situations because that's exactly when they could lose a ton of customers if things are handled poorly. So the last thing you want is to wait months for your insurance company to pay you while already struggling with losing your car and maybe your house. So if the service is bad in those times, insurance companies, they're probably going to lose thousands of customers.

26:06Daniel Mahncke:So it's a real point of vulnerability for them. But perhaps this is maybe a good moment to change the tone a bit and start talking about what has changed since our first episode. What is different now about Copart? Because there is the market narrative that market share dynamics have changed. And IAA, which is Copart's chief competitor, is now gaining market share. And so in our last episode, again, we talked about IAA and how it's closed the land capacity gap slowly. About five years ago, Copart still had 70 % more land capacity than IAA. Now that number is close to 25%.

26:47Shawn O’Malley:And I should add, if you ask yourself, well, Daniel just said five minutes ago that the land capacity will be a major mode for Copart even in the future. Obviously, there's a difference between scaling land because you lease it compared to scaling land or yards because you buy them, right? Nevertheless, I got to say, apparently they did a quite good job for the last few years. I mean, I think what the market is scared about right now is Copart's slowdown in the US insurance volume. So basically the core of the business. Part of that can be explained, fortunately, because there were no major hurricanes this year, which is good for society.

27:19Shawn O’Malley:It's not that good for Copart. I mean, talk about incentives. But even if you exclude natural disasters, the overall decline year over year would be about three to five percentage points. And while Copart's volumes are declining, IA's volumes have actually been up 10%. So it's not only that fewer costs are being totaled, it's also that IA is taking share from Copart, which, as you mentioned, didn't happen for, let's say, 20 to 25 years. And IA's management is actually claiming they have outperformed competition, which basically means Copart, for about six quarters in a row now.

27:50Daniel Mahncke:So what changed there that you have insurers suddenly switching over to IA? I mean, it seems like the modes we've been discussing are still largely in place. I don't think anything fundamentally has changed with Copart. And even if IA has more yard capacity than it did in the past, there's a question of whether they can offer the same liquidity for car auctions, which is, again, one of the major benefits of Copart is that they have this network effect reinforcing the entire flywheel. So yeah, what really has changed? Is there any reason in particular that insurers are looking to choose IAA over Copart?

28:27Shawn O’Malley:That was basically the big question for revisiting Copart, right? Has anything changed? Is there anything that I sort of missed where Copart is vulnerable? And I got to admit, I don't think, while there are problems and we'll get to them, that anything major has actually changed. And even if you listen and trust Jay Adair, he was quite vocal about not thinking that IAA has meaningfully improved its operations at all, which certainly is the market narrative right now. So there's primarily one insurer that has shifted its volume to IAA, and that's progressive. So the historical split of volumes between Copart and IAA is quite uneven.

29:02Shawn O’Malley:So usually an insurer is not splitting 50-50 between the two, but more like 75 % of the volume goes to Copart and then 25 % of the volume goes to IAA, just due to all the advantages of Copart that we have discussed earlier. So the reason why they split volume in the first place, and they're not just giving 100 % of the volume to the better operator, which is Copart, is that they don't want to create a monopoly. Because obviously in that case, Copart would gain significant pricing power and could increase the fees for insurance companies because they couldn't shift the volume anymore. Now, Progressive is going against the rest of the industry and has always leaned toward IAA.

29:39Shawn O’Malley:So they send three quarters of their volume to IAA and only one quarter to Copart. And I actually even heard that they shifted as much as 90 % of their volume to IAA recently. And the problem for Copart is that Progressive has just become the biggest US auto insurer, adding two and a half to three million policies per year.

29:59Daniel Mahncke:Well, I think it's a really interesting structure you have here where basically on the supply side, the suppliers are so strong that they're able to do a degree of tacit collusion and prevent either IAA or Copart from developing monopoly. And whether they admit it or not, it's something that is seemingly being done intentionally. And I think it's also good news that it's only primarily one insurer that's supporting this IAA outperformance. But the bad news is that Copart is also unlikely to win over Progressive. And Progressive is the fastest growing player in town.

30:37Shawn O’Malley:That's a problem right now. And I think you could even go a step further and say the second order effect here is that Progressive is winning share from other insurers, obviously, which are Copart customers. So Copart is basically losing volume, not only because Progressive tilts more to IA and send more of their volume over to them, but also because that volume is coming from Copart's insurance customers. So they are losing customers to Progressive and then Progressive shifts even more of that volume to IA. That's sort of the double whammy that Copart is experiencing there. Maybe you ask, okay, well, what's the reason for Progressive tilting towards IA and potentially getting even more volume to them?

31:15Shawn O’Malley:So in the first place, what I think is that they have partnered for a very long time and IA has basically provided priority services to Progressive. So they offer them faster vehicle pickup times and better storage slot placements. And it's also willing to operate. And that's the major part at quite a low margin on the Progressive business. So it was my impression that Adair indirectly, at least mentioned that Copart simply wasn't willing to offer Progressive very similar rates compared to IA because he didn't particularly and name them, but given that they are the only lost volume and Adea mentioned that Copa chose not to do business with one party, that's sort of the takeaway that I had coming out of that call.

31:55Shawn O’Malley:And you can even see in the margin that the progressive volume seems to come with quite low tag rates because Copa's auto segment has a margin of 36%. And if you go through the filings of Richie Brothers, which is the owner of IAA, they say that the auto segment is somewhere the 15 % to 20 % range. So it's significantly lower than Copart's.

32:16Daniel Mahncke:When I hear about the profit margin difference between these two companies, I think the first thing that comes to mind is that old Bezos quote about your margin is my opportunity. But if IAA is willing to accept a lower margin, then I would very much worry as a shareholder about there being a race to the bottom on pricing between Copart and IAA. And I think as Buffett and Munger would probably say, all it really takes is one ruthless competitor to ruin what is otherwise a wonderful business. And so right now, we're only talking about progressive, but what if other insurers start switching volume over to IA for similar reasons?

32:53Daniel Mahncke:Then we have a bigger problem on our hands.

32:57Shawn O’Malley:I think that's a good point. And it's actually also the one question that immediately popped up in my head when I looked at it. But after digging into IA's filings, it looks like the majority of the margin difference is due to depreciation relative to IAA's purchase price when Richie Brothers, which again is the parent company, bought IAA. And then you also have stock-based comp. And obviously, and this is coming back now, the leases that it pays for its land, because again, they don't own it. And that appears to be the majority of the margin difference. So it's not that Copart is overcharging for fees.

33:27Shawn O’Malley:And also, as we said earlier, most of the fees are paid for on the buyer side. So you're not necessarily overcharging the insurance companies, which is where you could lose most of your volume. So I'm not too worried that other insurers will start to choose IA over Copot because of fees or price or any of that. Because again, Progressive chose IA because they also get special treatment and sort of by definition, IA can't offer that to too many customers. And instead of all the other modes that we discussed earlier, I mean, they are still in place and I don't necessarily feel like they will evaporate anytime soon.

34:00Shawn O’Malley:So if you plan to be in business for the next 20 or 30 years, and most insurance companies do because it's a long-term business, you can still rely on Copart since, in case you didn't yet know it, they own the land. With IAA, you have the risk that they will lose land over time because permits are being revoked and land will be used in another capacity, especially when cities are getting larger and larger and you need more space for people to live. And also, if you trust Adair, he again, wouldn't agree with the market narrative that IAA has even become a better operator in the last couple of years.

34:33Shawn O’Malley:And that's very hard for me to judge from the outside, because all we can do basically is just look at, hey, how many insurance companies go over from Copot to IAA? And it doesn't look like any of the ones that favored Copot in the past have done that. So right now, I still feel quite good. However, should that change and you see insurers actually changing sides, that would be not good for Copart. And also you probably can't see that before it's actually happening. And then it's also priced into the stock.

34:59Daniel Mahncke:Did you say Copart owns the land? I might have. I haven't heard that before. Obviously, obviously kidding. No, but I would think it's very reassuring that the share loss is primarily due to one customer. If I were looking at this as a shareholder, and if you were seeing this coming from multiple customers, this might have been only the beginning of a long period in which Copart began to slowly lose market share. And even if they stay number one on paper, it would certainly hurt the stock because the numbers would look terrible compared to the comps. And I think what will be interesting to see is whether the insurance market actually becomes a tailwind for Copart again, after being a pretty strong headwind for the last few years.

35:42Daniel Mahncke:And just for context as to what I'm referring to between 2022 and 2024, sort of COVID-related, auto insurance got brutally, brutally more expensive. And so average full coverage premiums in the US rose 46 % over three years. So if you thought that you were going crazy, imagining that vehicle insurance was much more expensive, you're not crazy. It absolutely is. And the reason for that was like carriers got hammered, repair costs exploded after COVID. There's lots of shortages. You had prices for used cars correspondingly explode. And then the insurance company's combined ratios, which is an important term to understand.

36:23Daniel Mahncke:This is just the claims plus the operating expenses of the insurance business divided by the premiums that they receive. And so if you didn't understand any of that, all you need to know that is for a combined ratio, if the number is over 100, that means you're losing money on the underwriting itself. And so that's not a good thing. And in response to that, so that they could underwrite profitably and have a combined ratio below 100, at least that's the hope, you saw a lot of these companies raise rates significantly to be profitable again. But in times of high inflation and a tough economy, many people just aren't willing or able to stomach those premium increases.

37:03Shawn O’Malley:Yeah. What you basically saw happening is that some Some people just drop from full coverage to liability only, which basically means if they wreck their own car, no claim gets filed and no car goes to a salvage auction. And then some raise their deductible so high that basically all of these small and medium accidents never get reported. And then some just stop insuring the car at all, even though that's technically illegal and not only technically it is illegal. But I mean, if you look at the numbers, about a third of American drivers were now uninsured or at least materially underinsured. If you compare that to 2023, and especially up from 2017, which is almost 10 years now, this number is up more than 10%.

37:41Shawn O’Malley:And CCC, which is one of the most important data companies in this field, found that the share of third-party claims coming in as uninsured or underinsured motorists claims have nearly doubled in three or four years' time, so hitting 16 % at the end of last year. So there's just many data points showing that significantly fewer vehicles are insured, and there's obviously a pretty bad data point for Copart. And one more that I have is that CCC also reckons about a quarter of repairs are now self-pay, meaning that the driver just fixed it themselves rather than involving the insurer. They've even launched, I've heard that just recently, a buy now, pay later product for those people, which I think whenever buy now, pay later is involved, you sort of have an idea of how big a problem got.

38:25Shawn O’Malley:And Copart's own data is also proving this trend. So there are more cars on the road this year than last year up to Copart. but insured costs have dropped about 4%. So I think those were enough data points to prove the point that this is not only a corporate problem. Even though IA is growing, this is primarily a story of progressive shifting over. Generally, there simply is a cyclical factor here involved for a lot fewer costs by actually on the road insured. Let's take a quick break and hear from today's sponsors.

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42:40Shawn O’Malley:It's very difficult to say when the cycle will turn, but I think there are some signs that we might see a reversal soon. So the personal auto industry ran a 95 % combined ratio last year, and Progressive's own personal vehicle business is actually about 8 percentage points better than the target that they publicly set in their earnings call. So you could argue that there's some ammunition to cut prices now. And by the way, regarding Progressive, I should add, I don't see the trend of them winning more and more customers as a long-term threat because insurance is a highly competitive field, which is also why you see these combined ratios sooner or later go back and closer to 100.

43:16Shawn O’Malley:And if they outperform a couple of years, that's already a pretty good performance. Usually, that's very unlikely to continue. So basically, I would expect that by now, even though it can still take a couple of quarters, perhaps even years, you will see a shift and perhaps these insurance rates become a tailwind for Copart. And you should also see that Progressive is not winning more and more market share from the competition, at least not in the long run. And then as we see bigger market shifts with lower insurance rates, we might also see a shift in who wins more customers in that new environment.

43:47Shawn O’Malley:And I don't have a guess on which company that will be, but I'm quite confident most likely it will be a Copart customer. Generally though, even with first signs of a less hot insurance market, it will probably need a couple of quarters at least before you see a meaningful impact in the numbers. After all, the rates are still 50 plus percent higher than just a couple of years ago.

44:07Daniel Mahncke:All right, then. We alluded to it earlier, just to kind of tease it. It's the elephant in the room, but why don't we discuss the CEO transition a bit? And I got to say, it did come as a real surprise to me. Copart has this history of very long CEO tenures. For anybody who's a fan of the NFL, it's sort of like the Pittsburgh Steelers. They keep their coaches around for a long, long time. So it was a real shock when they fired Mike Tomlin this year. But after Willis Johnson, the founder, served as CEO for almost 30 years, you had Jay Adair take over and then run the company for 14 years. And he's somebody who had been with Copart doing other positions since 1989.

44:49Daniel Mahncke:So pretty long connection to Copart, plenty of experience. And then you had Jeff Liao, who took over in 2022 after serving as co-CEO with Jay for two years. And now just four years later, Jay Adair will take over again and Liao will step down. And as far as I know, Jeff will not even be a part of the board anymore. So he'll have something of a role like a special advisor, but I'm not really sure what that means. It might just be something to kind of placate him.

45:19Shawn O’Malley:I wasn't quite sure what your NFL reference means, but just for the people who know the Bundesliga, the equivalent would be SC Freiburg, who also likes to have coaches on for a very long time. But getting to Copart's CEOs, it is a bit difficult to figure out how exactly that decision has been made. I mean, J.A.D.R. scheduled a call, and this is basically the call I'm referring to throughout this recording today, between the Q3 earnings call and last week's Q4 earnings call. And they never did this in the three decades of being a public company. And by the way, we record this just before September 3rd.

45:53Shawn O’Malley:So the Q4 earnings call that I just said last week's earnings call, we actually haven't yet listened to it. And if anything massive should happen, you got to check out our free newsletter, which I will link to in the show notes, because over there, we will have all the new information and updates included so you don't miss anything. Anyway, on that call, Jay Adair basically made sure to say that he and Jeff agreed on the decision that they are still friends and they live on the same street and all of that stuff. But while that's all true, probably fact of the matter is that I don't think Jeff would have stepped down if things had gone great.

46:27Shawn O’Malley:And I also think that Jay Adair and Willis Johnson thought the company has been mismanaged to some extent and Jay is the one who could turn it around. Otherwise, why don't you have both people on the call? I think that would have helped to some extent. It also sounded like Jay had thought there's some stuff that needs fixing at the company.

46:43Daniel Mahncke:I would say it's pretty awkward if they actually literally live on the same street. That would be a bit of a weird vibe. But yeah, the market dropped 8 % when the news came out. And that is kind of surprising since Jay took the company from a market cap of$2 billion to$30 billion. So you would think that there should be more excitement about this veteran CEO and company builder coming back. And especially since he also said he will not be a transitionary CEO, he's planning to stay for a decade or even longer.

47:14Shawn O’Malley:I believe it was more about the fact that this transition felt like an admission that things were not going that well at the company. And that doesn't help, obviously, when the sentiment is bad anyway. And again, when we cover the company, it was already down like 30%. Back when this decision has been made, the stock was down even further and the sentiment was even worse. And by now I should say the stock has recovered quite significantly. It's up about 25 % from its lows. And also when the news first dropped and the market reacted, it wasn't immediately clear whether Jay Adair would actually stay on for the long term or basically would just be a transitional CEO, which definitely wouldn't have been a great sign because then you would need to look for a new CEO.

47:52Shawn O’Malley:It would even more be a sign of we didn't trust Jeff Liao and what he did with the company. Now that's a bit different. And, you know, Adair has also been quite clear, again, that he thinks the current narrative on Copart is just wrong. And he pushed very hardly back against the idea that some customers are unhappy with Copart or likely to switch to competitors. And it was also during that call that he mentioned that spending on yachts is no longer necessary to, you know, at least the same extent. So I think there's a lot of stuff that we will see in the future. It wasn't too clear about what that will actually be.

48:26Daniel Mahncke:I'm really curious. Did Adair say anything more about what capital allocation will look like going forward? And the reason I ask is because one of the most important changes since the last time we looked at Copart is that they started buying back stock massively. And that could be a really positive signal, especially given their fantastic track record with doing buybacks very, very well in a way that's accretive to shareholders. And so after actually having five straight years of no buybacks. Copart has initiated the biggest buyback program that it's ever done, at least in absolute dollar terms.

49:00Daniel Mahncke:And so Copart bought back more than$1.6 billion of stock in the last two quarters with more than$1.4 billion of that coming in the last quarter at what seems like fairly rock bottom prices. So basically what management is telling you is that they think that this stock is fabulously cheap.

49:19Shawn O’Malley:We use Copart as an example for how to make buybacks. In many of the presentations that we had in our community and also at events, so finally they started buying again, which probably especially for this company is a very good signal that the stock is most likely undervalued. And as you said, the last really meaningful buyback happened 15 years ago. So for the longest time, they thought the stock likely is overvalued, at least compared to where they otherwise could invest that capital, which again, to some extent has been in yards, for example. So I think generally, to me, Copod is very much a story of trusting the management team, both in capital allocation and also in making the right decisions to position Copod for a future of EVs, AVs, and international expansion.

50:05Shawn O’Malley:And I can already spoil, we'll not talk too much about AVs today, but we talked a lot about it in our first episode. And I think our take on that hasn't really changed. I think the risks are the same. The timeline is the same. So if you want to know our opinion on that topic, I would say you should listen to the first episode. Speaking of which, another change in the management team is that Jen Pocock has been promoted to president of the company and she ran Copart's UK business previously, which is the largest and the most established international market. And I think this is just another pointer to the importance of the international expansion.

50:42Shawn O’Malley:So if you ask me, where will they invest most of their money in the future? I think a significant chunk will likely go to the international business.

50:50Daniel Mahncke:Speaking of growth opportunities for Copart, with Adair coming back, what strategic shifts should we expect now? I mean, you just mentioned the international business. So I suspect that that will become an increasingly important focus for him and the management team as a whole.

51:04Shawn O’Malley:It seems that there are three pillars that Adair wants to focus on besides a general reversion to the mean in the core insurance volume. So the first is the often discussed, as you just mentioned, international business. Again, international revenue is up 14 % year over year. Service revenue grew especially rapidly. And the international operating market, and this is sort of the most important point, increased two and a half to three percentage points last year. And that happened for quite a long while right now. So Jay Day really pointed out that the breakthrough in Germany makes them confident that they can now use that as a blueprint to go into other markets and sort of initiate the service model there.

51:42Shawn O’Malley:Again, currently, the revenue there is up 18 % total. So if we assume it can grow 15 % per year on average, that contributes a bit under three percentage points to consolidated corporate growth and a bit more than that to the bottom line because of, you know, the margin expansion that we see. A second growth engine is what happens in the non-insurance business. So Copart has, as we talked about last time, what is called Blue Car, which is for fleet and commercial accounts, which basically provides tailored services such as asset recovery, arbitration, and condition reporting. And then they also have what's called cashforcars.com, which is just for buying cars directly from the public.

52:20Shawn O’Malley:And this used to be a growth driver, but it has slowed down recently. And Adair didn't give much insight into why that has been the case. But he did say that the whole car business will look, quote, very different in three to four quarters. Again, it's kind of vague, but, you know, at least he gives the impression of knowing what to do and how to handle growth in the future. Another thing that we also talked about last time is what they have called Purple Wave, which is an online auction site for heavy equipment, agriculture, construction vehicles, those sort of stuff. They actually acquired it a while ago.

52:52Shawn O’Malley:And then NPA, which is short for Natural Power Spot Auctions. which is doing the same. So we're talking auctions again for motorbikes, water sport vehicles like jet skis or something like that, and even snowmobiles and RVs and golf carts. So what's sort of special things that I think we mentioned last time, would definitely not be replaced by RVs anytime soon. And then the last growth pillar would be what they call technology services. So Copart basically operates what it calls Title Express, and that's a product for getting the vehicle title released from the bank or the owner, than paying off the outstanding loan.

53:28Shawn O’Malley:And that's part of a business model that sits somewhere between the insurance and the whole car business.

53:34Daniel Mahncke:So do you have any idea why he would say that the whole car business could look materially different in a couple of quarters? I mean, do you think they're planning an acquisition or something similar?

53:44Shawn O’Malley:I think the honest answer would be, I'm not sure. I think there's a cyclical element to the weakness in the sector, which is mainly the supply of at least quality three-year-old lease returns is at its lowest in over a decade because you know similar to what we said earlier in terms of the pandemic barely any new cars got built during the chip shortage that we saw in 2021 and 2022 and that should take care of itself over time so i think that's part of it and then i'm not sure what copart plans are directly but perhaps we could see a spin-off or something similar because it appears that copart just doesn't have the same sort of mode and reputation in whole cars as it has in the core salvage business.

54:23Shawn O’Malley:Because again, in your own salvage, you're up against IA and they win on land, they win on liquidity, and they also win on the international buyer base. But then when it comes to the whole car business, that's just a completely different competitive set. So you're up against, you know, Mannheim, which is a company that we also used for some data last time. And just many of these physical auction networks that are in the business for decades that people know when they actually want to buy a good car which is not wrecked which is usually what you get on copa so i don't know i could imagine some more structural change to the company i think some quarters ago in a call jeff liao who was back then still ceo was asked whether the brand would need to be a different one since again copa is not well known to consumers and if so they're again primarily known for wrecked and damaged cars and he said that you know perhaps they would need a sort of rebrand.

55:11Shawn O’Malley:And that could be, again, a spinoff, but that's just pure speculation on my end.

55:15Daniel Mahncke:So what's the deal with Purple Wave and national power sports auctions, NBA? Did they also get dragged down by this pretty tough market environment or are they performing well?

55:27Shawn O’Malley:Unfortunately, Copa doesn't disclose specific numbers for them, but they did mention that they expanded the sales force for Purple Wave specifically and made sort of a strategic decision to expand the business coast to coast, prioritizing the highest GMV market. So I just assume this means the business is doing well, or at least they're believing in the future of the business. But it doesn't appear to be a core focus either, because Adair, again, has publicly said on the call, he didn't yet spend much time on that business, and he would focus on the core insurance business first, and then over time go to Purple Wave, NPA, and those sorts of things.

55:59Daniel Mahncke:I've been thinking about Co-Part a lot, and there's something else I wanted to ask you about, And that is that just a couple of days ago, there was a rumor spreading that Copart is perhaps interested in buying CCC intelligent solutions. And admittedly, it's a company I know very little about, but it sounds like perhaps it could help with the data aspect of Copart's business. And so the deal might be related to one of these vague comments that Adair made in his July call with investors.

56:27Shawn O’Malley:It's actually a good point. It might be one of those, although we should say that at the time of this recording, at least, the potential acquisition is just a rumor. I think it was started because Bloomberg reported that Copart is in talks with CCC, but they're not the only bidder. They are basically up against a couple of private equity firms, including GTCR and Veritas Capital. And Copart's management doesn't strike me as the sort of people who would overpay for such a deal, which they might need to if PE firms are already in competition, but getting to CCC and what they actually do. I've actually indirectly mentioned them today a couple of times.

56:59Shawn O’Malley:I don't know if you realize that, but many of the data points I cited here came from CCC. So basically it's a company that was founded in 1980 in Chicago. And yeah, they built a software layer that sits between everyone involved after a car accident. So if you crash your car in the US primarily, there's a very high chance that the estimate determining whether it gets repaired or written off is generated in CCC's software. And they serve something like 300 insurance companies, including 27 of the top 30. So basically all of the big insurance companies are their customers. And then they have something like 30K repair shops, thousands of parts suppliers, plus the car manufacturers.

57:39Shawn O’Malley:And they've got a huge data library of, I read more than 300 million historical claims, which is what makes the damage estimates so accurate and also the data so important for companies like Copart, for example.

57:50Daniel Mahncke:So to recap, Copart's core business is clearly dependent on insurers deciding to total cars rather than repair them. But then now you have Copart wanting to buy the company that essentially helps insurers to decide whether a car is totaled or not. Yeah, that's basically it. Yeah. I got to say, it's a bit, sounds a little shady if you ask me. I mean, it feels like a pretty flagrant conflict of interest. I assume Copart wouldn't intentionally or blatantly influence the algorithm to push CCC to label more cars as being totaled, even though that would be good for their business, because that sounds very illegal and would destroy CCC's neutrality and credibility, and thereby really its entire product.

58:37Daniel Mahncke:But again, it feels like something that would be at a minimum flagged by regulators. And call me a pessimist, but if this sort of collusion or market manipulation is not possible or not what Copart wants to achieve. My question for you is, what exactly do they want to gain by buying CCC?

58:55Shawn O’Malley:Yeah, I think I should preface that everything I say now, it's just an opinion that I sort of have formed on short notice because the news more or less just dropped and I haven't yet had a chance to actually deeply research what CCC does and what the potential synergies were. It's something like that deal will actually happen. But I do see many possible advantages for Copart that have nothing or at least very little to do with changing the algorithms. I think the first one would obviously be faster cycle time because days in the yards is one of the most important metrics for companies like Copart and IA.

59:28Shawn O’Malley:And those could obviously be reduced when CCC's total loss trigger directly wires cars to Copart's dispatch.

59:35Daniel Mahncke:Maybe I was being a little too cynical, but talking about data, as you mentioned, CCC has millions of historical claims and Copart has the actual auction outcomes for millions of those cars. And so I can see why combined that would be maybe the best business model that they could build for predicting what a damaged car will fetch. And given that higher auction returns make totaling more attractive, a more accurate model surfaces more total losses. I do see your point on how it can fit into the existing Copart flywheel.

1:00:12Shawn O’Malley:And even if we would assume that some of these things wouldn't be possible given regulatory concerns, I mean, you would still get a business that has about a billion dollars in revenue, 96 % recurring subscriptions, low teen cash flow margins, which at that point they are adjusted for SBC. And I think they have some potential of seeing higher margins in the future. And it will also serve as a sort of natural hedge because it works the exact other way than Copart. So if total loss frequency, for example, keeps climbing, Copart wins and CCC's repair volume shrinks. But if that reverses, then you have CCC's repair business boom and Copart supply tightening.

1:00:49Shawn O’Malley:So obviously, since Copart would be the much larger part of the business, it's a small hedge, but at least the sort of dynamic where you could see some sort of advantage from that acquisition. But of course, you would need to get it at the right price for it to make any sense. And again, that might be difficult since PE firms are already involved in the bidding process. And I think currently CCC's stock is down about 27, so close to 30 % over the past year. And price to operating cashflow has declined from over 30 to about 10 times. And the reason it is that cheap is, well, we talk about it so often, the top line growth has slowed to around 10%.

1:01:24Shawn O’Malley:It was a faster grower before that. And obviously I don't need to tell you about it. The market is a bit nervous right now, if you haven't yet noticed about AI displacing software generally.

1:01:34Daniel Mahncke:It might be the understatement of the year. What would make this remarkable either way is that this would be by far the biggest deal Copart has ever done. For context, the Purple Wave deal was in the $100 million range. And for NPA, that motorbike auction business, that was estimated to be around in that same range as well. So this would be a minimum of a$4.5 billion deal, which is essentially Copart's entire cash pile. Although I'm sure they would raise some debt for the acquisition instead of burning all their cash. Point being, this is very substantial.

1:02:07Shawn O’Malley:And historically, Copa is not the type of company that likes to raise debt. But obviously, in this case, they would need to because you definitely not burn through all of your cash pile just to make an acquisition. And also, referencing the Adair call one last time, he did mention on that call that if the right opportunity comes up, he would also raise debt. So he would be open to it. And it's just a speculation, but perhaps he had his mind on CCC when he said that back then.

1:02:34Daniel Mahncke:What's that fun part of the episode where I think we should transition to the valuation section? And actually, I'm really curious about this one because as mentioned earlier, we briefly owned Copart before. So we're both fans of the business long term. And with the price being even lower than it was last year, I wouldn't be too surprised if you ended up recommending buying it again and maybe this time for the long haul. So with all that said, I also remember that we primarily bought the business due to our perception of the company's quality. And the expected return, though, just barely met the 12 % target that we have, our hurdle rate in your model last time.

1:03:14Daniel Mahncke:So has anything changed now? Do you feel like buying the stock at these prices is more likely to deliver a return that clears our hurdle rate?

1:03:23Shawn O’Malley:Well, in this case, we clearly have to say that it was not only the price that went down, but the fundamentals were unchanged. But you actually had revenue growth come down significantly and the price adjusted, right? So it's not the same as, for example, Google last year where the fundamentals are the same, the multiple drops, and therefore the stock gets more attractive. In this case, the stock might look more attractive because it's cheaper than a year ago if you just look at how much share costs. But growth also slowed down. So it's a bit different than, for example, the Google situation. So I've updated the DCF model than I did.

1:03:55Shawn O’Malley:And the result is not totally convincing. I gotta say. I mean, a total revenue growth of about 5 % to 6%, which is low compared to the history, but it's also close to none right now. An EPS growth of 9 % thanks to some buybacks and then some slight margin expansion, which Copart has seen basically throughout the last two or three decades. Then the expected return would be about 10 % from today's prices, assuming an exit multiple of 20, which again, if you would just look at the history, it might seem cheap, but I do think the stock has been replaced. And to some extent, we won't see multiples of 40 or 50X again.

1:04:28Shawn O’Malley:I think that's kind of unlikely. However, this time I also did a reverse DCF. And in a reverse DCF, you basically do the DCF backward. I would say that's an easy description of what you're doing. So the idea is that you assume today's price is exactly right. And then you solve for the growth rate of the business. So essentially, the growth rate the market currently expects Coper to achieve based on the price that the market values the business at today. Now, given that my growth rate assumption in the normal DCF has been in the mid-single digits, and the results have been that the stock is more or less fairly priced today, it shouldn't come as a major surprise that the growth rate the market currently expects for a high single digit to low and double digit return based on the reverse DCF is about 5%.

1:05:16Daniel Mahncke:Just to give folks a little easy summary, I think it would be that. At a mid-single digit, growth rate over the next five years, you could probably expect an 8 % to 10 % return complemented by buybacks and things like that. And should Copart return to double-digit top-line growth, you would probably see a very compelling return in the mid to high teens on an annualized basis. And so if Copart basically stays at current growth rates, returns will be probably in line with the market, nothing special, which is really what we mean when we say that a stock is fairly valued.

1:05:51Shawn O’Malley:And current growth rates, which are close to nothing, basically, obviously, you would massively underperform the market in the next couple of years. But yeah, I think that's what it currently looks like. And usually what we do is we sort of have a different likelihood assessed to a certain outcome. So, you know, a bear, a base, and a bull case. In this case, I think the likelihood of them actually achieving and going back to these double-digit growth rates is kind of high. So I would probably say there's, you know, a 40 % likelihood that happens. Then the base case, which would be mid single digital return is also 40%.

1:06:20Shawn O’Malley:And then you have a 20 % likelihood of them actually staying in this zero to 3 % growth rate. So I think it likely is a pretty good opportunity for people who very much like the business, always wanted to own it and sort of feel like now is a good opportunity because we are at these lows. Personally, I'm not quite there yet. I don't feel like Copart is the opportunity that now stands out to me when I look at the rest of our portfolio, where you immediately feel like we got to sell one of the companies, then make it happen and buy Copart. Because one of my major takeaways from, for example, the Biggest Loser episode is that we did not do too well on businesses where the revenue is declining, or at least the growth rate of the revenue is declining.

1:07:00Shawn O’Malley:And what I believe, I do understand the reasons for Copart. We just saw the management raising some yellow flags with the sudden CEO change, and then some more or less vague statements on what Jay Adair, the new CEO, will change about the business. And we sort of saw that, you know, we saw it with companies like Lulu, we saw it with PayPal, we saw it to some extent, although it's different with Adobe, and just sort of stops me from, you know, really being excited about the opportunity right now. And again, if you put me on the spot, then I would say Copart will be a good investment going forward, but perhaps not in the next couple of months, but once the cycle turns, and obviously we want to invest for the long-term.

1:07:36Shawn O’Malley:But if I look at our portfolio, I just don't see a company that I would want to sell right now in order to buy Copa. And we only have about 2 % cash left, actually a bit less than that. So basically what we need to do is sell one company and then buy Copa forward. And that's my take. How do you see it? Is there any company you would feel like, I got to own Copa, so I got to sell company Axio?

1:07:57Daniel Mahncke:I don't necessarily think so. I think we're probably both a bit traumatized from our experiences, looking at the biggest losers in that episode. And we'll link to that in the show notes in case you missed it. We have definitely come to appreciate how strong of a force downward momentum can be. Stocks almost always can fall further than you think possible, even when you model out these, what you think are very conservative bear cases. And so that's just the reality, especially in the short term. And because a stock falls to a point far below what anyone thought was possible, that's actually where you get the last sellers of the stock capitulating, and then the shares can finally take off rallying again.

1:08:35Daniel Mahncke:So it is sort of an inevitable process to have this pendulum swinging in finance. There's a lot of it, but I really like Copart because it's just such a perfect epitome of why you'll hear people say that you should invest in boring businesses. And unfortunately, that heuristic is too simplified, but Copart's business is very intuitive and boring in the sense that it's not going anywhere, even though we didn't even really discuss AVs today, which does promise to at least fundamentally change how we drive. And we don't really yet know how that will affect the business, but whether human driven or automated, I'm sure that in the US in particular, our vast highway system, cars are not going anywhere in our lifetimes.

1:09:18Daniel Mahncke:And if anything, AVs could lead to a proliferation of driving and therefore business for Copart, especially with the assumption that by baking in even more technology into cars to make them autonomous, totaling them becomes easier. So I would say that's probably my bull case on Copart. But again, with 20 times earnings, with decelerating growth, a CEO swap out, some of this fundamental uncertainty about autonomous vehicles, I would just agree that the stock is not obviously cheap, even though the price has come down a lot, which is counterintuitive to some people, but that's just the reality of how intrinsic value works.

1:09:55Daniel Mahncke:And so if we wait, we may very well be able to pick up shares at a bargain bin price and spare ourselves some of the rollercoaster ride. And if we don't get the chance to do so, I'm perfectly fine with that too. I think we own a lot of other great businesses.

1:10:08Shawn O’Malley:I think the last point is what it comes down to me too, where basically I would say, is this a company that I need to own at some point? And if it would be, I think it's at a great price right now to say, okay, well, maybe it gets a bit cheaper, But if I definitely want to own this business, I should use the opportunity right now to buy it and then potentially buy more when it comes down further. I think I really enjoy looking into Copart. I like the business. I like that it's one of the most moaty businesses that we looked at here on the show. And yet, as I said before, it doesn't excite me so much that I want to buy it necessarily.

1:10:39Shawn O’Malley:And that's not because it's a boring business. I think boring business is generally a great opportunity, but I think it needs to be cheaper. I think what you mentioned in terms of, you know, when the last person is selling stock, that's when you want to buy a company that you're not too sure of. I mean, you know, one of the things we discussed with our biggest losers is that basically when we sold PayPal, we were the last hand that sold the stock. And since then it went up, you know, 50, 60%. But I think that's not the case where we are currently with Copart. I think there are still enough people who are bullish on the company so that this might not be the bottom.

1:11:10Shawn O’Malley:Again, if you want to buy the company, I think it is at a cyclical low and I think it could be interesting. but for the two of us, considering the companies we already have in the intrinsic value portfolio, I think we're going to pass for now. And should the stock decline even further, I think that would be a bit of a different scenario. Also, I should say, you know, I mentioned in the podcast here, the stock is already up 25%. So we're not at the bottom anymore where I think it would have been even more attractive than it is today. Anyway, with all of that said, let me close it for today with a quote by none other than the co-profit founder, Willis Johnson himself.

1:11:43Shawn O’Malley:And he said, quote, as long as we have got the land in the right place to put the cars on, we can't fail. So I said it, you know, oftentimes today, we can't stop talking about the moat that the yachts have been, but even Willis Johnson can't stop talking about it. So we're probably right to do that. And with all that said, I hope you had a great time listening to this episode and see you all in the next one. Thanks for listening to TIP. Follow The Investor's Podcast on your favorite podcast app and visit theinvestorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax, or legal advice.

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