|Shares Out. (in M):||52||P/E||0||0|
|Market Cap (in $M):||333||P/FCF||0||0|
|Net Debt (in $M):||250||EBIT||0||0|
EZ Corp operates pawnshops and payday lending stores in the US, Mexico, and Canada. The company has fallen victim to rising and then declining gold prices and the US Government’s tougher stance on the practices of the payday lending business.
Let’s start with gold. Its price was rising and EZ Pawn was minting money: customers were willing to part with their gold trinkets at always-rising prices, pawnshops were able to lend the customers more for the same trinket, and same-store sales were rising. As gold prices declined, all these benefits were reversed and the company found itself worse off than it was before gold prices increased. Operating costs per store increased. It did not help that the old CEO, who had a retail background, decided that pawnshops should behave more like retail than lending stores. He started to deemphasize the pawn business in favor of the retail one.
A year ago that CEO was fired. The CFO was promoted to CEO but was replaced ten months later. Today EZ Corp has a brand new management team. Joe Rotunda, who ran the company from 2000 to 2010 (the glory days), is back to run the US pawnshop business, the company’s bread and butter. The company’s chairman, who led a successful turnaround of a New Zealand bank in the past, assumed the role of CEO. And the company brought in a new CFO.
In the past EZ Corp was more efficient and better-run than its nearest competitor, Cash America, but not today. Its operating costs per store, which historically were lower than Cash America’s, are now higher. Today pawnshop business is earning less than it should. Also, when Joe Rotunda took over the US pawnshop business he decided to the clear the decks and liquidate old inventory at fire-sale prices. This is why gross margins and earnings in the second quarter were very weak.
What is great about EZ Corp is that despite a lot of negative headlines, the new management doesn’t have to do anything heroic to turn around this company. If they were to sustain pawnshop sales at the current level – which should not be very difficult, considering that they are already 15% off their “golden” highs – and bring operating costs per store down to Cash America’s current level or EZ Corp’s 2012 level, then the US pawn stores alone could produce around $1.20-$1.40 of earnings per share. (That number is after interest expense, deduction of two-thirds of corporate overhead, and taxes.) Our thinking is that at 13 or 15 times earnings EZ Corp’s US pawnshop business alone is worth $16-21 per share.
The current management team is properly incentivized to succeed. In fact we could argue they are overincentivized – they get paid extremely well if they succeed. Pawnshops are not structurally broken, and it’s not a rocket-science business. In addition, Philip Cohen, who owns 7% of the company through super-voting class B shares, is on our side, at least now.
Philip Cohen was the investment banker who took this company public in the late ’80s. Until last year his behavior more resembled that of a blood-sucking parasite, as the company was paying him $7 million a year and getting nothing in return. Last year that sweet deal was canceled. Today the only way for Mr. Cohen to make money on EZ Corp is for the stock to go up; therefore hewas instrumental in shaking up the management team.
We view the pawnshop business as we regard cockroaches or Twinkies – it is always going to be around. The new management is using a plain-vanilla turnaround playbook – cut costs, improve customer service, focus..
We don’t know what EZ Corp’s payday loan business will look like in future. It has been under pressure from the CFPB (Consumer Financial Protection Bureau) lately. The CFPB is taking a stand that it is the underwriter’s sole responsibility to determine if a borrower can pay off a loan. It is easy to criticize payday lenders for high fees and interest rates, but it is important to understand that payday lenders provide a very important service to underbanked consumers, a service that banks are unable and unwilling to provide. We think regulators understand this and don’t want payday lenders to disappear.
More stringent regulations may drive mom and pop pay lenders out of business, and though such regulations would reduce margins for EZ Corp and whatever competitors remain standing, they would likely result in higher volumes. We believe the payday lending business is worth somewhere between -$1 and $3 a share. If CFPB makes the payday lending business too unbearable and EZ Corp decides to get out of this business, we estimate lease cancellations may cost EZ Corp about $1 per share. Today payday lending is earning about $0.30 a share; at 10 times earnings it is worth about $3 a share.
EZ Corp has two businesses in Mexico: it owns 279 pawnshops, and it is the majority owner of CreditAmigo, a smarter version of a payday loan business. CreditAmigo has contracts with government agencies in Mexico. It allows government employees to take out a loan up to three years against their future paychecks. Defaults in this business are relatively small, since principal and interest payments are taken directly from the customer’s paycheck.
In early May, EZ Corp announced that it will have to restate earnings in its CreditAmigo business and thus will not file financial statements until it completes restatements. In late 2014 the company changed auditors and the new auditor found that the company’s accounting of loan sales to outside investors, though appropriate based on Mexico’s GAAP, goes against the US GAAP. Any time we hear about an accounting irregularity our first emotion is to run for the door. In this case, though, the problem was isolated to a very specific issue in Mexico.
We value the Mexican business somewhere between zero and a few dollars a share. Any significant problems in this business will likely subtract from future upside but are not instrumental to making money on EZ Corp stock. Also, the Mexican business has about $250 million of debt, but it has no recourse to EZ Corp. If EZ Corp were going to walk away from its Mexican subsidiary, that $250 million liability would stay with the subsidiary.
Negative headlines that its Mexican business is generating today should have no impact on EZ Corp’s core businesses in the US. People who are pawning their bracelets in El Paso, Texas, don’t care if CreditAmigo’s accounting for sale of loans in Mexico is on par with the US GAAP. In other words, headlines that have driven the stock down lately have only impacted a very small segment of EZ Corp’s business, a segment that is not consequential to EZ Corp’s success.
Finally, EZ Corp owns a third of Australian payday loan chain called Cash Converters. Cash Converters is a public company. EZ Corp’s stake in it is worth about $100 million, which completely offsets EZ Corp’s corporate debt. EZ Corp is worth somewhere around $15 and $25. More importantly, the downside (i.e., permanent loss of capital) at our purchase price … well, we don’t see any.
company not dying