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DealerTrack Looks to Expansion

June 20, 2007

NEW YORK — As chief executive of a fast-growing company that serves the automotive dealership industry, Mark O'Neil understands customers' demands for a complete package.

His company, DealerTrack, recently completed the purchase of dealer management system maker Arkona Inc. According to officials, it was a move to enter that space, broaden competition with larger rivals ADP and Reynolds and Reynolds and answer the demands of existing customers that wanted it to branch out.

Lake Success, N.Y.-based DealerTrack paid about $58.9 million for Arkona. O'Neil said his company had been evaluating the dealer management system market for about a year.

"Dealers were starting to say to us, 'You're already into desking, eContracting, etc., why not get into accounting and DMS?'," said O'Neil. "Finally, with Arkona, we reached a point where we thought we could."

Arkona currently charges dealers about $1,500 for monthly access, versus the $6,000 to $8,000 cost of competitors' software. The cost component is crucial in a market that saw average net margins of just 1.5 percent in 2006.

O'Neil said Arkona will remain at its Salt Lake City-area headquarters with management and employee teams intact. The company, which has about 100 workers, reported revenue of $14 million for its fiscal year ended March 31.

O'Neil expects it will take about six months to integrate Arkona's operations, with the deal beginning to add to earnings sometime in the fourth quarter.

Arkona currently has a little more than 800 dealers signed on to its system, a far cry from Reynolds & Reynolds and ADP, which together account for 80 percent of dealers using dealer management systems. But DealerTrack said it has received positive response on the transaction from its customers.

Deutsche Bank analyst Christopher Mammone reiterated a "Buy" rating on DealerTrack and raised his price target to $42 last week, saying the addition of Arkona has enlarged the company's market opportunities.

Cowen & Co. analyst Peter Goldmacher says DealerTrack has a "hammerlock" on the loan origination and front-office software market for auto dealers, and now with Arkona, the company can "emerge as the only provider of integrated front and back office solutions for auto dealers."

Deutsche Bank's Mammone thinks DealerTrack could nearly triple Arkona's revenue to $40 million by 2009, but did warn the deal could dampen margins near-term for the parent company.

For its part, Reynolds and Reynolds says it doesn't expect to lose a significant portion of the 10,000 dealerships it services. Company spokesman Tom Schwartz points out that dealers already have a number of DMS providers to choose from, and even software giant Microsoft Corp. plans to develop a dealer-management system for the North American market.

ADP and Reynolds & Reynolds had combined DMS software revenue of about $2 billion in the last 12 months, according to Cowen's Goldmacher, who estimates the market opportunity for DMS to be $2.5 billion in the U.S. alone. An estimated 10,000 to 15,000 independent dealers currently don't use any DMS system.

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