JGWPT HOLDINGS INC JGW W
November 24, 2013 - 9:30am EST by
casper719
2013 2014
Price: 14.12 EPS $2.24 $2.57
Shares Out. (in M): 28 P/E 6.3x 5.5x
Market Cap (in $M): 396 P/FCF 11.1x 9.3x
Net Debt (in $M): 418 EBIT 0 0
TEV ($): 814 TEV/EBIT 0.0x 0.0x

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Description

Thesis

JGWPT Holdings Inc. (Ticker: JGW) is worth 42% more than the current stock price or $20.08, even at a 15% P/E discount to peers, based on 7.8x 2015E EPS of $2.57. There are two near-term catalysts: a debt refinancing over the next few weeks or months and sell-side initiations in the first week of December with a grand total of 7 firms on the IPO.

Introduction

JGW, under the brands JG Wentworth and Peachtree, is the leading purchaser and ‘securitizer’ of structured settlements in the United States. JGW IPO’ed (almost unsuccessfully) on November 8th during one of the busiest IPO weeks of the year and was received poorly with pricing cut from $19-$22 to $15-$16 before finally pricing the deal at $14.00 and then trading down to the high $12s.

There are many reasons not to like the company: private equity still owns 39%, has the majority of the voting rights, and 4 board seats; the PE sponsors did a dividend recapitalization earlier this year and loaded JGW up with $425mm in covenant-lite term loans to make a $304mm cash distribution (and repay the company’s existing term loan); the company went bankrupt four short years ago, in part caused by JLL’s greed to extract $290mm in debt-funded dividends; there is no peer to compare the company to; there is no generally accepted way to value JGW (yet); and the accounting appears to be a mess.

And now for the positives: JGW has the dominant franchise (60%+ market share with the #1 and #2 brands) in the low-growth, utility-like structured settlement purchaser business, generates over 80% of the industry profits, and is the low cost provider owing to its scale and regular access to securitization markets; JGW throws off over $100mm of EBITDA per annum; the current funding arrangements are structured to avoid the causes of the 2009 bankruptcy; the business is tax efficient and generates incalculable returns on capital; insiders took down 15% of the IPO for nearly $20mm; and the accounting is relatively simple when you look deep enough.

Business Overview

JGWPT provides liquidity to clients through structured settlements (89% of revenues), lotteries (6%), pre-settlement funding (3%), and annuities (2%). David Miller (CEO) explains JGW’s business in simple terms: http://tinyurl.com/mmagg2c

                         Revenue Composition: 1H13

Source: Company reports

  • Structured Settlements (89% of revenues): JGW is the largest purchaser of structured settlement payments in the U.S. Structured settlements are contractual agreements to settle a tort claim involving physical injury or illness whereby a claimant is compensated for damages through a series of payments over time rather than by a single upfront payment. JGW purchases these payments at a discount to the aggregate face amount of the future payments in exchange for a single up-front payment. The payment streams are typically paid by highly rated insurance companies and are reviewed and approved by judges.
  • Lotteries (6% of revenues): JGW purchases all or part of the lottery receivables at a discount to the aggregate face amount of future payments in exchange for a single up-front payment to the lottery winners.
  • Annuities (2% of revenues): JGW purchase all or part of annuity payments at a discount to the aggregate face amount of future payments in exchange for a single up-front payment.
  • Pre-settlement-Funding (3% of revenues): Pre-settlement funding is a transaction with a plaintiff with a pending personal injury claim to provide liquidity while awaiting settlement. JGW is assigned an interest in the settlement proceeds of the claim and, if and when a settlement occurs, payment is made to JGW directly via the claim payment waterfall, not from the claimant.

The Brand

JGW has the two most recognizable brands with JG Wentworth and Peachtree, which have spent 5x as much on TV advertising as the nearest competitor since 2008 and have spent over 80% of the total amount spent by major market participants. Since 1995, JGW has spent ~$600mm in marketing to create its brand. Unless a company is willing to put $40mm+ into marketing (according to industry contacts), there is no chance anyone can compete with JGW. As an example, Imperial tried to market on TV and JGW put its commercials as close as it could to Imperial’s commercials and chased them out of town.

 I’m sure many of you recognize these slogans:

  • “I have a structured settlement, and I need cash now.”
  • 877-CASH-NOW
  • “We’re Peachtree People”

 Or these TV advertisements:

How it Works

A Structured Settlement occurs when a plaintiff settles a personal injury claim with a defendant in exchange for a periodic payment over time. These payment streams are primarily backed by investment-grade insurance companies and have little prepayment risk.

A customer chooses to transfer a structured settlement payment stream for 4 reasons: debt reduction, housing, automotive, and education. State laws require that transfers of structured settlement payment streams must be court approved. In my mind, this eliminates much of the regulatory risk factors that the CFPB or other potential oversight bodies could go after. If it’s good enough for a court, it is most likely best for the consumer.

JGW invests $60mm+ per annum in marketing to source structured settlements and ~half of customers are repeat customers. JGW purchases the payment streams at a high single digit to low double digit discount rate, which is the cheapest form of financing customers have (e.g. credit cards are 15-29%+). JGW pays the cash upfront to the client and immediately receives an advance from the warehouse at ~120% of cash paid to the claimant as the warehouse gives the company an advance using a lower discount rate than on the payment to the claimant. This is the beauty of the business: JGW can run its business with negative equity and net working capital given the company generates cash up front.

JGW takes the payment streams and securitizes them in one of its three securitizations per year. Since 2002, cumulative losses have been less than 0.08% on purchases of guaranteed structured settlement while the company assumes the securitizations will have 0.25% expected losses so there is upside in the future if securitizations outperform assumptions. Investors purchase these structured settlement securitizations because they are uncorrelated with most other asset classes. The securitizations are sold at a 3.5-8% discount rate historically and JGW retains a portion of the securitization as a residual on its balance sheet, which has cash flows that come in over a 25 year period. The spread between the discount rate on the purchase price and the discount rate on the securitization generates spread revenue for JGW.

Spread Revenue Illustration

Here’s an illustrative example of the spread revenue JGW generates on the purchase and a securitization of a structured settlement. JGW buys $100K of Total Receivables Balances (TRB) for $34,984 using a 10.92% discount rate. JGW receives 120% of the cash paid or $41,631 upfront from the its warehouse. JGW securitizes the structured settlement using a 4.50% discount rate and receives $56,321 in cash and pays off the warehouse. It retains a residual interest of ~$3-4K. Overall, JGW generates a ~20% spread on each dollar of TRB. Industry professionals think there is a good chance that the spread revenue remains in the high teens/low 20s over time and the company expects to be over 20% for the next few years.

Note: Discount refers to the discount rate.

Then versus Now

The Cause of the 2009 Bankruptcy:

  • The securitizations prior to the bankruptcy were club deals with 5 or fewer investors and sizes of ~$70mm. Management would call half a dozen buyers and would get the deals done quickly. As the CEO told me, “the coffee wasn’t cold by the time they called them all.” When the securitization markets froze in 2008/2009, there were no buyers even though the credit losses on the securitizations continued to be pristine.
  • The funding “platform” wasn’t truly a platform. It consisted of one warehouse facility from Deutsche Bank with $250mm of capacity.
  • The facility had variable advance rate and discount rate, which was dependent on the prior securitization.
  • The warehouse would require collateral to be mark-to-market at spread over LIBOR. When Lehman blew up, their collateral was marked at a 1,000bps spread and caused a capital drain on JGW.
  • Not having a CIO didn’t help either.

 The Bankruptcy Avoidance Plan:

  • 35+ buyers of securitizations and growing
  • $685mm of warehouse capacity and financing capacity through multiple facilities
  • Warehouse facilities with Barclays/Natixis, Deutsche Bank, and PartnerRe with $600mm of capacity, two of which are structured with fixed advance rates and no mark-to-market exposure.
  • Warehouse revolve until 2016 before entering an 18 month amortization period.
  • JGW has a chief investment officer now with Stefano Sola, whose responsibility is developing and implementing the firm’s financing and capital markets platform.

Opportunity Set

JGW has the opportunity to consolidate the market. JGW is in talks with 6 potential targets participating in existing markets. JGW estimates the price would be between $5-$75mm and its net income would increase between $5mm and $20mm. Using ‘straight math,’ this infers that the company would be paying anywhere from 1x earning to 4x earnings after stripping out 1x’ers and cost saves. Clearly, this can generate significant upside to my estimates if any of these come to fruition and are successful. JGW is currently working on opening up other opportunities including getting the regulation in place for pre-settlements and leveraging its incoming calls by brokering relationships with 3rd parties.

The weakness in the structured settlement annuity business is explained by the aftermath from the Great Financial Crisis; 2) historically low interest rates; 3) new regulatory restrictions; 4) the Executive Life of New York liquidation; and 5) the departure of several product providers including: Allstate, John Hancock, Symetra and Hartford (Source: http://tinyurl.com/moynx7n). This is both a negative and a positive for JGW: 1) growth in structured settlements will be hard to come by outside of inorganic growth; 2) competition will have a tough time breaking into the business given the pie isn’t growing quickly.

Source: http://tinyurl.com/lglk7fw

The IPO

JGW IPO’ed during one of the busiest weeks of the year (http://tinyurl.com/ltqa95x & http://tinyurl.com/kk9jfkt). The initial offering range was $19-$22 or ~ 8x 2014E EPS for a seemingly complicated company with no direct comps, a levered balance sheet with negative equity, in a bad tape with the market down 1%+, and private equity selling when the getting is good. Why would anyone spend the time given this is a story that often has the same ending? Demand didn’t materialize at $19-$22 and the IPO price range was cut to $15-$16. JGW came public to pay down a portion of the debt and give private equity holders an opportunity to realize some gains.

JLL Partners adds an interesting complexity to the IPO. The firm was planning to be a seller when the initial pricing was $19-$22 (80% primary / 20% secondary) but became buyers when the offering price dropped below $15. By the time it made the rounds that JLL was actually re-upping in the IPO it was too late for anyone to do work or start caring. The IPO went off at $14.00 and the stock opened below $13.00. The IPO color I heard was that 30% of the deal went to retail, which is a poor recipe for success when the demand was weak.

What seems to have been missed by the select few people on the sell-side and buy-side that even care on this is that JLL made a capital call in Fund V, the same fund that made the original equity investment in JGW, to make the investment (http://tinyurl.com/mbbovu3). After speaking with a few people in the know, JLL made the investment because of the merits of the investment at $13.125/share. Take it with a grain of salt, but the CFO said he thought JGW would have had to fend off investors if they knew JLL was re-upping as they did. The skeptical part of me thinks JLL needed to re-up to get the IPO off but I don’t think their $20mm investment made the difference. 

"The number we got was a pretty good number. It's a fair price. It will make for happy investors"

-David Miller, CEO of JGW (http://tinyurl.com/o6enlmm)

Private Equity Hangover

JLL still has its grip on JGW with Alexander Castaldi, Kevin Hammond, Paul Levy, and Francisco Rodriguez all of JLL on the board. JLL has made out like bandits on JGW twice now (http://tinyurl.com/lnxjqdu). The difference with the first time and now is our interests are mostly aligned with JLL. JLL wants the stock to go up and to realize the value for their LPs.

Credit Suisse Global Private Equity Fund took shares in JGWPT for its stake in Peachtree. The merger has been a homerun for all parties involved. Read CS’s private equity doc’s for an idea of what the firm thought their investment was worth. This leads me to believe that M&A in the space will be very accretive given JGW’s cost structure.

2013Q1: https://www.credit-suisse.com/au/products/doc/gpefQ12013.pdf

2012Q3 : https://www.credit-suisse.com/au/products/doc/gpefQ3.pdf

2012Q2 : https://www.credit-suisse.com/au/products/doc/gpefQ2.pdf

2012Q1 : https://www.credit-suisse.com/au/products/doc/gpefQ1.pdf

2011Q3 : https://www.credit-suisse.com/au/asset_management/doc/gpefQ33.pdf

2011Q2 : https://www.credit-suisse.com/au/asset_management/doc/gpeq211.pdf

2010Q3: https://www.credit-suisse.com/au/asset_management/doc/gpeq310.pdf

2010Q2 : https://www.credit-suisse.com/au/asset_management/doc/gpe_q2102_pdf.pdf

Management

David Miller, CEO, Chairman & Director, has been at the helm since January 2009 and helped guide the company out of bankruptcy and through a merger with Peachtree. He is a straight shooter, which I find rare particularly in the specialty finance space, and tells the JGW story as it is. I believe when the street gets to know Miller better they will feel more comfortable with the merits of the investment and business model. Miller’s other experience includes EVP at Ace Group’s International Accident and Health Insurance Business. Before his employment at Ace Group, he was President and CEO of Kemper Auto and Home Insurance, as well as COO of Providian Direct Insurance. Miller has a BSEE in electrical engineering from Duke University and a MBA in Finance from Wharton. Since 2013, Mr. Miller has served on the Board of Ellington Residential Mortgage REIT, a publicly traded REIT listed on NYSE. He was previously a member of the New York Stock Exchange.

Shareholders

JLL currently holds a 39% economic interest and a 63% voting interest in JGW so it is safe to say that JLL controls the company. These numbers are slightly lower when accounting for the shoe, stock options, and the stock incentive plan. Interestingly enough, 43% of the class A shares are already owned by 13G filers and from conversations with other shareholders I can account for over 50% of class A shares. 

 Top Shareholders

 


Financial Projections

 

Peers

Simply put, there are no good peers for JGW. I took a basket of specialty finance companies that operate in controversial businesses. JGW trades at 6.3x 2014E earnings (a 41% discount to peers) and 5.5x 2015E earnings (a 40% discount to peers).

Source: Bloomberg

Valuation

I estimate the stock is worth $20.08 or 7.8x my 2015E EPS of $2.57, a 15% P/E discount to peers for conservatism. This is based on a probability weighted basis with a downside (20% probability) of $12.87 or 5x 2015E EPS, base (60% probability) of $20.59 or 8x 2015E EPS, and upside (20% probability) of $25.74 or 10x 2015E EPS. I arrive at an expected return of 42% today.

 

Risks

  • Interest rates spike before a securitization
  • Weak demand for securitizations
  • Regulation
  • Tort reform
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Debt refinancing. The company is currently in the process of refinancing its term loan.
  • Sell-side initiations in the first week of December
  • Investment community gains comfort with business model and valuation approach
  • Accretive M&A
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