Ritchie's Operational Excellence Continues

The company garners nearly all of its revenue from unreserved auctions, in which it charges commission to sellers and a small fee to buyers (together known as the auction rate, totaling roughly 11.5%-12% of the equipment's final sale price). However, some of this business (typically 25%-35%) is also at risk; here, Ritchie either guarantees a minimum sales price or, in some cases, purchases the machinery outright ahead of an auction. We believe its immense data set of recent selling prices helps Ritchie manage this business, and we're encouraged that auction rates have improved as at-risk business has become an increasing portion of auction proceeds in recent years. Moreover, the at-risk business can buoy sellers' willingness to bring equipment to auction, reinforcing the source of Ritchie's moat.

Ritchie aims to grow through its traditional auction business as well as its online portals, RitchieBros.com and EquipmentOne.com. The firm has offered buyers the ability to bid remotely from the Internet for more than 10 years, and this source made up 41% of auction proceeds in 2014.

Recent gains in operational improvement stem from Ritchie's latest management changes, and we believe this leadership team will continue to preserve and enhance the company's wide moat. In July 2014, Ravi Saligram became CEO. He ran OfficeMax between 2010 and 2013 before selling it to Office Depot. His tenure at OfficeMax was characterized by migrating the business into the small- and medium-size business segment, increasing the company's ability to sell across physical stores and online channels, and closing unproductive stores. We believe Saligram's prior experience rationalizing a company's asset base and modernizing systems will be very welcome at Ritchie Bros.

Network Effect Digs a Wide Moat We believe Ritchie Bros. has created a wide and formidable economic moat in the industrial auction industry. Based on a unique global network of auction sites, it has become the largest global operator of on-site auctions, generating $4 billion in 2014 auction proceeds. Additionally, it is famous for conducting the world's largest industrial auction in Orlando, Florida, an event that generated almost $170 million of auction proceeds in 2014. While on-site auctions have been a successful format for the industry's entire history, Ritchie Bros. has also been successful at making the transition into the digital era as more than 50% of its successful bids now come from online. Ritchie's scale and multichannel auction strategy have created a sizable network effect that should propel the business into future market share gains.

Like most businesses that generate a moat via a network effect, Ritchie Bros. provides compelling value for all of its customers. For buyers, Ritchie's ability to draw seller's equipment into multiday auctions that have been promoted for days in advance provides assurance that the event will offer many lots of equipment that will cater to virtually all of their equipment needs. Also, Ritchie's unreserved auction format means that the highest bidder wins the lot. Unlike reserve auction formats, a buyer doesn't have to worry that a failure to meet the seller's sales price will result in a "no sale" event.

Sellers also get compelling value. On low-value items, the seller's commission can be as high as 20%, but typically sellers' commissions are less than 2% when a high dollar amount of equipment is sold. With the ability to draw some of the largest auction audiences in the industry, sellers can be confident that they are likely to sell their equipment in the most liquid and advantageous environment possible. Additionally, Ritchie has mastered the art of auction dynamics. Drawing on bidders' competitive arousal (people like to win) and quasi-endowment effect (bidders ascribe higher than market value to items they are pursuing), a big audience of bidders can lead to very high auction results.

Ritchie Bros. is roughly 6 times larger than its next closest competitor, IronPlanet. That scale allows it to see more transactions and know market prices better than the competition. The company's massive scale and the value it creates for buyers and sellers create a virtuous cycle, spurring more buyers and sellers to join Ritchie's ecosystem.

We would consider a narrow moat rating if an auction competitor could significantly exceed Ritchie's scale in an omnichannel format (on-site and online auctions). For example, IronPlanet recently acquired Caterpillar Auction Services and Kruse Energy & Equipment Auctioneers to gain scale and blend its online venue with on-site venues. If IronPlanet or another company could successfully acquire, rebrand, and integrate acquisitions in a manner that rivals Ritchie's, it would cause us to reassess our moat rating.

Competition and Global Recession Pose Risks We assign Ritchie Bros. a medium uncertainty rating. Ritchie is the largest auction company in the world but represents only about 4% of the $100 billion used-equipment auction market. While we believe the company's scale and strong network effect will prevent substantial competition in this arena, some companies (most notably IronPlanet) nonetheless provide alternatives for sellers. More important, Ritchie estimates that there is another $100 billion of used-equipment transactions annually that occur outside auctions. Here, the company faces competition from its own customers, who can sell their equipment at lower rates than the firm's commissions; Ritchie must work to prove it provides the best possible selling price and service for its consignors.

On a larger scale, although Ritchie's business is typically able to handle recessions better than other firms thanks to the ability to attract buyers from an economically stronger portion of the world for equipment being sold in weaker locales, global downturns (as seen in 2008-09) can lead to declining gross auction proceeds. The company also faces risk when hiring new sales employees, as the ramp-up period for these representatives to match their legacy colleagues' productivity is roughly 18-24 months.