Is Copart's Acquisition of ACV Auctions a Masterstroke or a Mistake? A Deep Dive into Growth, Supply Constraints, and Valuation

There were quite a few comments from my last two posts that raised concerns about Copart’s acquisition of ACV Auctions Inc. The general perception was that this was a bad decision because the company currently has a negative net profit and a large stock based compensation program. At first sight, that is a reasonable observation. However, sometimes things are different from how they appear. To understand whether this was the right move, it is necessary to examine Copart’s current business health and future prospects, and that is where I want to start, as it forms the foundation of my investment thesis.

Why did they buy ACV Auctions instead of executing aggressive stock buybacks at this price?

I started to suspect the answer when I stumbled upon the return of Jay Adair to the CEO position after just two years away. Simply looking at the timeline and the slowdown in earnings growth makes anyone suspicious that something is wrong. It doesn’t take an in depth analysis to reach that conclusion. But most of the time, gut feelings and intuition are rather misleading when evaluating these situations.

The best way to make a rational decision is to model the company’s growth over the coming years, so this time I ran a 5-year projection.

The growth of this business is dominated by vehicle supply, not demand. Copart sells everything that reaches its platform, boasts an extensive buyer network, and possesses decades of data analyzing consumer behavior to secure the best prices. The real bottleneck is the supply of vehicles received from insurance companies.

To understand this mechanism, I came up with the following formula:

Copart Vehicle Supply = Insured Vehicle Supply × Collision Frequency × Total Loss Frequency × Copart Market Share

These are the variables that dictate their network intake, and analyzing them revealed the rationale behind acquiring ACV.

There has been a structural decline in collision frequency, dropping from a pre COVID level of 5.6% to 4.5% post COVID. At the same time, as inflation spiked repair costs, insurers totaled a higher percentage of damaged cars, pushing total loss frequency up from a pre-COVID average of 16.1% to a post-COVID average of 21%, eventually peaking and flattening at 23%.

This is unlikely to go much higher into the mid 20s unless we face runaway inflation.

This surge in totaled vehicles masked the underlying structural reduction in collision frequency for nearly six years, keeping total vehicle intake healthy. However, that crutch hit a wall once the volume of totaled vehicles stopped growing. As inflation cooled and total loss rates stabilized, the structural decline in collision frequency was exposed, casting a dark cloud over short to medium term growth.

Why did collision frequency decrease?

The primary drivers are the adoption of collision avoidance technology, blind spot detection systems, sensors, and cameras (now standard on almost every vehicle), alongside the shift toward remote work, which reduced miles traveled per capita, and economic factors such as high fuel prices that keep people off the road.

Plugging the last 10 years of data into the equation yields a baseline growth rate of about 6% for the next five years, which is propped up by international sales. Without international markets, organic growth drops to 5.4%.

To get back to double digits, management had to act.

How do they solve it?

The answer is as simple as increasing vehicle supply.

This is where Jay Adair is critical. Under his watch, he transformed Copart into what it is today and has proven capital allocation skills. He and his team have identified this supply bottleneck and deployed a clear strategy:

1. International expansion: This segment is currently supporting overall growth and pushing it toward the 6% range. Growing it further is a straightforward strategy since it’s already a strong revenue engine.
2. The ACV acquisition: Totaled vehicle supply may have peaked, forcing them to look elsewhere. ACV gets them straight into the wholesale vehicle market.
3. Scaling the core business: This includes technology, automation, and yard expansion.

This strategy closely matches the challenges I found during my investigation. Without it, the company faces a structural growth slowdown that would be very difficult to overcome relying solely on the salvage segment.

Was ACV the right acquisition?

This is the million dollar question, and time will tell as the transaction becomes accretive to Copart’s EPS.

From a strategic perspective, diversifying into wholesale vehicles makes sense, and ACV is a natural fit. The synergies are evident. The systems and technology share obvious similarities that should yield early efficiencies.

In the short term, we may see a progressive reduction in ACV’s R&D expenses, a major component of their cash burn, as technology sharing between Copart and ACV kicks in. Utilizing Copart’s extensive yard network should also happen progressively, improving storage and transportation efficiency.

However, I believe the main objective is opening Copart’s massive buyer network to ACV. More specifically, I believe management is trying to connect ACV’s vehicle supply to Copart’s global demand network rather than simply acquiring ACV’s existing buyer base.

If only 5% of Copart’s existing network engaged with ACV inventory, ACV could potentially more than double its current buyer base, which could have a significant impact on revenue.

That said, it remains to be seen whether a salvage buyer is also interested in purchasing wholesale inventory. Local businesses or international buyers utilizing cheaper labor to rebuild totaled salvage vehicles may not find it financially viable to buy higher end wholesale cars for the same purpose.

This overlap between Copart buyers and ACV inventory is one of the largest unknowns in the acquisition thesis.

This suggests that primarily the lower end of ACV’s inventory will successfully cross over into Copart’s ecosystem, leaving much of the value creation dependent on the first two benefits plus ACV’s existing dealer network.

Copart’s Valuation and Investment Strategy

I ran a 10-year model incorporating the ACV acquisition across three scenarios:

• Bear case (6.4% growth)
• Base case (7.7% growth)
• Bull case (9.1% growth)

The bull case briefly touches double digit growth by 2029, though it is initially weighed down by low first year growth following the acquisition.

Using an 8% discount rate, my base case valuation yields an intrinsic value of $31 per share, suggesting the stock is currently trading around fair value.

My thesis hinges on Copart’s exceptional business quality and economic moat, making it a true compounder. However, looking at the opportunity cost relative to other portfolio options, I would prefer to enter at a 15% discount to fair value, putting my buy zone between $26 and $27.

Normally I demand a 40%+ margin of safety, but given the fortress like quality of the business, I’d be happy entering around that range. Other investors may decide to enter at fair value for a company like Copart.

Where do you place fair value, and how much of a margin of safety do you require before initiating a position?

Disclaimer: I am not a financial advisor. This is simply my own valuation, estimates, and portfolio strategy. Please do your own research before making any investment decisions.