|Shares Out. (in M):||56||P/E||15||10|
|Market Cap (in $M):||13,900||P/FCF||0||0|
|Net Debt (in $M):||6,143||EBIT||1,700||2,100|
Alliance Data Systems
· The market doesn’t understand the franchise value and long-term earnings power of Alliance Data Systems (“ADS”)
· ADS’s primary business creates high utility loyalty programs to subscale retailers that are delivered through private label credit cards. The cards have an APR consistent with subprime lending (prime rate + 21.74%), but loans are to prime borrowers with small balances and therefore small credit losses (6%)
· Unlike other private label credit card issuers that are primarily used for off-balance sheet financing, ADS shares very little of the card economics with their retail partners due to differentiated loyalty program services, which results in high returns on assets (6%) and a franchise value
· Investors believe increases in net charge-offs are indication of declining credit quality, but we believe they reflect normalization after 2008/09 charge-offs, which accelerated default by weakest cardholders, depressing net charge-offs in recent years
· Quality of recent customers wins (Williams-Sonoma, Wayfair, Signet’s prime portfolio) and organic growth in credit balances indicates room for 10-15% earnings growth
· At the current price of $250, shares of ADS trade at 10x 2018E earnings power and it appears that no price is being paid for the significant earnings growth potential of the company
Card Services (56% of revenues and 66% of EBITDA)
o Card services business is a leading provider of tailored marketing and loyalty solutions, delivered through private label credit programs that drive more profitable relationships between ADS brand partners and their cardholders
o ADS loyalty programs have high utility as they are critical to their brand partners’ success/profitability, but are a small component of costs at approximately 60bps of retailer sales. The utility of their programs is also increasing due to competitive response to Amazon, which designs similar programs internally
o Private label credit programs allow ADS to capture customer name, address, and email, which is then augmented by SKU-level transaction data provided by retail partners and external demographic/psychographic (married, kids, etc.) data. This unique data then allows ADS to design targeted loyalty programs to individuals
o ADS manages approximately 160 private label credit programs for U.S. retailers with highly-recognized brands. Segment focuses on long tail of smaller retailers that lack the economies of scale and core competencies necessary to handle the logistics of their own database and loyalty programs. ADS allows these smaller retailers to do expensive loyalty programs that Epsilon does, but shifts the majority of the expense to the consumer through private label credit programs
o 42.5mm active accounts and 25.5mm with small revolving average balance of $625. Cardholder base consists of middle- to upper-income individuals, in particular women (approx. 93%), who use the card to access the retailer’s loyalty program and to get discounts on purchases, which has better value proposition than a general purpose card
o 70% of balances and 80% of credit sales are from retail partners’ most profitable/loyal customers that are +2 years old, therefore growth not through churning (+80% of tender share growth is from cardholders that are +3 years old). Spending from cardholders is 2-3x spending from non-cardholders
o 26% APR on balances appears high, but cardholders get approximately 5% off everyday purchases and 5-30% off during promotions, which avoids yield price discovery (regulatory scrutiny) and the net APR similar to general purpose credit card like AXP
§ ADS has a higher revolve rate of 80-85% vs 40-50% at peers. ADS also has 8-10 purchases per year vs Synchrony (“SYF”) at 2-3 purchases per year
o Also, with small balances, the consumer looks at using a private label credit card as an installment plan and a tax on purchase payment
· Industry Structure
o Card services segment operates in a consolidated industry structure where top 3 private label credit card issuers have 85% share and long-term, 5-10 year contracts with retail partners
o SYF and Citi Retail Services (which together are 70% of market) focus on large private label credit programs (Walmart, Lowe’s, etc) and do not focus on smaller merchants where ADS plays (ADS average file is $100MM). High entry barriers result in rational competitive behavior as competitors have segmented market amongst themselves
o SYF and Citi earn 2.5-3% ROA, which prevents new entry as they are not overearning and new entrants would earn less due to scale economies and discounting needed to incent retail partner switching. Large retail partners do not switch private label card issuers often (SYF has avg. relationship length of 17 years with retail partners) due to cost/disruption from integrating into new networks and issuing new cards
o ADS has competitive edge over SYF, Citi, and other players due to marketing capabilities. ADS gets SKU-level data for loyalty programs whereas large retailers do not provide this data to their private label credit card issuers (large retailers have the scale to analyze SKU data and develop loyalty programs in house or hire 3rd party marketing firm to analyze) and primarily use them for off-balance sheet financing. SYF and Citi are also limited in developing their marketing and data analytic capabilities, either organically or inorganically, due to S&L holding company and bank holding company regulations
§ This is evidenced by lower retailer share agreements (ADS retail share agreements are approximately 2% of receivables vs SYF retail share agreements at 6% of receivables) and higher ROA economics (6% for ADS vs 2.5-3% for SYF)
o ADS has a cost and scale competitive advantage over 3rd party marketing agencies as cost of loyalty programs shifted to consumer and ADS owns Epsilon, which is the #1 CRM/direct marketing agency in the U.S. and world and #1 largest agency from all disciplines according to Ad Age. In addition, the high utility of a loyalty program relative to its small cost (60bps of retailer sales) translates into contracts that are less about extracting best price from issuer than growing sales for retail partners
o ADS retail partners have high switching costs as they would lose ADS marketing analysis of their most loyal/profitable customers
§ For example, if a competitor offers a -50% reduced loyalty program cost (30bps instead of 60bps, which is equivalent to 4% RSA vs ADS 2% RSA) the retailer would increase operating profits by 3% assuming 10% average operating margin. But, if the utility of the competitor’s loyalty program is less than ADS loyalty program and results in 20% lower private label credit sales, the operating profit of the retailer would decline by -30% (assuming contribution margin of 50%)
§ This high cost of failure creates large switching costs for retailers and has resulted in 99% annual retention rate for ADS
o Due to industry structure, switching costs, and high utility product relative to cost, ADS franchise is highly defensible and sustainable
o ADS has an estimated 30% penetration of addressable market that could use their card services. The addressable market for ADS, which excludes major department stores, Amazon, and large mass chains, consists of approximately $360B sales. Approximately 33% of sales go on their cards and 50% have balances, which results in $50B balances vs ADS current $16B balances
o ADS penetration of private label credit sales is approximately 30% of existing retailer client’s sales. The company’s most mature stores have 50% penetration, which suggests continued tender share gains for ADS
· Credit Analysis
o Normalization of credit: in the aftermath of credit crisis, charge-offs were effectively pulled forward resulting in several years of sub-normalized credit losses as those who were going to default did so during the crisis
o As credit begins to normalize from historically low levels, the resulting provision building has been a headwind to ADS earnings, but this should end in 2018 as reserves reach 10 year average of 6%
o ADS believes they have a higher quality customer on average now and reserves should be sub 6% long-term
§ Federal Reserve data shows revolving credit approximately 25% less per capita in real terms than pre 2008
§ ADS has higher % of 800-plus FICOs in portfolio and 20% of average receivables are co-brand today vs 0% pre-recession
§ ADS net charges offs increased 350bps during the GFC vs 600bps for general purpose cards. Private label credit cards have singular utility and lower limits vs general purpose cards
o As of September 30, 2017, Comenity Bank’s Common Equity Tier 1 capital ratio 15.6% (vs minimum 4.5% plus a mandatory conservation buffer of 2.5%, which will be fully phased in by January 1, 2019), Tier 1 Capital Ratio 15.6% (vs min 6% plus a phased-in mandatory conservation buffer of 2.5%), total capital ratio 16.9% (vs min 8% plus a phased-in mandatory conservation buffer of 2.5%), and leverage ratio 14.4% (min 4%)
Epsilon (27% of revenues and 21% of EBITDA)
· Epsilon provides marketing services that use rich data and analytics to help clients acquire, retain and grow relationships with their customers through direct marketing
· Epsilon competes with a variety of niche providers as well as large media/digital agencies who either lack full spectrum of data-driven marketing services used for traditional/online advertising and promotional/loyalty marketing programs or the internal integration of offerings to deliver a seamless “one stop shop” solution
· For targeted direct marketing services offerings, their 25 year history of analyzing SKU-level transaction data from the largest clients in the world provides them with scale advantages that are difficult for competitors to replicate
· Epsilon has ~1,400 clients, operating primarily in the financial services, insurance, media and entertainment, automotive, consumer packaged goods, retail, travel and hospitality, pharma, and telco industries
· Ad Age ranks Epsilon the #1 CRM/direct marketing agency in the U.S. and world and #1 largest agency from all disciplines in the U.S.
LoyaltyOne (16% of revenues and 13% of EBITDA)
· Air Mile reward program is an outsourced loyalty program used by 170 sponsors including Shell Canada, Bank of Montreal, Amex Canada
· Sponsors tend to be exclusive to their market category, enabling them to realize incremental sales and increase market share as a result of their participation
· ADS uses the information gathered through loyalty programs to help clients design and implement marketing programs
· Approximately 70% of households in Canada carry the AIR MILES card
· Current and proposed legislation relating to card services segment could limit business activities, product offerings and fees charged and may have an impact on profitability. In particular, now that Comenity Bank has +$10B of assets, their prime regulator is Consumer Financial Protection Bureau
· Increases in net charge-offs, due to general economic factors, such as the rate of inflation, unemployment levels and interest rates, or other factors, could impact capital and net income
· If the company is unable to securitize their credit card receivables due to changes in the market, they may not be able to fund new credit card receivables, which could have a negative impact on their operations and profitability
· In the card services segment, the 10 largest clients represent approximately 60% of revenue with L Brands and Ascena Retail Group representing 16% and 13% of revenue, respectively. The loss of any of these clients could materially impact revenue and profitability. Contract with L Brands expires in 2019
· ADS may not be able to successfully grow its receivables portfolio due to full penetration of existing clients tender share or addressable market for its card services
· At the current price of $250, ADS trades at 10x 2018E earnings power of $25. Capital needed to grow card services business is 15% of receivables portfolio. This translates into a free cash flow yield of 8% that should grow +10% annually over the next several years due to continued organic share gains, new customer wins, and portfolio acquisitions
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Large activist shareholder could spin/sell LoyaltyOne and Epsilon segments
|Entry||05/03/2018 02:51 PM|
The stock has gotten hit hard since you wrote it up. Down over 20%.
We do not think the news flow has been horrible. Any thoughts on why the selling? Is this about the credit cycle or is this about being tied into retail?
We have been wading in here. Trading at less than 8x. Mgmt is shareholder friendly with cash flow. Lots of bad news priced in here.
Love to here updated thoughts. Thanks.
|Subject||Re: Bull case?|
|Entry||05/18/2018 10:36 AM|
Financials with franchise value are misunderstood because credit analysts don't understand equity franchise value and traditional equity investors dont understand how to analyze credit, which creates opportunity.
We think about valuing financials the same way we would any other company, which is a function of returns on capital and growth. For example, there are 2 companies that I will call Company A and Company B. Company A has returns on capital of 100% (due to sustainable competitive edge) and grows 8% per year. Company B has returns on capital of 8% (equal to cost of capital) and grows 100% per year. Which deserves the higher P/E or P/B multiple? Obviously Company A because it has a franchise value and Company B simply consumes capital that doesnt add shareholder value. How should one value company A and company B? Company B earns its cost of capital, has no franchise value, and therefore is worth its capital (all else equal) or 1x book value; new capital raised for growth that earns cost of capital doesnt increase intrinsic value per share. Company A has a franchise value and should be valued off the earnings power of the business or based on a P/E multiple (which is a shorthand way of doing a discounted cash flow valuation).
Turning back to ADS. ADS card portfolio has pre-tax returns on capital of 9% (rough math 24% NIMs, 9% opex, 6% normalized charge offs) whereas a private label credit card competitor like Synchrony financial has 4-5%, which is in line with other credit card operations (see page 6 below). Credit cards have historically been profit centers for banks as bank total pre-tax returns on capital are about 1.5% (JPMorgan). Returns on capital at banks are different than returns on capital at say an industrial company; it is more equivalent to the unlevered spread between cost of capital and return on capital for an industrial company that can then be levered. ADS card segment has after tax returns on capital of 7% and an assets/equity multiplier of 7, which generates an ROE of about 45%. Why doesn't ADS provide this math, because monopolists lie to protect their profits.
So why does ADS card portfolio have such high returns on capital? Two reasons 1) small balances and 2) loyalty programs and loyalty program competitive edge.
1) small balances: on a small balance the consumer is willing to pay a high APR because they do not think about it as a fat APR they think about it as a tax on the purhchase price or an installment plan. For example, a typical 2 week payday loan of $100 has a $15 fee. Does the consumer look at that as a 400% APR? No, they think about it as a tax or the cost of going to the movies or a night club (we wont get into the negative social consequences of this). When "Jennifer" uses her ADS J. Crew private label credit card to buy a $100 jacket, she gets 5% off so the purchase price is $95, chooses to revolve the balance over six months and pays about $2 of interest charges each month and ends up paying in total $107.
This is a good primer on general purpose and PL credit cards economics with segmentation data:
2) Loyalty programs: why is ADS card segment able to generate higher returns on capital than their competitor Synchrony, because Synchrony doesnt provide loyalty programs as part of their offering and ADS does. See my write-up for more detail on loyalty programs, but just think of these as when you go on Amazon.com and buy a book on Warren Buffett, Amazon will recommend a book on Charlie Munger or a book by Bruce Greenwald, etc. ADS does the same to their retail partners where Jennifer buys a jacket at J. Crew, and ADS has data that says other customers who bought the same jacket also bought this purse, shoes, scarf, etc. Amazon has the scale to do this in house, but smaller retailers do not, and can only afford those programs if the cost is subsidized by a high profitability private label credit card operation, both of which ADS provides as one product. When ADS buys Signet's prime portfolio at 1x book value, they generate franchise value immediate because they are also getting paid to run the loyalty program, which then allows them to earn a 9% pretax return on that portfolio. It's the same thing as "accretive M&A" and ADS value creation is indifferent between acquiring a portfolio where they run a loyalty program or they sign a new retailer like Wayfair and start from 0. For more detail on ADS competitive edge and industry structure refer back to the write-up.
So tying it all together. Banks lack franchise value due to low competitive edge, low returns on capital, and low growth and are therefore should valued off of book value. ADS has 2x returns on capital and 2x growth as Synchrony (and multiples more than JPM), has franchise value due to competitive edge, and should therefore be valued off of earnings power. We think the right multiple for the card segment is probably 16x. What multiple would you pay for a somewhat cyclical business with 45% ROE growing 10% per year? Not 2x book or 4.5x earnings...
In terms of SOTP, we think there's a good probability that ADS card segment gets sold to SYF, who is looking to develop their own loyalty programs to create stickier customer relationships, which would probably be at 15-18x segment earnings. Epsilon gets sold to Adobe at multiples similar to other ad tech multiples (which are quite high), and Loyalty gets sold to PE or spun off. We think its a $400-500 stock in a few years, even if Ascena retail goes into Chapter 11 (although it prob wont go to Chapter 7)
|Subject||Re: Re: Bull case?|
|Entry||07/13/2018 04:48 PM|
The other shoe just dropped...
|Subject||Re: Re: Re: Re: Bull case?|
|Entry||07/16/2018 08:46 AM|
Or SYF is not catching up with ADS marketing and data analytics capabilities as they claim (hence why they lost WMT; although WMT file too big for ADS to bid on) and either SYF buys ADS to fill the WMT hole they just lost or ADS chooses not to be bought because they can continue to disrupt and win share from larger issuers.
In terms of issuer competition, I suggest you look at the economics of NY&Co program in their 10k, which is a larger than average (somewhere around $300MM portfolio probably) ADS PLCC program that they re-signed at what we estimate to be a 9-10% pretax ROA. Issuers like Citi, COF, SYF, WF aren't interested in files below $500MM b/c too small to move the needle for them and they lack ADS marketing and data analytics capabilities to compete (ie grow retailer sales the way ADS can), which results in ADS having sustainable and increasing competitive edge/franchise value.
ADS might give some economics to Victoria's Secret (L Brands), but if they re-sign at a -5% lower ROA (conservative) it would only hurt EPS by -5% so not the end of the world.
|Subject||Re: Re: Re: Re: Re: Bull case?|
|Entry||07/16/2018 02:23 PM|
SYF hasn't lost WMT yet, correct?
|Subject||Re: Re: Re: Re: Re: Re: Bull case?|
|Entry||07/16/2018 02:51 PM|
Correct, but seems inevitable
|Subject||Re: Re: Re: Re: Re: Re: Re: Bull case?|
|Entry||07/16/2018 10:13 PM|
Inevitable because...? I get the others have lower costs of capital, but SYF probably would do near anything not to lost WMT. And besides, it's a big pain to switch credit card providers
|Subject||Re: June credit stats|
|Entry||07/27/2018 09:48 AM|
Synchrony Lost Walmart Card Deal in Battle With Capital One
|Subject||Re: Re: Re: Re: Re: Re: Re: Re: Bull case?|
|Entry||08/01/2018 06:09 PM|
Why WMT bailed, among other reasons...
From Synchrony 2017 proxy. So for CEO Margaret Keane, her $8,446,941 of stock that hadn’t vested from IPO “founders’ equity grants” from 7/31/14, 100% vested in July 2018.
Same July 2018 vesting for Brian Doubles (CFO), Glenn Marino (CEO-payment solutions), Jonathan Mothner (evp and general counsel), and Tom Quindlen (CEO-retail card). Page 47 of proxy also shows change in control payments.
Doesn’t appear to be much incentive for Synchrony senior management to stick around, remain a public company, or try to compete against ADS
2017 Outstanding Synchrony Equity Awards Vesting Schedule
(1) This column shows the vesting schedule of unexercisable or unearned options reported in the “Number of Securities Underlying Unexercised Options (Unexercisable)” column of the “—2017 Outstanding Synchrony Equity Awards at Fiscal Year-End Table.” The stock options vest on the anniversary of the grant date in the years shown in the table above.
(2) This column shows the vesting schedule of unvested RSUs reported in the “Number of Shares or Units of Stock That Have Not Vested” column and unvested PSUs reported in the “Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested” column of the “—2017 Outstanding Synchrony Equity Awards at Fiscal Year-End Table.” The RSUs vest on the anniversary of the grant date in the years shown in the table above.
(3) PSUs granted in 2016 vest, to the extent earned, on December 31, 2018.
(4) PSUs granted in 2017 vest, to the extent earned, on December 31, 2019.
(5) This grant applies to Ms. Keane and Mr. Doubles only.
(6) RSUs granted to Ms. Keane and Mr. Doubles in 2017 vest on April 1, 2020.
2017 Outstanding Synchrony Equity Awards at Fiscal Year-End
The following table provides information on the current holdings of Synchrony common stock and Synchrony equity awards by the NEOs. This table includes unexercised (both vested and unvested) option grants and unvested RSUs with vesting conditions that were not satisfied as of December 31, 2017. Each equity grant is shown separately for each NEO. The vesting schedule for each outstanding award is shown following this table.
2017 Outstanding Synchrony Equity Awards at Fiscal Year-End Table
(1) The market value of the stock awards represents the product of the closing price of Synchrony common stock as of December 29, 2017, which was $38.61, and the number of shares underlying each such award.
(2) PSUs granted in 2017 and 2016 vest, to the extent earned, on December 31, 2019 and December 31, 2018, respectively. The market value of PSUs that have not vested as of December 31, 2017 was calculated using the closing price of Synchrony common stock as of December 29, 2017, which was $38.61, multiplied by the number of unvested units based on achieving target performance goals.
|Subject||Re: the value add of ADS's customer data|
|Entry||08/28/2018 01:41 PM|
We've spoken with customers. Typically providing a PLCC results in 20% incremental sales per cardholder vs non cardholder and without data analytics. Adding ADS data analytics theres about another 20% increase in sales per cardholder so total 40% increase in ADS cardholder vs without a card. ADS also shows this A-B testing to their existing and new customers to demonstrate the value add.
ADS is also better than competitors at driving penetration/conversion of PLCCs at retail partners. For example, ADS goes deaper into near and sub prime than SYF and others, which not only increases customer sales/profits but is also a profitable incremental credit for ADS. I would encourage anyone to also touch and feel the products by going into one of ADS's retail partners like Victorias Secret and one of SYF's retail partners like GAP. Vicky's Angel Card agreement comes in a glossy pamphlet whereas GAP's is just a legal document.
In terms of examples of data analytics, one example with Vicky's is if there are 20 women on a block, ADS will know that 10 prefer black lingerie, 5 prefer pink lingerie, and the other 5 prefer red lingerie. So when Vicky's mails their catalogue, ADS will tell them to mail a catalogue with mostly black lingerie to the 10 women on the block, a pink catalogue to the 5 women, etc, which drives incremental sales.
|Subject||Re: Re: the value add of ADS's customer data|
|Entry||08/28/2018 02:04 PM|
Also, based on ADS increasing win rate, competitive dynamics with SYF and others, and RSA financials below, ROA and franchise value sustainable