Description

A day late and a dollar short on posting this, plenty of downside left however…

Enova International was last written up on VIC in Feb 2016.  It was a well written and well thought out thesis in my opinion, but at the time the stock was trading relatively cheap on an earnings (approx 5x) and book (1.0x) basis.

What has changed the most is that ENVA now trades at a substantial premium to book value (1.9x) inclusive of $267MM of balance sheet Goodwill which represents more than 100% of Q1 2017 book equity of $258MM; and a 15x trailing / 12.3x forward earnings multiple.

ENVA is a essentially a payday lender masquerading as fintech.  The first two sentences of the company’s 2016 10-K read as follows: “We are a leading technology and analytics company focused on providing online financial services” followed by “In 2016, we extended approximately $2.1 billion in credit to borrowers.”

Enova is a short because 1) there are early signs of credit deterioration in the company’s loan portfolio [while the company has levered up and grabbed market share/customers from competitors who have pulled back due to losses], 2) valuation – it trades at 2x P/B for a lending company, 3) mgmt keeps telling investors to value the company on an EBITDA basis and keeps showing EBITDA growth, which makes no sense given Interest is a key operating cost in lending operations and after adjusting for interest (and actual raw material cost for a lending operation) and looking at EBITDA less GAAP Interest, there is no gain in profitability over a 4 year period but rather declines, 4) mgmt. is obsessed with quarterly numbers at the cost of long-term results (points 3 & 4 are because management’s short-term comp is determined entirely by EBITDA), and 5) the company has grabbed market share from peers who have exited or pulled back due to losses.

1. Albeit not of blow-up-tomorrow proportions, several things indicate the beginning of credit deterioration that a lender would experience when it grows loans rapidly.  

·         ENVA has seen a gradual decline in loans that are actually repaid in cash, both relative to originations and in absolute terms.

·         Renewals (kicking the can down the road in terms of repaying principal), have grown from 13% to 15% of originations for YE 2014 to YE 2016.  The company will tell you that these are lower risk because that have a history of payment patterns for that customer.  As long as the finance charges associated with the renewal/extension are paid, these loans are fully confirming and not delinquent.  In fact, if the loan is renewed or extended and the finance charge associated with that renewal is not paid, ONLY the finance charge is accounted for as a delinquency (2016 10-K p. 51).  Renewals do indeed count as a new loan origination.

·         Loan loss provisions are expensed through Cost of Revenues.  This cost of revenue item has grown by 650 bps from 12% in 2014 to 18.5% in Q1 2017.

·         However, despite taking larger loan loss provisions, ENVA’s recoveries represent a shrinking figure relative to gross charge-offs and delinquencies.

2. Shares on ENVA over the past 1.5 years have seen their value increase from 0.8x book to 2x book.

·         Book value on the balance sheet, at $258MM, is less than Goodwill at $267MM.  The rest of the company’s $985MM in assets is largely loans and other finance receivables, and approx. $100MM in cash.

3. Mgmt’s focused on EBITDA is absurd.  

·         As a lending operation, it makes no sense to talk about profitability above the interest expense line.  After deducting interest, the company has experienced profit erosion.  We can blame UK reg changes and speculate about coming US reg changes, but those are some of the inherent risks in generating payday style loans.

·         Moreover, the company’s proxy shows that management’s short-term variable comp is driven by some qualitative factors but only one quantitative factor: EBITDA.

Proxy filed April 2017, page 23

Page 28:

“Our 2016 STI performance measures and goals were based on our earnings before interest, income taxes, depreciation and amortization expenses (EBITDA), which is a non-GAAP financial measure (2016 STI EBITDA), and had the following requirements in order for potential STI awards to be earned and paid pursuant to the Senior Executive Bonus Plan:

·         Earnings Threshold: Potential STI awards began to accrue based on a formula set forth in the Senior Executive Bonus Plan’s terms and conditions once a certain earnings threshold established for the 2016 STI EBITDA (the Earnings Threshold) was exceeded. The Earnings Threshold for the 2016 STI plan was $97.5 million.

·         Earnings Target: If a certain earnings target for the 2016 STI EBITDA was achieved, then the named executive officer was eligible to receive a cash payment equal to 100% of his Target Award (the Earnings Target). If the Earnings Target was exceeded, each named executive officer was eligible to receive a cash payment in excess of his Target Award calculated in accordance with the Senior Executive Bonus Plan’s terms and conditions. The Earnings Target for the 2016 Senior Executive Bonus Plan was $130.0 million.”

4. Management’s attention to quarterly/near-term profitability is troubling.

·         Q4 2016, CEO Fisher: During Q3, we made the decision to maintain strong short-term profitability in the face of heavy demand from new customers. As we've discussed in the past, rapid growth in originations especially originations in new customers typically will result and lower near-term profitability from a GAAP perspective as we incur upfront marketing expenses as well as higher levels of loan loss provisions.

[Note that over the past 3 years we have NOT seen “rapid” growth in originations, and so declining profitability can’t be blamed on growth or new loans with customers without payment history and therefore excessive provisions.]

·         Q3 2016, CEO Fisher: And rapid growth in originations, especially originations in new customers can impact near-term profitability from a GAAP perspective as we incur upfront marketing expenses as well as higher levels of loan loss provisions. Steve will discuss this in more detail in a few minutes. But in Q3, we made the decision to moderate growth to maintain strong profitability for the quarter.

[Yes, they are managing to the quarter apparently.]

5. ENVA is dabbling in the same lending industry with the same customer base where others have experienced awful results recently.

Q4 2016 Earnings call, CEO Fisher:

·         “while we are aware that some of our competitors have seen pressure on their credit performance over the last 12 months, we have not.”

·         “A number of our competitors have either ceased funding or completely shut down over the past several months.”

·         “From the intelligence we were able to gather, this is largely due to credit issues and their portfolios.”

·         “We spent our time learning and developing the product, improving our underwriting models and building a portfolio that hasn’t blown ourselves unlike what we're seeing out there in the marketplace or number of our competitors’ portfolios have blown them so, them up because they were, they moved too quickly.”

Q1 2017 Earnings Call, CEO Fisher

·         “we are taking advantage of opportunities to gain further share, as others pull back in the face of credit concern and liquidity issues.”

[Is ENVA’s credit approval algorithms, which approve in minutes, really that much superior to everyone else’s to the point of them experiencing entirely different results over the longer term while dabbling in the same customer base?]

Valuation:

ENVA should trade at a modest premium to book, like any other flat to moderate growth lender.  Auto delinquencies are on the rise – people default on a payday loan before their vehicle loan. ENVA peers have seen deteriorating credit quality – the same space that ENVA has sought and grabbed market share.  The company’s fintech is not particularly different than anyone else’s, evidenced by the fact that EBITDA less Interest is not growing.  A generous 1.5x book multiple puts ENVA below $12/share.

Risks:

·         Valuation short.  Typically a no-no.

·         Company has grown book value per share substantially over past few years, continued growth.

·         Stock still trading at reasonable to cheap P/E.

·         Somebody buys them for the fin or for the tech or for both.

·         Acquired

Catalyst

Deterioration in quality of loan book

Weak profit growth or no profit growth at all