ALLIANCE DATA SYSTEMS CORP ADS
December 27, 2017 - 4:27pm EST by
thistle933
2017 2018
Price: 250.00 EPS 17 25
Shares Out. (in M): 56 P/E 15 10
Market Cap (in $M): 13,900 P/FCF 0 0
Net Debt (in $M): 6,143 EBIT 1,700 2,100
TEV ($): 20,043 TEV/EBIT 11.8 9.5

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Description

Alliance Data Systems

 

Thesis

·         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)

·         Summary

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

·         Penetration

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

Risks

·         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

Valuation

·         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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Catalyst

Large activist shareholder could spin/sell LoyaltyOne and Epsilon segments

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    Description

    Alliance Data Systems

     

    Thesis

    ·         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)

    ·         Summary

    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

    ·         Penetration

    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

    Risks

    ·         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

    Valuation

    ·         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

     

     

    DISCLAIMER: Reports that may provide investment ideas and/or provide information regarding investments is available for informational purposes only. The information, research, and opinions contained in our report may have been obtained or derived from sources believed to be reliable, but we cannot guarantee its accuracy, timeliness and completeness nor the opinions based thereon. You should not rely solely upon the research herein for purposes of transacting securities or other investments, and you are encouraged to conduct your own research and due diligence, and to seek the advice of a qualified securities professional before you make any investment. None of the information contained in our report constitutes, or is intended to constitute a recommendation by us of any particular security or trading strategy or a determination by us that any security or trading strategy is suitable for any specific person. None of the information contained in this report constitutes a solicitation, offer, opinion, or recommendation by our Firm to buy or sell any security, futures, options or other financial instruments or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment; and  the information provided on this site is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. Trading in any security can result in immediate and substantial losses of the money invested. The information on this web site is not intended for persons who reside in jurisdictions where providing such information would violate the laws or regulations of such jurisdiction. To the fullest extent permissible pursuant to applicable law, our Firm, its officers, directors, employees, subsidiaries, affiliates, suppliers, advertisers, and agents disclaim all warranties, express, implied or statutory, including, but not limited to, implied warranties of title, non-infringement, merchantability, and fitness for a particular purpose or use, and all warranties relating to the adequacy, accuracy, timeliness or completeness of any information available through the Site. Decisions based on information contained on this Website are the sole responsibility of the visitor. Before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. All content on this Website is presented only as of the date published or indicated, and may be superseded by subsequent market events or for other reasons. The views expressed herein are subject to change without notice at any time and the author and its affiliates may trade in any manner in the company’s securities, whether consistent or inconsistent with the information provided herein, as they deem appropriate. Past performance of a security is neither indicative nor a guarantee of future results of such security. There can be no assurance that an investment in any company will be profitable or that the assumptions regarding future events and situations will materialize or prove correct. The author or affiliated funds may presently have a position in securities of this issuer and may trade in and out of these positions without notice.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Large activist shareholder could spin/sell LoyaltyOne and Epsilon segments

    Messages


    SubjectUpdate?
    Entry05/03/2018 02:51 PM
    Memberstraw1023

    thistle,

    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.

     


    SubjectRe: Bull case?
    Entry05/18/2018 10:36 AM
    Memberthistle933

    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.

    https://www.federalreserve.gov/publications/files/ccprofit2017.pdf

    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:

    https://files.consumerfinance.gov/f/documents/cfpb_consumer-credit-card-market-report_2017.pdf

    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)


    SubjectRe: Re: Bull case?
    Entry07/13/2018 04:48 PM
    Memberthistle933

    The other shoe just dropped...

    https://www.wsj.com/articles/walmart-in-talks-to-move-credit-card-partnership-to-capital-one-1531421740

     

     


    SubjectRe: Re: Re: Re: Bull case?
    Entry07/16/2018 08:46 AM
    Memberthistle933

    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. 


    SubjectRe: Re: Re: Re: Re: Bull case?
    Entry07/16/2018 02:23 PM
    MemberShoe

    SYF hasn't lost WMT yet, correct?


    SubjectRe: Re: Re: Re: Re: Re: Bull case?
    Entry07/16/2018 02:51 PM
    Memberthistle933

    Correct, but seems inevitable


    SubjectRe: Re: Re: Re: Re: Re: Re: Bull case?
    Entry07/16/2018 10:13 PM
    MemberShoe

    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 


    SubjectRe: June credit stats
    Entry07/27/2018 09:48 AM
    Memberthistle933

    Synchrony Lost Walmart Card Deal in Battle With Capital One

    https://www.bloomberg.com/news/articles/2018-07-26/synchrony-falls-on-report-capital-one-wins-walmart-card-business

     


    SubjectRe: Re: Re: Re: Re: Re: Re: Re: Bull case?
    Entry08/01/2018 06:09 PM
    Memberthistle933

    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

     

     

    Compensation Matters

     

     

    2017 Outstanding Synchrony Equity Awards Vesting Schedule

     

                         
    Name of Executive    Grant
    Date
       Option Awards Vesting Schedule(1)    Grant
    Date
        Stock Awards Vesting Schedule(2)

    All NEOs

       7/31/14    100% vests 2018      7/31/14     100% vests 2018
         9/17/14    20% vests 2018 and 2019      9/17/14     20% vests 2018 and 2019
         4/1/15    20% vests 2018, 2019 and 2020      4/1/15     20% vests 2018, 2019 and 2020
         4/1/16    20% vests 2018, 2019, 2020 and 2021      4/1/16     20% vests 2018, 2019, 2020 and 2021
                     4/1/16     100% vests 2018(3)
         4/1/17    20% vests 2018, 2019, 2020, 2021 and 2022      4/1/17     20% vests 2018, 2019, 2020, 2021 and 2022
                     4/1/17     100% vests 2019(4)
                     4/1/17 (5)    100% vests 2020(6)

    (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

     

                                                                                     
        Option Awards     Stock Awards  
       

     

     

       

     

     

     
                         
    Name of Executive   Option
    Grant Date
       

    Number of

    Securities

    Underlying

    Unexercised

    Options

    (Exercisable)

       

    Number of

    Securities

    Underlying

    Unexercised

    Options

    (Unexercisable)

        Option
    Exercise
    Price
        Option
    Expiration
    Date
        Stock
    Award
    Grant
    Date
        Number of
    Shares or
    Units of
    Stock That
    Have Not
    Vested
        Market Value
    of Shares
    or Units of
    Stock That
    Have Not
    Vested
    (1)
        Equity Incentive
    Plan Awards:
    Number of
    Unearned
    Shares, Units
    or Other Rights
    That Have
    Not Vested
        Equity Incentive
    Plan Awards:
    Market or
    Payout Value
    of Unearned
    Shares, Units
    or  Other Rights
    That Have
    Not Vested
    (2)
     
    Margaret Keane     7/31/14             323,218        $23.00       7/31/24       7/31/14       218,776       $8,446,941                  
          9/17/14       32,889        31,926        $24.55       9/17/24       9/17/14       21,016       $   811,428                  
          4/1/15       25,412        38,120        $30.41       4/1/25       4/1/15       28,366       $1,095,211                  
          4/1/16       23,617        94,470        $29.33       4/1/26       4/1/16       53,919       $2,081,813                  
                                                  4/1/16                       96,283        $3,717,487      
          4/1/17             166,123        $34.30       4/1/27       4/1/17       82,812       $3,197,371                  
                                                  4/1/17                       118,304        $4,567,717      
                                                  4/1/17       29,576       $1,141,929                  
    Brian Doubles     7/31/14             184,696        $23.00       7/31/24       7/31/14       125,015       $4,826,829                  
          9/17/14       5,805        11,610        $24.55       9/17/24       9/17/14       7,642       $   295,058                  
          4/1/15       8,291        12,437        $30.41       4/1/25       4/1/15       9,254       $   357,297                  
          4/1/16       5,603        22,416        $29.33       4/1/26       4/1/16       12,794       $   493,976                  
                                                  4/1/16                       21,742        $   839,459      
          4/1/17             28,449        $34.30       4/1/27       4/1/17       14,181       $   547,528                  
                                                  4/1/17                       20,259        $   782,200      
                                                  4/1/17       29,576       $1,141,929                  
    Glenn Marino     7/31/14             139,099        $23.00       7/31/24       7/31/14       94,152       $3,635,209                  
          9/17/14       13,060        8,708        $24.55       9/17/24       9/17/14       5,731       $   221,274                  
          4/1/15       7,166        10,750        $30.41       4/1/25       4/1/15       7,999       $   308,841                  
          4/1/16       4,926        19,705        $29.33       4/1/26       4/1/16       11,246       $   434,208                  
                                                  4/1/16                       20,083        $   775,405      
          4/1/17             24,919        $34.30       4/1/27       4/1/17       12,421       $   479,575                  
                                                  4/1/17                       17,745        $   685,134      
    Jonathan Mothner     7/31/14             115,435        $23.00       7/31/24       7/31/14       78,134       $3,016,754                  
          9/17/14       1,322        4,644        $24.55       9/17/24       9/17/14       3,057       $   118,031                  
          4/1/15       6,251        9,912        $30.41       4/1/25       4/1/15       7,374       $   284,710                  
          4/1/16       4,527        18,112        $29.33       4/1/26       4/1/16       10,337       $   399,112                  
                                                  4/1/16                       18,458        $   712,663      
          4/1/17             23,258        $34.30       4/1/27       4/1/17       11,594       $   447,644                  
                                                  4/1/17                       16,562        $   639,459      
    Tom Quindlen     7/31/14             174,307        $23.00       7/31/24       7/31/14       117,983       $4,555,324                  
          9/17/14       19,155        12,771        $24.55       9/17/24       9/17/14       8,407       $   324,594                  
          4/1/15       9,120        13,680        $30.41       4/1/25       4/1/15       10,180       $   393,050                  
          4/1/16       6,164        24,659        $29.33       4/1/26       4/1/16       14,074       $   543,397                  
                                                  4/1/16                       22,744        $   878,146      
          4/1/17             29,811        $34.30       4/1/27       4/1/17       14,860       $   573,745                  
                                                  4/1/17                       19,212        $   741,775      

    (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.

    https://www.sec.gov/Archives/edgar/data/1601712/000119312518107511/d512206ddef14a.htm

     


    SubjectRe: the value add of ADS's customer data
    Entry08/28/2018 01:41 PM
    Memberthistle933

    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. 


    SubjectRe: Re: the value add of ADS's customer data
    Entry08/28/2018 02:04 PM
    Memberthistle933

    Also, based on ADS increasing win rate, competitive dynamics with SYF and others, and RSA financials below, ROA and franchise value sustainable

     

    Retail Share Agreement

                         
                           
      2014 2015 2016 2017   Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18
                           
    Merchant Royalty and Other Program Expenses                      
    Comenity Capital Bank               3,975             55,909             75,640             85,033               19,715             21,216             21,920             22,182             17,973             21,155
    Comenity Bank             31,726             26,724             48,564             31,816                 9,016               9,705               9,988               3,107             11,653               8,720
    Total merchant royalty and other program expenses             35,701             82,633           124,204           116,849               28,731             30,921             31,908             25,289             29,626             29,875
    % of average receivables 0.05% 0.49% 0.54% 0.53%   0.50% 0.54% 0.55% 0.51% 0.41% 0.48%
                           
    Advertising and Marketing Expense                      
    Comenity Capital Bank             13,645             24,062             37,625             41,111                 9,006             10,178               7,759             14,168               9,027             14,113
    Comenity Bank           132,196           142,546           143,650           157,611               33,252             33,713             37,741             52,905             36,615             35,912
    Total advertising and marketing expense           145,841           166,608           181,275           198,722               42,258             43,891             45,500             67,073             45,642             50,025
    % of average receivables 1.67% 1.47% 1.29% 1.23%   1.08% 1.12% 1.14% 1.54% 1.03% 1.14%
                           
    Total Retail Share Agreement Expense           181,542           249,241           305,479           315,571               70,989             74,812             77,408             92,362             75,268             79,900
    Average receivables       8,750,100     11,364,600     14,085,800     16,185,500       15,685,400     15,739,900     15,949,800     17,366,900     17,722,400     17,570,400
    RSA % of AR 2.1% 2.2% 2.2% 1.9%   1.8% 1.9% 1.9% 2.1% 1.7% 1.8%
                           
    Source                      
    https://cdr.ffiec.gov/public/ManageFacsimiles.aspx                      
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