When is a merger worth it? For shareholders, when it gets the buyer something it couldn’t get otherwise. Unfortunately for investors in industrial equipment purveyor Ritchie Bros Auctioneers (RBA), that’s not entirely the case in its $7 billion deal with salvage-yard operator IAA, Inc. (IAA).

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Announced in November, the cash-and-stock merger has drawn stiff opposition. Investors owning 10% of Ritchie’s shares, as well as IAA shareholder Discerene, want it nixed. There are boosters, too. Ritchie sealed a $500m investment from Starboard Value in support. Holders of a further 8% of Ritchie are in favor, along with IAA shareholder Ancora, who after pushing for the deal’s terms to be re-cut now backs it.

Ritchie’s shares have been fickle, too. They are about where they were before the deal was announced, but only after crashing 20% upon its unveiling. There’s some reason for that. Acquirers justify paying a premium for a company by touting new opportunities gleaned by combining, including at the very least some cost savings. In this case, the companies say savings should juice EBITDA by around $110 million, at the midpoint. Taxed and capitalized, that’s worth under $900 million, barely more than the premium Ritchie is paying.

Worse, because Ritchie shareholders will only own part of the combined company, they don’t get the benefit of all of those savings, unlike in an all-cash deal. To get a sense of how much they’ll lay claim to, put together the unaffected market values of Ritchie and IAA from before the deal and add in the synergies. Then take Ritchie investors’ 59% ownership of that value, and deduct the cash paid to IAA. They’re left with around $6.4 billion – less than the company’s market value today.

Cost savings aren’t the whole story, though. After weeks of pushback, Ritchie boss Ann Fandozzi revealed a list of “revenue opportunities” the deal unlocks. The company says these should increase EBITDA by anywhere from $250 to $780 million. Though revenue synergies are often unrealistic – and in this case the company’s estimated value for them runs nearly as high as Ritchie’s standalone stock price – generous shareholders could give Fandozzi some credit. Some of IAA’s scrap yards are in locations that can’t be duplicated, because of zoning and other issues, and Ritchie’s access to them could enable the new company to be more nimble with its equipment inventory.

The problem is, that will account for, at the high end, $125 million in extra profit, and there is no guarantee it won’t be closer to the lower end of Ritchie’s estimate. Plus, some of the identified opportunities aren’t clearly connected to this particular merger. Goals like winning share from IAA arch-rival Copart – the largest identified opportunity – and moving into new markets once a non-compete with the target’s former owner expires don’t require a deal. So if the opportunity is simply one in which IAA’s existing business gets better, its existing shareholders can push existing management to do that without the hassle of a merger.

Fandozzi, who has a background in the world of private equity-backed dealmaking, is confident that she sees things more clearly. In a response released on Wednesday, Ritchie casts opponent Luxor Capital’s case as factually inaccurate. In the end, she would need at least $150 million in extra synergies to get the math just to break-even for Ritchie shareholders, while successfully navigating the risk inherent in merger integration. In that sense, the deal requires a lot of faith in Fandozzi for it to stack up.

Context News

Heavy equipment auction company Ritchie Bros Auctioneers agreed on Nov. 7 to acquire salvage-yard operator IAA for $7.3 billion, including debt. IAA shareholder Discerene and Ritchie Bros investors Luxor Capital, Janus Henderson, Vontobel, Deep Field Asset Management and Eminence Capital have publicly announced their opposition to the deal. Starboard Value has agreed to invest $500 million in Ritchie Bros in support of the deal, while IAA shareholder Ancora is also in favor.

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