CARS - TEGNA = 23% upside

Cars.com finished its first day as a spin-off (June 1) on a high note. Cars.com (CARS) with a market cap of $2 billion closed at $27.28, up 7% on its first day as an independent stock. The unit was spun off from broadcast-oriented parent Tegna (TEGNA), which has a market cap of $3.3 billion and a stock price of $15.35. Gannett had bought out other owners that held Cars.com in 2014, and those assets went with Tegna (itself spun-off from Gannett in 2015).

Cars.com provides car buyers with research and makes money from selling ads to car dealers and automakers: the company had generated $633 million in revenue. We expect the trend of more car shoppers going online in search of cars to continue and advertising revenue from increased traffic to websites such as Cars.com to increase.

CARS was launched in 1998 by a group of newspapers that were eager to hang on to lucrative classified auto advertising. Cars.com operates Auto.com, DealerRater.com, NewCars.com and PickupTrucks.com; all specialized websites targeting different consumer segments. The company hosts about 4.7 million vehicle listings at any given time and manages 20,000 franchise and independent car dealers across all 50 states.

Post spin, both TEGNA and Cars.com were kicked out of the S&P 500 Index, but are included in the S&P 400 Midcap Index. With several trillions of dollars mimicking the S&P 500 Index, exclusion from the S&P 500 may lead to technical selling pressure, which may create an opportunity to purchase CARS shares at attractive levels.

Cars.com is a high-growth and high-margin business, which is likely to focus on its growth strategies subsequent to the spin-off. It is amongst the leading online automotive marketplaces for original equipment manufacturers (OEM), dealers and consumers in the United States. OEMs are manufacturers who resell another company’s product under their own name and branding. The online/digital automotive industry has witnessed some key merger and acquisition activity in the past few months, and in our view, the pure-play higher-growth online automotive business should be valued at higher multiples compared to the parent (TEGNA).

Valuation
We expect the spin of Cars.com will deliver shareholder value, given the company’s high-growth and high-margin business fundamentals. We are optimistic about the company’s mid-term prospects and believe that management’s margin guidance could prove to be conservative. Despite the high leverage, we think that Cars.com should trade at its peer group (EV/Adjusted EBITDA 2017E: 11.5x, P/E 2017E: 22.5x). This suggests fair value of $33 per share, implying a 23% upside from the current market price of $26.81 on June 2.