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UNIVERSITY OF FLORIDA AUTONATION INC. (NYSE: AN) Sector: Consumer Discretionary Industry: Automotive Retail STUDENT RESEARCH Recommendation: SELL Target Price: $42.50 (13.3%)

Current Price as of 1/9/2014: $49.00

HIGHLIGHTS Down Goes Frazier!!! An Industry Leader Loses its Edge Market Profile  Reversal of Historical Premium Valuation to Peers: AN has long had average margins 52 Week Low 38.55 relative to its peers and its diminished advantages no longer warrant a large premium. Current % above Forced sales by large institutional investors as well as a loss in its SG&A to gross profit 27.1% low advantage justify diminished premium representing a new normal. 52 Week High 54.49  Recent New Vehicle Sales Not Representative of Historical Growth: The industry Current % below has seen unprecedented new vehicle sales growth as a result of the 2008-2009 recession. (10.1%) high Market expectations incorporate a continuation of this trend while it is unsustainable as Shares evidenced by 2013 new vehicle sales. Outstanding 121.8  Industry Multiple Compression: The industry is currently trading at a cyclical high. (mm) Margin compression in the new and used car segments should cause a decline in valuation Avg 3M Daily back to historical norms. 1.02 Volume (mm)  Projected P&S Growth Artificially High Following Recession: Expected rapid Activist expansion of the 0-5 year fleet, the primary driver of Parts and Service revenue, is a 28.2% Ownership function of unsustainable new car sales growth resulting from the post-recession decline Top 15 in new vehicle sales. While Parts and Service revenue will increase due to the post- Shareholder 69.9% recession surge, these gains will revert in the long term and are over-priced. Ownership  Internet Rebranding Initiative and Economies of Scale Validate Small Premium: Source: CapIQ Rebranding, search enginge optimization, and the development of a more user friendly rd website will increase web traffic, thus reducing fees paid to 3 party lead originators. Additionally, AutoNation’s market share advantage warrants a premium to peers, albeit lower than historical levels. Market Value ($MM) 50.0% 1 Year Performance Market $6,052.2 Capitalization 40.0% Total Debt $1,856.3 Enterprise Value $7,840.2 30.0% LTM P/E 17.1x 20.0% LTM 9.7x EV/EBITDA 10.0% Source: CapIQ Operating Model Summary 0.0%

-10.0%

AN Russell 3000 Peer Group

Operating Model Summary 2010A 2011A 2012A 2013E 2014E 2015E 2016E 2017E 2018E Revenue $12,461.0 $13,832.3 $15,668.8 $17,608.1 $18,195.0 $18,823.8 $19,468.7 $20,130.2 $20,808.8 Growth 11.0% 13.3% 12.4% 3.3% 3.5% 3.4% 3.4% 3.4% This report is published for Gross Profit 2,127.5 2,304.0 2,486.4 2,779.3 2,852.0 2,949.0 3,048.2 3,149.6 3,253.3 educational purposes only by Growth 8.3% 7.9% 11.8% 2.6% 3.4% 3.4% 3.3% 3.3% students competing in the CFA Margin 17.1% 16.7% 15.9% 15.8% 15.7% 15.7% 15.7% 15.6% 15.6% Institute Global Research EBITDA 514.2 611.0 691.0 790.2 824.3 871.7 920.7 971.3 1,023.6 Challenge. Growth 18.8% 13.1% 14.4% 4.3% 5.7% 5.6% 5.5% 5.4% Margin 4.1% 4.4% 4.4% 4.5% 4.5% 4.6% 4.7% 4.8% 4.9% Price Target: Net Income 226.6 281.4 316.4 381.4 394.7 420.4 447.1 470.0 503.7 Sell – >0% Below Current Growth 24.2% 12.4% 20.6% 3.5% 6.5% 6.4% 5.1% 7.2% Hold – 0 - 15% Above Current Margin 1.8% 2.0% 2.0% 2.2% 2.2% 2.2% 2.3% 2.3% 2.4% Buy – >15% Above Current

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BUSINESS DESCRIPTION Figure 1.1 Revenue AutoNation (AN) is a leading provider of new and pre-owned vehicles and the largest automotive Breakdown retailer in the United States. The Company offers a diverse range of products and services including new and used vehicles, parts and service (P&S), and finance and insurance products (F&I). AN has 267 new and used-vehicle franchises throughout the country, primarily concentrated in Sunbelt metropolitan areas. Operating Segments AN divides its operating segments into Domestic, Import, and Premium Luxury vehicles, all of which sell both new and used vehicles, automotive and maintenance services, and automotive finance and insurance products. Domestic revenue represents about 33% of total revenue, Imports about 37% of total revenue, and Premium Luxury about 29% of total revenue. AutoNation, like most of its peers, is well diversified by brand but is skewed more towards domestic sales (at the expense of luxury sales) than its peers. New and Used Vehicle Sales AN acquires new vehicles from original equipment manufacturers (OEMs), distributors, and dealer Source: Filings trades with other stores of the same franchise. Used vehicles are generally acquired from customer trade-ins, auctions, and lease terminations. New vehicle sales represent about 57% of total revenue Figure 1.2 Gross Profit and 23% of gross profits; used vehicle sales make up approximately 24% of total revenue and 12% Breakdown of gross profits. Used vehicle margins are significantly higher than new vehicle margins, with AN LTM Used vehicle margins of 7.9% vs. 6.1% for New vehicles. New vehicle revenue growth in 2011 and 2012 were 12.4% and 18.8% respectively while used vehicle revenue growth in 2011 and 2012 were 12.7% and 5.7% respectively. Parts and Service The higher margin parts and service business provides a wide range of automotive repair, maintenance, and collision repair services including warranty work, which can only be performed at franchised dealerships, as well as customer-pay service work. In addition to the retail aspect, AN has a wholesale parts operation, selling automotive parts to collision and independent repair shops. This business generally tends to be less sensitive to macroeconomic conditions compared to new and used vehicle sales. The parts and services business makes up about 15% of revenues and 41% of gross profits. Margins for this segment are significantly higher than for vehicle sales with LTM Parts and Services margins of 42.5%. Parts and Services revenue growth in 2011 and 2012 were 3.8% and 4.6% respectively.

Source: Filings Financing and Insurance The company arranges financing for customers in the form of installment loans or leases with Figure 1.3 New Light Vehicle third-party lenders, including the manufacturers’ and distributors’ captive finance subsidiaries, for a Sales commission. AN does not directly finance its customers leases or purchases and does not take credit risk. The financing and insurance business makes up about 4% of revenues and 23% of gross 20.00 profits. Almost all Finance and Insurance revenues flow through to gross profit. Finance and 18.00 Insurance revenue growth in 2011 and 2012 were 13.3% and 20.4% respectively. This high growth 16.00 segment has been used as a means of offsetting new and used vehicle margin compression. 14.00 Business Model and Strategy 12.00 AutoNation competes in a highly fragmented industry dominated by small regional competitors 10.00 that lack access to public equity markets and other low cost sources of financing. In addition, 8.00 regional competitors are unable to take advantage of back office and advertising economies of scale 6.00 resulting in higher SG&A expense. Further, size allows AutoNation considerable leverage over 4.00 suppliers leading to more favorable floorplan financing terms. These advantages allow AutoNation 2.00 to compete on cost, emphasize unit volume, and yield superior returns due to relatively high 0.00 operating leverage.

Source: US Government

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Figure 2.1 New Car Gross INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING Margins AutoNation, the largest automotive retailer in the United States, offers a diverse range of products and services and in 2012 had 1.76% and 1.06% of the new and used vehicle unit market shares respectively. Franchise dealers are local monopolies, as OEMs look to prevent price competition and rarely take away franchise rights or grant new franchises in the same territory. The industry is highly fragmented and mature; AutoNation, along with other major public dealership groups like Asbury Automotive, Group 1 Automotive, Lithia Motors, Penske Automotive Group, and Sonic Automotive account for only 5.58% of 2012 new vehicle unit sales. The rest of the competition predominantly consists of private “mom and pop” franchises. The major players have been successful reinvesting cash at high returns through accretive acquisitions, using their leverage over property owners to buy-in properties at high cap rates, or returning capital to shareholders via buybacks. Larger dealer groups are able to spread out fixed costs (i.e. marketing, back office / dealership accounting), have the experience and capacity to efficiently manage inventory, and invest in CRM tools to improve customer satisfaction. The industry has used its operating leverage to bring down its SG&A as a percentage of gross profit (a common industry metric as opposed to the conventional percentage of sales) from 79.1% to 73.9% between 2010 and Source: Filings Q3 2013 LTM. As a result, they have seen increased support from OEM’s (particularly warranty Figure 2.2 Variable Cost expansion, but also floorplan financing support) who see value in creating larger, healthier dealers Structure Provides Stability that can reduce churn and sell more OEM parts. Unit volume sales are heavily dependent on overall health of the economic environment in which individual dealerships operate. Key drivers such as consumer confidence, real estate and investment asset values, access to credit, and disposable income were negatively impacted in the years of the 2008-2009 recession. The automotive retail industry’s variable cost structure allowed the industry to mitigate the impact of reduced vehicle sales and maintain stable pre-tax profits relative to other consumer discretionary industries. In the years following the recession new vehicle sales grew at a historically unprecedented pace with four consecutive years of +8% new vehicle units sales growth between 2009 and 2012. While key industry drivers are expected to improve, new unit sales will grow at a more tepid, historic growth rate of 1% as annual new vehicle sales revert to normalized levels. Supporting this was exceedingly modest new vehicle sales growth of 0.6% in 2013. F&I and P&S Counteract Front-end Margin Compression All repair work for cars under warranty is required to take place at franchised dealerships; even if shoppers buy elsewhere, a franchisee with a favorable customer approval rating can expect to retain the majority of parts and services revenue in their territory. While the proliferation of the internet Source: Filings as an information source has led to reduced gross margins on the front end, reducing new vehicle margins by 160 bps or (-19%) over the last decade, dealerships have countered by focusing on Figure 2.3 F&I Sales Offset more profitable segments of the business (i.e. F&I + P&S). The risk born by ancillary insurance Compressed Margins products, like car-key insurance, and lease financing arrangements are taken on by third parties that (Growth Rates) pay dealers a fee for origination. Essentially, this F&I is 100% gross profit business. Considering F&I revenue as a component of gross profit earned on each new vehicle sold illustrates that gross margins have grown at an average rate of 1.49% from 2000-2012, more or less keeping up with inflation. However, a rising rate environment and additional scrutiny by the Consumer Finance Protection Bureau (CFPB) could adversely impact this segment. Increased Focus on Internet Presence The internet acts as a primary source of information that consumers use to make educated purchase decisions. Companies like Cars.com, AutoTrader.com, and Edmunds.com have been able to capitalize on this by allowing consumers to sift through vehicle inventories by geographic area, brand, model, and even dealership service record on a user-friendly interface. While this has led to an increase in sales for automotive retailers on the front-end, the fees charged for lead origination have managed to make a low margin segment even less profitable. Recognizing this, AutoNation has developed a plan for disintermediation that involves increased digital advertising, improving the effectiveness of its website, and rebranding its domestic and import dealerships under the Source: Filings AutoNation name. The hope is that it will be able to direct more traffic to it’s website through search engine optimization, which should lead to decreased dependency on third party lead- originators. Moreover, the internet could diminish the importance of traditional brick and mortar

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car salesmen leading to a decrease in compensation expense; compensation expense accounted for Figure 2.4 SG&A Mix – AN & 45.2% of gross profit in 2012 for public auto retailers. Peer Group

Source: Filings

INVESTMENT SUMMARY Figure 3.1 New Light Vehicle New Car Sales Environment Sales Growth As discussed in the industry overview, while new car sales grew at an unprecedented rate from 2009-2012, new car sales growth is expected to return to more modest historical norms. Growth 15.0% 11.7% 12.6% from 2009-2012 (averaging 10.8%) was the function of pent up demand stemming from a -35.7% 9.9% 8.9% decrease in 2008 new vehicle sales. In the last thirty years there has only been one case of consecutive years of +8% vehicle sales growth, 2009-2012 saw four consecutive years of this 5.0% 0.6% growth. A long term average growth rate of 1% is both sustainable and to be expected for the industry going forward. (5.0%) AN Lacks the Margins of its Peers (15.0%) The Company’s 2012 and Q3 2013 LTM New, Used, and Parts and Services margins all trail the peer group average, with AutoNation boasting worst in class Parts and Service margins for 2010, (25.0%) 2011, 2012, and Q3 2013 LTM. As margins compress across the industry for new and used vehicle sales, AutoNation’s weak Parts and Services margins are particularly concerning. Offsetting the (35.0%) concerns somewhat is AN’s 2012 best in class Finance and Insurance as a percentage of total revenue, a growing source of industry gross profit. SG&A Advantage Diminished from Peer Gains Source: Filings While AutoNation has seen favorable SG&A as a percentage of sales compression by (260) bps

Source: Google from 2010 to LTM, its peer group has seen compression of (520) bps over the same time period. gle During the time period AN’s rank within its peer group slipped from 1st to 3rd in this key expense Figure 3.2 P&S Retention category. Strongest in Early Years Parts and Services While on average representing less than 15% of revenue of automotive retailers, parts and services contributes close to half of dealerships’ annual gross profit. Furthermore, due to lower SG&A expenses associated with this segment, P&S gross profit flows through to operating income at higher incremental margins. The substantial decrease in new vehicle sales following the 2008-2009 financial crisis will provide a tailwind for this business segment; as the number of new cars sold grows, the size of the 0-5 year old fleet of cars is expected to increase, benefitting the industry as a whole. Younger cars are more likely to be under warranty and have a higher retention rate. Additionally, dealer share of the parts and service segment has widened due to OEM support and a focus on CRM. OEM’s are now including service packages up front with new and certified pre- owned cars. Customers can have this work done for free, and franchised dealers nearly always receive full commission. The option to sign longer leases means cars can be under warranty for as long as four years. Free service aside, “mom and pop” dealers are having a tougher time investing in Source: Filings the diagnostic tools required by increasingly complex automobiles. Proactive CRM techniques are

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improving satisfaction among consumers and result in more off-warranty work like oil changes for dealers. Internet and Rebranding As consumers shift more of their time spent in the auto purchase process online, 3rd party websites have been the primary beneficiary as they generate sales leads for retailers. AutoNation’s recent rebranding efforts are an attempt to displace the 3rd party websites. Through greater visibility AutoNation will be able to reduce its reliance on these costly 3rd party leads. FINANCIAL ANALYSIS Figure 4.1 Google Trends - Internet and Rebranding Peer In Q1 and Q2 2013 AutoNation increased their advertising expenditures by $18 mm in an effort to rebrand non-luxury franchises under the AutoNation banner. According to company filings, the 100 intention of the rebranding was to “enhance our strong customer satisfaction and expand our 80 market share” as well as to “drive more traffic to our websites through the AutoNation retail brand, which will allow us to market to more customers directly, rather than through third- party 60 websites”. AutoNation estimates that customers were reached over 50 times with their new message on TV and that they generated over two billion impressions over the launch period. 40 Rebranding raises a few questions: was rebranding successful and how can rebranding be quantified financially? 20 Internet Presence Significantly Improved, However Still Trailing 3rd Party Googel Trends (100=Max) 0 Internet presence has become increasingly important in automotive retail. According to R.L. Polk, 75% of car buyers use the internet when shopping for a car, spending an average of 11.3 hours online, representing 76% of the time spent in the buying process. AN LAD Because automotive retailers are typically geographically concentrated and customers seek to Source: Google compare prices across dealers, the 3rd party lead generation business has developed with companies like AutoTrader.com, Cars.com, and Edumunds.com. These companies advertise dealer inventories Figure 4.2 Google Trends – to generate sales leads. According to the National Automobile Dealers Association (NADA), an 3rd Party industry trade group, in 2012 dealers spent on average 26.2% of their advertising budget on internet spending. We estimate that 3rd party spending accounts for more than 40% of this internet 100 spending and will likely increase. 80 To evaluate improved customer awareness we utilized Google Trends to see how often 60 AutoNation appeared in web searches. As illustrated in Figure 4.1, AutoNation has significantly improved its web presence since December 2012. In comparison to Lithia Motors (LAD), AN’s 40 only peer that uses family branding for its dealerships, AutoNation generated nearly five times the 20 search interest at its peak this year. However, in comparison to 3rd party websites, as depicted in Figure 4.2, AutoNation is merely a blip on the radar. At its peak, AutoNation search interest 0 represented only 9.7% of the 3rd party average search interest. The Company must make significant Google Trends Google (100=Max) improvements if it believes that it can reduce its reliance on 3rd party websites. Internet Cost-Savings – Compensation and Advertising Expense AN Cars.com An improved internet presence should benefit AutoNation by reducing both advertising and Edmunds.com AutoTrader.com compensation expense. Advertising expense should be reduced as AN will be less reliant on 3rd Source: Google party websites to generate sales leads. By projecting monthly 3rd party fees per dealer and a 3rd party savings ramp of 7.5% per year in our base case, we project 3rd party spending to remain level with annual cost savings in our terminal year of nearly $10 mm. In addition, we expect that improved in- house lead generation will reduce the number of sales staff required by (0.2) employees per dealership, generating 300 bps of savings as a percentage of gross profit in the terminal year. We expect advertising and compensation expense to compress by (370) bps in our base case. Use of Cash When considering share repurchase opportunities, AutoNation evaluates their shares based on intrinsic value through the use of P/E ratios. Although AutoNation’s P/E had been at the bottom of its three year average, Q3 2013 buybacks were nonexistent. We believe this signals a strategy shift in the capital allocation policy away from share buybacks to explore accretive acquisition opportunities. Prior to the nine months ending September 2013, the company had aggressively

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pursued buybacks at a relatively low P/E compared to the month before and after. Though share repurchasing has been a strength for the Company in the past, in the foreseeable future they do not look to be continuing at the same frequent pace. We continue to see AutoNation take advantage of attractive acquisition opportunities in their target markets. Acquisitions have averaged ~$100MM a year for the past four years with no signs of Figure 4.3 Revenue by diminishing. Large cash reserves and a continued low interest rate environment should bode well Geography (2012) for additional acquisitions in the future. We project in our base case that AN will acquire three franchises annually, matching their historical pace. 40.0% Since 2009, AN has generated a return on invested capital that is 1.0% greater than its peer group 35.0% confirming its successful acquisition strategy. AutoNation continues to target dealerships in the 30.0% Sunbelt region with all but one of their acquisitions over the last four years coming from these 25.0% 20.0% states. 15.0% Concentration and Market Penetration 10.0% AN’s exposure to the Sunbelt region (#1 in its peer group) proved favorable for them following the 5.0% 2008-2009 recession as the region experienced faster growth than much of the country. New – housing starts and new home sales have been up considerably since the beginning of 2011 in the Sunbelt. This coupled with the favorable skew towards domestic brands supported AN as commercial, heavy duty vehicle purchases ticked upward. In addition, per capita household income in the Sunbelt increased roughly 3% YoY from 2011 to 2012. We believe this exposure has reached Peer Average AutoNation an inflection point for AN as housing markets in these states have begun to perform poorly Source: Filings compared to other regions in the US. Recent Federal Reserve action has pushed mortgage rates to near two year highs, severely reducing mortgage applications and stemming the rise in home prices in the region. Figure 4.4 Revenue by Revenue by Segment Segment (2012) The automotive retail industry divides revenue in three ways: brand, geography, and business segment. While the leader in both new and used market share, AN differs in revenue skew from its Segment AN Peers Peer Rank peers. By brand AutoNation favors domestic brands at the expense of luxury brand exposure (32% Domestic 31.7% 22.2% 2 vs. 22% peer domestic) and has recently benefitted from an increase in domestic truck sales. We Sunbelt 93.0% 72.1% 1 do not expect brand skew to contribute to a premium relative to peers. By geography AN has the Used Vehicle 23.7% 28.0% 6 highest exposure to the Sunbelt states among its peers (93% vs. 72% peer in 2012). While Parts and Service 15.3% 11.9% 1 exposure to the Sunbelt has recently been favorable, as conditions have normalized, a skew to the Finance and Insurance 3.6% 3.2% 1 region no longer merits a premium. By business segment AutoNation derives the highest Source: Company Filings proportion of its revenue from the high margin Parts and Services (15.3% vs 11.9% peer in 2012) and Finance and Insurance (3.6% vs. 3.2% peer in 2012) segments. This however comes at the expense of Used Vehicle revenue, where AN derives the smallest portion of its revenue relative to its peers (23.7% vs. 28.0% peer in 2012). We expect Parts and Service and Finance and Insurance skews to support a premium in excess of the negative of lower Used sales, especially as Used margins compress. Figure 4.5 SG&A % of Gross Profit and Rank vs. Peers Margins by Business Segment 85% AN has new and used vehicle margins that are both below the peer group average (New 6.1% vs. #1 # 2 #2 #3 6.4% peer LTM, and Used 7.9% vs. 8.3% peer LTM), as well as consistently eroding. As the industry sees new and used margin compression as a result of 3rd party comparison websites, AN is 80% 79% 76% unlikely to reverse any of these losses. Causing further concern is AN’s worst in peer group Parts 75% 74% and Service margins (42.5% vs. 53.8% peer LTM). As the industry becomes increasingly reliant on 75% 73% 72% Parts and Service revenue this should cause AN to trade at a discount to its peers. 70% 70% 70% Size and SG&A AutoNation is the largest new and used auto retailer based on units sold (New 1.85% vs. 0.80% peer in 2012, and Used 1.06% vs. 0.51% peer in 2012) and ranks second in number of 65% dealerships with 267. These advantages in scale have translated into overhead expense as a

SG&A SG&A a as of % GrossProfit percentage of gross profit that is consistently in the top two among its peers and well below the 60% peer average (17.8% vs. 24.6% peer LTM). However, as a result of higher than peer compensation 2010 2011 2012 LTM and advertising expense as a percentage of gross profit, AN has given ground to peers in its AN Peer formerly best in class SG&A as a percentage of gross profit (70.4% vs. 73.9% peer LTM) with its Source: Company Filings

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rank among peers deteriorating from 1st to 3rd from 2010 to LTM. This reduced advantage relative to its peers fails to warrant any multiple premium going forward. Figure 4.6 Floorplan Financing Support Cash Conversion Cycle AN has a significantly shorter cash conversion cycle than its peers and typically ranks in the top two 1.6% in the industry (4.4 days vs. 11.5 peer LTM). Days Sales Outstanding have been stable over the 1.4% 1.4% last three years with AN experiencing about average DSO (12.7 vs. 12.9 peer LTM). While 1.2% maintaining new vehicles days inventory held that has consistently ranked at the bottom of its peer 1.2% 1.0% group (5th LTM), AN has better than peer used vehicles days inventory (3rd LTM) and best in 1.0% class parts and service and other inventory (1st LTM). Together AN has an average days inventory 0.8% 0.8% rd 0.8% 0.7% 0.7% held that ranks 3 LTM. AN’s cash conversion cycle advantage lies in its trade vehicle floorplan days. While peers have transitioned away from trade floorplan financing (in favor of non-trade) AN 0.6% finances 73% of its inventory through trade finance compared to a peer average of 31%. The 0.4% Benefit Benefit / Inventory rationale for this comes from the generous terms that AN receives from OEMs. While peers have 0.1% 0.2% average LTM trade vehicles days payable of 20.3, AN has LTM trade vehicle days payable of 46.3. This advantage has been sustained over the last three years and is attributable to AN’s size. We 0.0% 2010 2011 2012 LTM expect AN to maintain this advantage in cash conversion cycle which should contribute to a AN Peer premium relative to peers. Floorplan Financing and Support Source: Filings As mentioned above, automotive retailers finance the majority of their inventory through floorplan financing facilities that come in two forms: trade (OEM) and non-trade (financial institution). Historically OEMs have provided support to dealers to reduce floorplan expenses with the benefits Figure 5.1 ESL Ownership being realized in lower inventory costs and higher new and used vehicle margins. While AN has an 60% 55% LTM floorplan expense as a percent of inventory that is roughly in line with peers and below the median (2.07% vs. 1.99% peer, rank 5th), AN receives greater floorplan assistance as a percent of 50% 44% 41% inventory leading to a net floorplan benefit that is significantly greater than the peer average (1.37% 40% vs. 0.78%, rank 2nd). Further, as OEM floorplan assistance has increased over the last three years, 32% 28% AN has sustained its advantage relative to its peers. AN’s favorable treatment is the result of its size 30% 25% and its use of trade floorplan financing. This should provide AN with a sustainable advantage to its 20% peers and supports a premium valuation.

10% SHAREHOLDER ANALYSIS Eroding Support from a Key Shareholder 0% Since 2000, AutoNation has enjoyed the support of Edward Lampert’s ESL Investments, which as recently as September 2012 maintained an ownership stake of more than 55%. ESL maintains a seat on AutoNation’s board and is best known for its investments in retail companies where ESL often pushes for the implementation of cost-cutting programs. However, as detailed in Figure 6.1, Mr. Source: CapIQ Lampert and ESL have been forced to significantly reduce their stake (55% to 25%) in AutoNation, Figure 5.2 Multiple largely driven by redemption requests from ESL’s limited partners. Redemption requests have been Compression - Peer Average attributed to the poor performance of ESL’s largest investment Sears Holdings Corporation (SHLD). The forced selling by ESL has put pressure on AutoNation’s shares and can be identified 6x as one of the sources of AutoNation’s multiple spread compression relative to its peers. Since 5.0x 5x September of 2012, AutoNation’s LTM P/E premium to its peer group mean has contracted from 5.0x to 1.6x as of September 2013. Over the same period, AutoNation’s LTM EV/EBITDA 4x premium relative to its peer group has contracted from 2.9x to 1.1x. Further forced selling by ESL 2.8x 3x 2.5x could lead to additional multiple compression and is a significant risk for AutoNation investors. 2.2x 1.9x 1.8x 1.6x 2x 1.6x Outside of ESL, a Stable Investor Base 1.4x 1.1x AutoNation’s top 15 shareholders account for nearly 70% of shares outstanding. AN benefits from 1x the support of the Bill Gates family (a 14.9% owner) through its investment vehicles Cascade 0x Investment and the Bill & Melinda Gates Foundation. Cascade Investment is a respected long term Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 investor that often is compared to Berkshire Hathaway and has been steadily increasing its P/E Premium ownership in AutoNation. AN further benefits from membership in the S&P 500 (the only EV/EBITDA Premium member of its peer group included in the index) as evidenced by significant ownership by passive investment vehicles. While ESL’s ownership represents a risk, the remainder of AutoNation’s Source: CapIQ investor base appears stable.

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VALUATION Operating Model Assumptions Revenue: Drivers of revenue were isolated for each business segment. New vehicle sales were calculated as a function of three factors: US Light Duty Vehicle Sales, Market Share (organic and Figure 6.1 Operating Model acquired), and New Unit average price. US Vehicle sales were derived based on historical long term Summary average growth rates, resulting in a 1.0% growth rate in the base case. This expected growth rate differs significantly from the +8% growth rates experienced over the last four years. We project 0.01% organic market share expansion and 0.02% acquired market share expansion annually for our base case given AN’s ability to compete on cost in local markets and its capital allocation history. New unit prices were grown at 0.75% based on historical norms and our projections for inflation. Used vehicle volume is expressed as a percent of new vehicle sales units and is constant at 71% in our base case, in line with historical norms. Used vehicle unit prices were grown in the same manner as new unit prices. Parts and Service revenue consisted of the size of the AutoNation new and used car historically sold fleet and revenue per unit in the fleet. The AN fleet grew based on our projected new and used car sales averaging 4.0% annually, while revenue per unit grew at 3.0% annually, in line with historical norms. Finance and Insurance revenue was projected as a percent of new vehicle sales and was held constant at 6.9% of new sales in our base case implying average annual growth of 5.7%. Margins: New and used vehicle margins compress at a rate of (0.1%) annually in our base case in line with our view that buyer power will increase as a result of 3rd party comparison websites. New Source: Team margins average 5.8% for the projection period while used margins average 7.8%. In contrast, parts and service margins expand by 0.1% annually in our base case and average 42.9%. Improved volume should benefit parts and service margins as management has stated that the parts and service segment has higher operating leverage than other portions of the business. All of finance Figure 6.2 Margins and Gross and insurance revenues flow through to gross profit. Profit Compensation Expense: Compensation expense is a function of the number of franchises, employees per franchise, and compensation per employee. In our base case we project franchise growth in line with historical capital allocation, while employees per franchise compresses by (0.2) employees per year as a result of internet lead generation as detailed below. As wages have been stagnant over the past few years and have not kept pace with core inflation, compensation expense grows at 1.5% a year in our base case. We project a (1.7%) compression in compensation expense in our base case averaging 45.2% of gross profit over the projection period. Advertising Expense: Excluding Q1 and Q2 2013 rebranding expenses, LTM advertising expense would be in line with historical norms at 5.5% of gross profit. Through AN’s improved web presence we project advertising expense compression of (10) bps annually (compress by 5 bps annually instead of expanding by 5 bps annually) as a result of savings from reduced 3rd party website lead generation. Overhead Expense: In our base case overhead expense compresses annually by (20) bps as a percent of gross profit as operating leverage combines favorably with improved volume. Overhead expense averages 17.1% as percent of gross profit over the projection period. Source: Team Floorplan Interest Expense: AN’s floorplan financing is completely LIBOR based. Taking into account historical spreads we calculated an implied borrowing rate by increasing 3 month LIBOR and AN’s spread by 2 bps each month to account for the historically low rate environment and tight credit spreads. This borrowing rate was multiplied by our floorplan payable projections to generate floorplan interest expense. Comparable Company Analysis Historically AutoNation has traded at a premium to its peers on both a P/E and EV/EBITDA basis, and currently automotive retailers trade at a historically tight discount to the S&P 500. However, recent changes have led to erosion of support for that premium. AutoNation’s size will grant it some premium to its peers going forward; however, it will be less significant that it has been historically.

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CFA INSTITUTE RESEARCH CHALLENGE JANUARY 9, 2014 Industry at Historically Tight Discount to Market The automotive retail industry currently trades at a (0.6x) discount on LTM EV/EBITDA basis and a (2.7x) discount on a LTM P/E basis relative to the S&P 500. For both of these metrics the automotive retail industry is trading at a tighter spread to the S&P 500 than it has averaged over the Figure 6.3 Margins vs. Peers last one, two, and three year periods. On an EV/EBITDA basis, the industry typically trades on average at 7-8x (current 9.0x) and on a P/E basis the industry typically trades at 12-15x (current 16.9x). Cyclically this is a high point for the automotive retail industry; however, given expected margin compression for new and used cars we expect multiples for the industry to compress back towards their historical norms. AutoNation’s Premium Diminished AutoNation has historically traded at an average premium of 3.9x on a P/E basis and 2.3x on an EV/EBITDA basis over the last three years relative to its peer group. However, recently this premium has compressed significantly to 1.6x on a P/E basis and 1.1x on an EV/EBITDA basis. A number of factors have contributed to AN’s declining premium. First, major shareholder ESL Investments has been forced to reduce its position from 55% to 25% of shares outstanding as a result of limited partner redemption requests. Second, AN’s advantage in SG&A as a % of gross profit has eased as rivals have trimmed margins considerably. Finally AN has lower margins and derives a smaller portion of its revenue from the all-important Parts and Services segment than its peers. Offsetting these factors however are improved branding, an expanding online presence, a Source: Filings strong cash conversion cycle, leadership in market share, and inclusion in the S&P 500. While AN still deserves a premium relative to its peers, a premium below historical averages appears justified. An appropriate premium for AutoNation should be in the ball park of 1-2x on a P/E basis and 0.5x-1x on an EV/EBITDA basis. Comparable Company Analysis Valuation Figure 6.4 Cash Conversion For our comparable company analysis we choose to analyze P/E, EV/EBIT, and EV/EBITDA vs. Peers based on 2012, LTM, 2013E, and 2014E measures. In calculating our price target we applied the median comparable multiple and an AutoNation premium to each metric for both historical values and our projected base case. Premiums ranged from 1-2x, 0.4-0.8x and 0.5-1.0x on a P/E, EV/EBIT, and EV/EBITDA basis respectively. Each of these twelve valuations were equally weighted to generate our comparable company price target of $40.78, a discount to the current share price of (16.8%). Discounted Cash Flow Analysis For our discounted cash flow analysis we sensitized our valuation in 24 ways and included each of the following:  A levered and unlevered DCF with a bear, base, and bull case  Weighted average cost of capitals using both a bottom-up cost of equity as well as a regression beta cost of equity  Terminal value calculated using both multiples and perpetuity growth The bottom-up cost of equity was calculated by taking the industry average asset beta and re- levering it with AN’s capital structure. In contrast, the regression beta utilized a one year beta relative to the S&P 500. This yielded a cost of equity of 10.55% and 9.66% respectively. AN’s cost Source: Filings of debt was calculated using AN’s most recent debt issuance’s YTM, representing the cost of AN’s next borrowed dollar. WACC under the two methods was 7.98% and 7.37% respectively. A perpetuity growth rate of 2.0% was used for both the levered and unlevered DCF as it approximates long term economic growth rates. The unlevered DCF utilized an EV/EBITDA multiple of 9.0x while the levered DCF utilized a P/E multiple of 14.0x, both representing industry average valuations with AN’s previously described premium added. We weighted our bear, base, and bull median price targets by 20%, 60% and 20% respectively to generate a DCF price target of $43.65, a discount to the current share price of (10.9%).

UNIVERSITY OF FLORIDA - PAGE 9

CFA INSTITUTE RESEARCH CHALLENGE JANUARY 9, 2014

Summary Football Field

DCF BULL

DCF BASE

DCF BEAR

EV/EBITDA

EV/EBIT

P/E

$25 $35 $45 $55 $65 Price Per Share INVESTMENT RISKS  Expedient Internet Advertising Market Penetration: Upside stands to be achieved if AN gains 3rd party market share faster than anticipated. This would have the effect of decreasing both compensation and advertising expense by reducing lead commissions paid to 3rd party websites.  Better Than Expected Gross Profit Margin in New and Used Segment: 3rd party comparison sites do not grow as quickly as anticipated in our valuation keeping new and used gross profit margins intact.  Decrease in SG&A as a Percentage of Gross Profit: If the rebranding initiative leads to greater lead generation through AN advertising, SG&A could materially decrease.  Better than Forecast New and Used Car Sales: If new and used car sales buck historic trends and continue to grow at post-recession levels, the auto industry as a whole stands to gain significantly.  Continued Robust Sunbelt Recovery: If the Sunbelt recovers easing economic gains, namely housing prices, AN stands to benefit from further brand skew towards domestic.  Better than expected P&S Growth: An older car fleet that has yet to see the full benefits in average age reduction from an improving new and used car sales environment, could yield better than expected “customer pay” parts and service business.  Key Shareholders Retain or Expand Investment: ESL, AN’s largest shareholder, could increase its position or reduce the speed of its exit if performance in ESL’s other key position, Sears, materially improves.  Industry Multiples Represent New Normal: While industry multiples are trading at historically tight spreads to the market, this could be the result of changing shareholder opinions, namely “The Great Rotation” to equity markets. CONCLUSION Unprecedented new car sales growth in the years following the 2008-2009 recession is the exception not the trend for future industry growth. This rate of growth is unsustainable and should eventually revert back to historical norms, which we believe is currently leading to unrealistic, lofty valuations. As margins begin to compress in the new and used car segments, in the future valuations should come back in line with historical norms. The same is true for parts and service segment growth, which has been assigned artificially high growth rates as a result of unsustainable new vehicle sales forecasts. The long held premium AutoNation has enjoyed to its peer group is no longer justified. AutoNation’s margins across the board fall in the middle of the pack and it no longer has the support of a key shareholder. It should be able to maintain a thin premium to peers as a result of its recent internet rebranding initiatives as well as scale benefits. Our price target of $42.25, which implies a (13.3%) downside, maintains AutoNation’s premium on a relative value basis.

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CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 1: Auto Retailer Industry Overview

Porter’s Five Forces

Threat of New Market Entrants: Low It is inexpensive to operate a private dealership. However, areas with established dealers are unlikely to see increased inter- brand competition. OEM’s prefer to avoid price wars and want to enter new markets.

Supplier Power: Competitive Rivalry: Buyer Power: Medium Medium Medium Change from manufacturer push The industry is highly fragmented. The internet has firmly placed the model should shift some of the Individual dealerships compete on front-end portion of the business downside risk back to dealers who service and location. However, in the hand of consumers. used to receive incentives to large metropolitan area often have However, customers are still very continually take on more multiple dealerships within the likely to return to dealers for more inventory. same franchise. profitable warranty work.

Threat of Substitutes: Medium Improved car quality/design and increased selection from both domestic and import manufacturers. Still, the main driver is P&S revenue. Only franchised dealers can perform warranty work.

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CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 2: Revenue Analysis

2012 Industry Revenue Attribution Brand AN ABG GPI LAD PAG SAH Peer Average AN Rank Domestic 31.7% 18.6% 19.1% 54.8% 4.0% 14.5% 22.2% 2 Import 39.5% 62.9% 42.4% 31.3% 28.0% 33.5% 39.6% 3 Luxury 28.8% 18.6% 38.5% 13.9% 68.0% 52.0% 38.2% 4 Geography AN ABG GPI LAD PAG SAH Peer Average AN Rank Northeast 0.0% 0.0% 15.2% 0.0% 5.8% 0.0% 4.2% 6 Mid-Atlantic 2.0% 7.9% 5.8% 0.0% 8.4% 5.7% 5.6% 5 Southeast 34.0% 74.2% 12.3% 0.0% 7.6% 27.2% 24.2% 2 Southwest 26.0% 6.7% 44.5% 27.0% 9.3% 28.7% 23.2% 4 West 33.0% 0.0% 14.6% 65.0% 9.9% 33.6% 24.6% 3 Mid-West 5.0% 11.2% 1.4% 8.0% 4.9% 4.8% 6.1% 3 International 0.0% 0.0% 6.2% 0.0% 54.1% 0.0% 12.1% 6 Sunbelt 93.0% 80.9% 71.4% 92.0% 26.7% 89.5% 72.1% 1 Segment AN ABG GPI LAD PAG SAH Peer Average AN Rank New Vehicle 56.8% 56.2% 57.4% 55.7% 51.5% 56.4% 55.4% 2 Used Vehicle 23.7% 28.0% 27.4% 29.3% 28.5% 26.7% 28.0% 6 Parts and Service 15.3% 12.2% 11.8% 10.5% 11.0% 13.9% 11.9% 1 Finance and Insurance, net 3.6% 3.6% 3.5% 3.4% 2.5% 3.0% 3.2% 1 Other 0.5% 0.0% 0.0% 1.1% 6.6% 0.0% 1.5% 3

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CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 3: Comparable Company Overview

P/E EV/Sales EV/EBIT EV/EBITDA EBITDA/Interest Expense Debt/EBITDA Credit Risk Company Name 2012 LTM 2013E 2014E 2012 LTM 2013E 2014E 2012 LTM 2013E 2014E 2012 LTM 2013E 2014E 2012 LTM 2012 LTM Moody's S&P Altman Z-Score PENSKE AUTOMOTIVE GROUP INC 22.0x 17.5x 16.6x 14.4x 0.39x 0.36x 0.35x 0.32x 14.0x 12.1x 12.1x 10.3x 12.2x 10.0x 10.5x 9.5x 4.9x 5.7x 2.5x 2.1x Ba3 BB- 4.14 GROUP 1 AUTOMOTIVE INC 16.9x 15.5x 13.1x 11.5x 0.30x 0.27x 0.26x 0.24x 9.6x 8.5x 8.4x 7.4x 8.5x 7.6x 7.5x 6.8x 8.5x 7.7x 2.2x 1.9x Ba2 BB+ 4.79 SONIC AUTOMOTIVE INC-CLASS A 10.9x 11.6x 9.4x 8.5x 0.21x 0.20x 0.19x 0.18x 7.2x 7.2x 7.3x 6.7x 6.0x 5.9x 6.0x 5.5x 3.6x 4.5x 2.6x 2.6x B1 BB 4.41 ASBURY AUTOMOTIVE GROUP 19.7x 15.4x 14.9x 13.6x 0.46x 0.41x 0.40x 0.38x 11.5x 9.9x 9.4x 8.6x 10.2x 8.9x 8.5x 7.8x 12.6x 4.4x 2.5x 2.2x Ba3 BB 4.31 LITHIA MOTORS INC-CL A 19.8x 16.2x 15.5x 13.7x 0.54x 0.46x 0.44x 0.40x 11.9x 10.2x 9.7x 8.6x 10.7x 9.2x 8.8x 7.7x 7.4x 9.1x 1.4x 1.2x N/A N/A 4.57 AUTONATION INC 19.5x 17.7x 17.1x 15.3x 0.51x 0.46x 0.45x 0.43x 12.2x 11.3x 11.0x 10.1x 10.8x 10.0x 9.7x 9.1x 5.6x 5.7x 2.5x 2.3x Baa3 BBB- 4.56 Mean 17.9x 15.2x 13.9x 12.3x 0.38x 0.34x 0.33x 0.30x 10.8x 9.6x 9.4x 8.3x 9.5x 8.3x 8.2x 7.4x 7.4x 6.3x 2.2x 2.0x 4.44 Median 19.7x 15.5x 14.9x 13.6x 0.39x 0.36x 0.35x 0.32x 11.5x 9.9x 9.4x 8.6x 10.2x 8.9x 8.5x 7.7x 7.4x 5.7x 2.5x 2.1x 4.41

25th Percentile 16.9x 15.4x 13.1x 11.5x 0.30x 0.27x 0.26x 0.24x 9.6x 8.5x 8.4x 7.4x 8.5x 7.6x 7.5x 6.8x 4.9x 4.5x 2.2x 1.9x 4.31 75th Percentile 19.8x 16.2x 15.5x 13.7x 0.46x 0.41x 0.40x 0.38x 11.9x 10.2x 9.7x 8.6x 10.7x 9.2x 8.8x 7.8x 8.5x 7.7x 2.5x 2.2x 4.57

UNIVERSITY OF FLORIDA - PAGE 13

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 4: Comparable Company Key Metrics

Key Industry Metrics Autonation Peer Group Average Peer Group Rank Profitability 2010 2011 2012 LTM 2010 2011 2012 LTM 2010 2011 2012 LTM New Vehicle Margin 6.8% 7.3% 6.5% 6.1% 7.1% 7.1% 6.7% 6.4% 3 3 3 3 Used Vehicle Margin 8.6% 8.1% 8.1% 7.9% 8.7% 8.5% 8.3% 8.3% 2 3 2 2 Parts and Service Margin 43.6% 42.3% 42.0% 42.5% 52.7% 52.6% 53.2% 53.8% 6 6 6 6 SG&A % of Gross Profit 73.0% 71.6% 70.4% 70.4% 79.1% 76.4% 74.8% 73.9% 1 2 2 3 Compensation 47.6% 46.5% 46.8% 46.5% 46.7% 46.0% 45.2% 44.8% 5 4 6 6 Advertising 5.9% 5.7% 5.5% 6.2% 4.8% 4.4% 4.5% 4.5% 5 6 5 5 Overhead 19.5% 19.4% 18.2% 17.8% 27.5% 25.9% 25.0% 24.6% 1 2 1 2 Rent Expense 2.6% 2.3% 1.9% N.Av 7.1% 6.3% 5.8% N.Av 1 1 1 N.Av Overhead ex. Rent 16.9% 17.1% 16.2% N.Av 20.4% 19.6% 19.3% N.Av 1 2 2 N.Av Size New Car Market Share - Units 1.66% 1.66% 1.76% N.Av 0.71% 0.71% 0.76% N.Av 1 1 1 N.Av Used Car Market Share - Units 0.89% 1.10% 1.06% N.Av 0.37% 0.49% 0.51% N.Av 1 1 1 N.Av Number of Franchises 242 258 265 267 150 151 156 163 2 2 2 2 Balance Sheet Veh. Floorplan Payable - Trade % of Assets 23.1% 22.0% 24.5% 24.9% 16.1% 12.5% 12.2% 12.4% 2 1 2 2 Veh. Floorplan Payable - Non-Trade % of Assets 8.1% 8.7% 10.7% 10.3% 15.4% 20.5% 25.8% 24.5% 5 6 6 6 Veh. Floorplan Payable - Trade % of Inventory 73.9% 75.3% 73.7% 73.4% 42.6% 34.1% 30.9% 30.8% 1 1 1 1 Veh. Floorplan Payable - Non-Trade % of Inventory 26.1% 29.7% 32.3% 30.5% 40.7% 55.3% 61.6% 57.3% 5 6 6 6 FP Int Exp / Floorplan Financing 2.28% 2.25% 1.79% 1.99% 3.04% 2.47% 2.09% 2.20% 2 4 2 3 FP Int Exp / Inventory 2.28% 2.36% 1.90% 2.07% 2.54% 2.22% 1.95% 1.99% 4 5 4 5 FP Assistance / Inventory 2.98% 3.38% 3.07% 3.44% 2.69% 2.90% 2.71% 2.76% 3 2 2 2 Benefit / Inventory 0.70% 1.02% 1.17% 1.37% 0.14% 0.68% 0.76% 0.78% 2 2 2 2 Capex % of Sales 1.21% 1.08% 1.02% 0.95% 0.91% 1.19% 1.29% 1.31% 3 4 6 6 Cash Conversion Cycle Days Sales Outstanding 13.5 15.5 16.3 12.7 14.2 15.0 15.6 12.9 4 4 5 4 Days Inventory Held 65.9 57.3 66.4 63.1 67.7 62.2 70.0 68.7 5 3 4 3 New Vehicles 86.9 73.4 84.9 79.9 84.0 74.6 86.5 80.6 5 5 5 5 Used Vehicles 34.8 32.4 34.1 34.5 40.8 40.8 40.4 45.9 3 2 3 3 Parts and Service and other 33.9 34.7 36.8 35.9 66.4 66.9 70.1 76.6 1 1 1 1 Days Payable 71.7 66.5 76.9 71.5 64.5 64.0 73.9 70.1 2 2 3 3 Vehicle floorplan payable - trade 48.7 43.1 48.9 46.3 27.7 20.4 19.8 20.3 1 1 1 2 Vehicle floorplan payable - non-trade 17.2 17.0 21.4 19.2 27.4 34.0 44.3 40.0 5 6 6 6 Accounts payable 5.8 6.4 6.5 5.9 9.5 9.7 9.9 9.7 4 4 4 4 Cash Conversion Days 7.8 6.3 5.8 4.4 17.4 13.1 11.7 11.5 2 3 2 2

UNIVERSITY OF FLORIDA - PAGE 14

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 5: Football Field Valuation

Summary Football Field

DCF BULL

DCF BASE

DCF BEAR

EV/EBITDA

EV/EBIT

P/E

$25 $35 $45 $55 $65 Price Per Share

UNIVERSITY OF FLORIDA - PAGE 15

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 6: WACC Analysis

Discount Rate Calculation - Assumptions Nominal Risk-Free Rate: 3.61% Equity Risk Premium: 4.96% Market Value of Debt $1,930 Pre-Tax Cost of Debt: 4.04% Debt/Equity 31.89% Most Recent Coupon: 5.50%

Comparable Companies - Unlevered Beta Calculation Levered Equity Unlevered Name Beta Debt Value Tax Rate Beta PENSKE AUTOMOTIVE GROUP INC 1.58 $ 1,061 $ 4,110 35.0% 1.35 GROUP 1 AUTOMOTIVE INC 1.38 $ 587 $ 1,622 35.0% 1.12 SONIC AUTOMOTIVE INC-CLASS A 1.55 $ 752 $ 930 35.0% 1.02 ASBURY AUTOMOTIVE GROUP 1.59 $ 520 $ 1,606 35.0% 1.32 LITHIA MOTORS INC-CL A 1.28 $ 225 $ 1,535 35.0% 1.17 Median 1.55 1.17 Regression Beta 1.22

UNIVERSITY OF FLORIDA - PAGE 16

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 6: WACC Analysis

Auto Nation - Levered Beta & WACC Calculation Unlevered Equity Levered Beta Debt Value Tax Rate Beta Auto Nation 1.17 $1,930 $ 6,052 38.5% 1.40 With Industry Average Cap 1.17 $2,060 $ 5,922 38.5% 1.17

Cost of Equity using Bottom-Up Beta: 10.55% Cost of Equity using Regression Beta: 9.66%

Projected Capital Mix Year: 2014 2015 2016 2017 2018 % Debt: 31.9% 31.9% 31.9% 31.9% 31.9% % Equity: 68.1% 68.1% 68.1% 68.1% 68.1%

Projected Cost of Equity Year: 2014 2015 2016 2017 2018 Cost of Equity: 9.66% 9.66% 9.66% 9.66% 9.66%

Projected WACC Year: 2014 2015 2016 2017 2018 Cost of Capital: 7.37% 7.37% 7.37% 7.37% 7.37%

UNIVERSITY OF FLORIDA - PAGE 17

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 7: Unlevered Discounted Cash Flow Analysis

Auto Nation - Cash Flow Projections Auto Nation - DCF - Terminal Growth Method 2014 2015 2016 2017 2018

Revenue: $17,608 $18,195 $18,824 $19,469 $20,130 EBITDA: 790.2 824.3 871.7 920.7 971.3 Operating Income: 696.0 724.5 766.2 809.3 853.7

Effective Tax Rate: 38.50% 38.50% 38.50% 38.50% 38.50% Less: Taxes ($268) ($279) ($295) ($312) ($329)

Plus: Depreciation and Amortization $100 $105 $111 $118 $124 Less: Increase in Working Capital: ($34) ($11) ($11) ($12) ($13) Less: Capital Expenditures ($182) ($188) ($195) ($201) ($208)

Unlevered Free Cash Flow $312 $352 $377 $402 $428 Present Value of Free Cash Flow $301 $316 $315 $313 $311

Weighted Average Cost of Capital 7.37% 7.37% 7.37% 7.37% 7.37% Normal Discount Period: 1.000 2.000 3.000 4.000 5.000 Mid-Year Discount: 0.500 1.500 2.500 3.500 4.500 Discount Factor 0.965 0.899 0.837 0.780 0.726

Free Cash Flow Growth Rate: 13.0% 6.9% 6.7% 6.5% 8.3%

UNIVERSITY OF FLORIDA - PAGE 18

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 7: Unlevered Discounted Cash Flow Analysis

Auto Nation - DCF - Terminal Growth Method Auto Nation - DCF - Exit Multiples Method

Half-Year Convention? Yes Half-Year Convention? Yes WACC: 7.37% WACC: 7.37%

Perpetuity Growth Rate: 2.00% Terminal EBITDA Multiple: 9.0 x Implied EBITDA Multiple: 9.0 x Implied Perpetuity Growth Rate: 2.19% Terminal Value: $ 8,124 Terminal Value: $ 8,741

PV of Terminal Value: $5,898 PV of Terminal Value: $6,347 Sum of PV of Cash Flows: $1,556 Sum of PV of Cash Flows: $1,556 Sum of PV of NOLs: $0 Sum of PV of NOLs: $0 Enterprise Value: $7,454 Enterprise Value: $7,903

Terminal Value % EV: 79.1% Terminal Value % EV: 80.3%

Enterprise Value: $7,454 Enterprise Value: $7,903 Balance Sheet Adjustment: ($1,788) Balance Sheet Adjustment: ($1,788) Implied Equity Value: $5,666 Implied Equity Value: $6,115

Implied Price Per Share: $ 45.88 Implied Price Per Share: $ 49.51

Implied Upside -6.4% Implied Upside 1.0%

UNIVERSITY OF FLORIDA - PAGE 19

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 8: Unlevered Discounted Cash Flow Sensitivity

Auto Nation - Share Price Sensitivity - Terminal EBITDA Multiples Discount Rate $ 49.51 6.6% 6.9% 7.1% 7.4% 7.6% 7.9% 8.1% 7.5 x $ 42.40 $ 41.91 $ 41.42 $ 40.94 $ 40.47 $ 40.01 $ 39.55 8.0 x $ 45.34 $ 44.82 $ 44.31 $ 43.80 $ 43.30 $ 42.80 $ 42.31 8.5 x $ 48.29 $ 47.74 $ 47.19 $ 46.65 $ 46.12 $ 45.60 $ 45.08 9.0 x $ 51.24 $ 50.65 $ 50.08 $ 49.51 $ 48.95 $ 48.39 $ 47.85

Multiple 9.5 x $ 54.18 $ 53.57 $ 52.96 $ 52.36 $ 51.77 $ 51.19 $ 50.61

Terminal EBITDA Terminal 10.0 x $ 57.13 $ 56.48 $ 55.85 $ 55.22 $ 54.60 $ 53.98 $ 53.38 10.5 x $ 60.07 $ 59.40 $ 58.73 $ 58.07 $ 57.42 $ 56.78 $ 56.15 Auto Nation - Share Price Sensitivity - Terminal Growth Rates Discount Rate $ 45.88 6.6% 6.9% 7.1% 7.4% 7.6% 7.9% 8.1% 1.85% $ 53.60 $ 50.27 $ 47.25 $ 44.51 $ 42.01 $ 39.73 $ 37.63 1.90% $ 54.22 $ 50.81 $ 47.74 $ 44.96 $ 42.42 $ 40.10 $ 37.97 1.95% $ 54.84 $ 51.38 $ 48.25 $ 45.41 $ 42.83 $ 40.47 $ 38.31 2.00% $ 55.48 $ 51.95 $ 48.76 $ 45.88 $ 43.25 $ 40.86 $ 38.66 2.05% $ 56.14 $ 52.53 $ 49.29 $ 46.35 $ 43.68 $ 41.24 $ 39.01

Terminal Growth Rate Terminal 2.10% $ 56.81 $ 53.13 $ 49.82 $ 46.83 $ 44.12 $ 41.64 $ 39.37

2.15% $ 57.49 $ 53.74 $ 50.37 $ 47.32 $ 44.56 $ 42.04 $ 39.74

UNIVERSITY OF FLORIDA - PAGE 20

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 9: Levered Discounted Cash Flow Analysis

Auto Nation - Cash Flow Projections AutoNation - DCF - Terminal Growth Method 2014 2015 2016 2017 2018

Net Income: $381 $420 $447 $470 $504

Unlevered Free Cash Flow $312 $352 $377 $402 $428

Debt Cash Flows: Less: Interest Expense ($73) ($83) ($83) ($82) ($90) Plus: Interest Tax Shield $28 $32 $32 $32 $34 Plus: Debt Issuance $14 $36 $29 $516 $159 Less: Debt Repaid ($14) ($36) ($29) ($516) ($159)

FCFE $267 $301 $326 $351 $373 Present Value of Free Cash Flow $255 $262 $259 $254 $246

Levered Cost of Equity: 9.66% 9.66% 9.66% 9.66% 9.66% Normal Discount Period: 1.000 2.000 3.000 4.000 5.000 Mid-Year Discount: 0.500 1.500 2.500 3.500 4.500 Discount Factor 0.955 0.871 0.794 0.724 0.660

Free Cash Flow Growth Rate: 12.9% 8.1% 7.8% 6.2% 8.7%

UNIVERSITY OF FLORIDA - PAGE 21

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 9: Levered Discounted Cash Flow Analysis

AutoNation - DCF - Terminal Growth Method AutoNation - DCF - Exit Multiples Method

Half-Year Convention? Yes Half-Year Convention? Yes Cost of Equity: 9.66% Cost of Equity: 9.66%

Perpetuity Growth Rate: 2.00% Terminal P/E Multiple: 14.0 x Implied P/E Multiple: 10.8 x Implied Perpetuity Growth Rate: 3.91% Terminal Value: $ 4,964 Terminal Value: $ 7,052

PV of Terminal Value: $3,278 PV of Terminal Value: $4,657 Sum of PV of Cash Flows: $1,276 Sum of PV of Cash Flows: $1,276 Sum of PV of NOLs: $0 Sum of PV of NOLs: $0 Implied Equity Value: $4,554 Implied Equity Value: $5,933

Terminal Value % EV: 72.0% Terminal Value % EV: 78.5%

Implied Price Per Share: $ 36.87 Implied Price Per Share: $ 48.04

Implied Upside -24.8% Implied Upside -2.0%

UNIVERSITY OF FLORIDA - PAGE 22

CFA Institute Research Challenge – Appendix January 9, 2014 Exhibit 10: Levered Discounted Cash Flow Sensitivities

AutoNation - Share Price Sensitivity - Terminal Growth Rates Discount Rate $ 36.87 8.2% 8.7% 9.2% 9.7% 10.2% 10.7% 11.2% 1.85% $ 44.68 $ 41.48 $ 38.72 $ 36.32 $ 34.22 $ 32.37 $ 30.72 1.90% $ 44.97 $ 41.72 $ 38.93 $ 36.50 $ 34.38 $ 32.51 $ 30.85 1.95% $ 45.27 $ 41.97 $ 39.14 $ 36.69 $ 34.54 $ 32.65 $ 30.97 2.00% $ 45.57 $ 42.22 $ 39.35 $ 36.87 $ 34.70 $ 32.79 $ 31.09 2.05% $ 45.87 $ 42.48 $ 39.57 $ 37.06 $ 34.86 $ 32.93 $ 31.22

Terminal Growth Rate Terminal 2.10% $ 46.18 $ 42.74 $ 39.79 $ 37.25 $ 35.03 $ 33.07 $ 31.34 2.15% $ 46.50 $ 43.00 $ 40.02 $ 37.44 $ 35.19 $ 33.22 $ 31.47

AutoNation - Share Price Sensitivity - Terminal P/E Multiples Discount Rate $ 48.04 8.2% 8.7% 9.2% 9.7% 10.2% 10.7% 11.2% 11.0 x $ 41.98 $ 41.29 $ 40.61 $ 39.96 $ 39.32 $ 38.69 $ 38.08 12.0 x $ 44.84 $ 44.09 $ 43.36 $ 42.65 $ 41.95 $ 41.28 $ 40.62 13.0 x $ 47.71 $ 46.90 $ 46.11 $ 45.34 $ 44.59 $ 43.86 $ 43.15 14.0 x $ 50.57 $ 49.71 $ 48.86 $ 48.04 $ 47.23 $ 46.45 $ 45.68

Multiple 15.0 x $ 53.44 $ 52.51 $ 51.61 $ 50.73 $ 49.87 $ 49.03 $ 48.22

16.0 x $ 56.31 $ 55.32 $ 54.36 $ 53.42 $ 52.51 $ 51.62 $ 50.75 Terminal Net Income Terminal 17.0 x $ 59.17 $ 58.13 $ 57.11 $ 56.12 $ 55.15 $ 54.20 $ 53.28

UNIVERSITY OF FLORIDA - PAGE 23

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CFA Institute Research Challenge