ADS - Alliance Data Systems

[Peregrine]

How has it "clearly" shown? If you use market tickers as the ultimate judge, then weren't those who bought Bitcoin in the middle of 2017 "clearly" right  at the end of 2017?

 

ADS may well start growing receivables again, and perhaps at higher rates than SYF given its smaller size. What if its stock outperforms SYF's? Would that "clearly" mean that he was right?

 

If I am losing 50% On any investment, I am clearly wrong, there no if and when. If nothing else, the timing was wrong and timing, just as well as stock selection, is a critical part of any investment process.

 

So let me ask you this: is it wrong for someone to not have bought bitcoin in early 2017 and sold out in late 2017 at a 18x gain? Because that's a 18x gain foregone.

 

Or how about this: is it wrong to have bought B of A at $5 in early 2009? After all, the stock fell another 50% in just a few short weeks thereafter.

 

By your definition, those were all wrong decisions.

[vince]

How has it "clearly" shown? If you use market tickers as the ultimate judge, then weren't those who bought Bitcoin in the middle of 2017 "clearly" right  at the end of 2017?

 

ADS may well start growing receivables again, and perhaps at higher rates than SYF given its smaller size. What if its stock outperforms SYF's? Would that "clearly" mean that he was right?

 

If I am losing 50% On any investment, I am clearly wrong, there no if and when. If nothing else, the timing was wrong and timing, just as well as stock selection, is a critical part of any investment process.

 

I absolutely agree with Frank here, you can't tell after 1 year.  That 50% rule is a perfectly good way to lose a possible winner.  The only thing that matters is business performance (obviously dependent on price paid relative to earning power) over time.  I have had a few BIG drops and it would have been a HUGE mistake to sell, Cabo 2 years ago comes to mind, it fell to low 600's, check it out.  However, the market is often right so a 50% drop is definitely concerning

[vince]

How has it "clearly" shown? If you use market tickers as the ultimate judge, then weren't those who bought Bitcoin in the middle of 2017 "clearly" right  at the end of 2017?

 

ADS may well start growing receivables again, and perhaps at higher rates than SYF given its smaller size. What if its stock outperforms SYF's? Would that "clearly" mean that he was right?

 

If I am losing 50% On any investment, I am clearly wrong, there no if and when. If nothing else, the timing was wrong and timing, just as well as stock selection, is a critical part of any investment process.

 

 

In addition, it's impossible to get the timing right consistently, in fact I don't believe it should enter the calculus at all.  The only thing you can really control is your skill in identifying whether the asset is undervalued or not relative to earning power.  Buffett bought the washington post for 20-25% of private value and it got sliced by more than half AFTER he bought it.  Are we to assume his 1000 bagger was bad timing or that he should have sold when it fell significantly after he bought it?  I'm sorry but that makes no sense at all, it may feel like it matters but thats a dangerous feeling when you are investing real money

[NotSoWise]

As per Oct28 SEC filing, it looks like ValueAct sold 3.8m shares in ADS. The question is whether they are going to sell out completely or will do some kind of pref stocks structure so they will remain below 10% after buybacks.

On the other hand, they just converted old pref stocks...

[vince]

As per Oct28 SEC filing, it looks like ValueAct sold 3.8m shares in ADS. The question is whether they are going to sell out completely or will do some kind of pref stocks structure so they will remain below 10% after buybacks.

On the other hand, they just converted old pref stocks...

 

That's a clear sign to get out imo.  Not that an investor should blindly follow any professional but ValueAct was on the board which decreases the chances of a complete blow-up.  I have to admit that the market was right all along while mgmt was spinning the story.  Yes they have some newer healthier retailers but the legacy business is falling apart and that does not bode well for this business.  I mistakenly assumed that the legacy retailers were healthier and that the the signings of the last few years would more than offset whatever weakness from the legacy retailers.....I am no longer confident of that and ValueActs activities sealed it for me

[NotSoWise]

My thinking is along the lines you pointed out Vince. After the fact it seems that Ed was fed with Melissa's input (indirect) to his quarterly results calls. Last quarter was same as past quarters, the difference being Melissa was directly speaking.

 

As for ValueAct - being in the Board, they realized the situation is serious and the business (environment) has changed from the time they bought it. Most likely their expected results in this new situation were 1x-1,5x in 5 years from the current price, so they decided to sell and put money elsewhere. So its not going to collapse, but it might be a dog.

 

I lost a nice 50% on this position and my lesson learned is that I will focus on great businesses at somewhat overvalued prices (hard to buy at fair price). My experience with value plays is that i get them 50% right (random?) and the ones that are doing well are usually 1-3 years behind the schedule.

[kab60]

I understand why people would dump this between lack of management credibility and a sophisticated board member resigning and dumping a huge positon near multiyear lows, but what's the downside here (aside from a huge deteoration in credit, but I haven't seen anything to suggest that and charge-off trends etc. looks fine - it's obviously a risk though).

 

Looking at the breakup/liquidation value, LoyaltyOne did 254m ebitda in 2018. Let's round that down to 200m and slap a 7-10x multiple on for 1,4-2b.

 

Then there's some 20b in receivables (2b held for sale) which, if I got this correctly, implies equity at their bank subsidiaries of around 3b.

 

Now it's obviously not as clear cut as that, but it seems like the value of Loyaltyone and the equity in the receivables portfolio basically covers the market cap. Then there's obviously the debt, but unless credit losses explode or they have to take large writedowns on their credit card receivables shouldn't we be pretty good?

 

I'm a total bagholder here, and I'm still not sure whether this is a massive thesis drift, but what IF management is right and earnings grown 25-30 pct. next year? I mean, at this valuation they could sell half of their receivables portfolio and just stick with Ulta, Sephora etc. and I don't think it would be expensive. P/E would be higher but so would the growth and a lot of the overhang would probably be lifted (I really wouldn't want them to do that - pretty bad signal to dump your clients to improve optics for shareholders).

[NotSoWise]

After few years at the Board with informal access to management, ValueAct should have developed a view that is probably more insightful than that of outsiders/ public investors (i.e. re market development, IRRs of new portfolios, etc). Despite being cheap (at least it seems so) they must have concluded that returns from the current price point over the next few years are not adequate. So the price may not collapse, but it may stay where it is over the longer term. If ValueAct was confident its 2x over the next 3-4 years, they would have not sold.

 

Last quarter was a disaster in terms of new management credibility (receivables growth downgrade, EPS downgrade, etc), so what they say about the next year is not worth much. Management will do what they can to take salary as long as possible, including being overoptimistic or not saying everything. In a sh... business, every new quarter they get salary is a win for them.

 

 

[stahleyp]

Valueact doesn't know everything. Their 1st /2nd largest holding was BHC in 2015....right before it blew up.

[kab60]

After few years at the Board with informal access to management, ValueAct should have developed a view that is probably more insightful than that of outsiders/ public investors (i.e. re market development, IRRs of new portfolios, etc). Despite being cheap (at least it seems so) they must have concluded that returns from the current price point over the next few years are not adequate. So the price may not collapse, but it may stay where it is over the longer term. If ValueAct was confident its 2x over the next 3-4 years, they would have not sold.

 

Last quarter was a disaster in terms of new management credibility (receivables growth downgrade, EPS downgrade, etc), so what they say about the next year is not worth much. Management will do what they can to take salary as long as possible, including being overoptimistic or not saying everything. In a sh... business, every new quarter they get salary is a win for them.

You're probably right, but others might be fine with a lower IRR and take a longer term view.

 

I think it's somewhat meaningless to try and figure out their motives (because we can't, eh?), but either way ValueAct didn't sell into the tender offer, so they're not exactly looking savy.

 

They basically lost 1/3 of the investment in a couple of months by not selling into the tender.

 

So either they suddenly had a unique insight (after the stock had plunged), or perhaps they jumped ship because they weren't in agreement with the rest of the board re divestments and possibly a sale of the whole company. It's not inconceivable that ValueAct were pushing for a quick flip to recoup their investment/improve IRR versus holding for plus five years.

 

I really have no idea, I'm just trying to figure out the downside.

[buffetteer1984]

Valueact also has their biggest position in citigroup which they wanted a board seat and was only given so if they removed potential conflict of interest ie their board seat on ADS. 

[RVP]

Not to sound like a broken record, but I think the time spent trying to understand other fund(s) motivations in regards to their trading activities would be better directed at doing deeper diligence on the company to hopefully reach a better understanding. I think kab60's approach of keeping a steady hand while focusing on the business is a healthy one (regardless of if it works out or not).   

 

Regarding ValueAct specifically, there could be a host of reasons why they sold out. They might think the business will deteriorate. They might have better opportunities to deploy the funds into. They might want to take the tax loss to offset some of the potential large gains they are sitting on, and may very well buy it again next year. Or they might simply be wrong about their assessment and capitulated at the wrong time. Etc.

 

My point being - without being in the shoes of another investor, we are just speculating and I'm not sure that's the best use of our energies and time (though its entertaining for sure). 

[Peregrine]

Not to sound like a broken record, but I think the time spent trying to understand other fund(s) motivations in regards to their trading activities would be better directed at doing deeper diligence on the company to hopefully reach a better understanding. I think kab60's approach of keeping a steady hand while focusing on the business is a healthy one (regardless of if it works out or not).   

 

Regarding ValueAct specifically, there could be a host of reasons why they sold out. They might think the business will deteriorate. They might have better opportunities to deploy the funds into. They might want to take the tax loss to offset some of the potential large gains they are sitting on, and may very well buy it again next year. Or they might simply be wrong about their assessment and capitulated at the wrong time. Etc.

 

My point being - without being in the shoes of another investor, we are just speculating and I'm not sure that's the best use of our energies and time (though its entertaining for sure).

 

Agreed.

[NotSoWise]

They clearly made a mistake to buy (after the fact - easy one...), but there is a higher chance they did the right decision when they exited (better understanding of the business). At the entry they were outsiders, but at the exit they were insiders.

 

Agree also that there might be other reasons they sold out, in particular:

 

to quote KAB60:

So either they suddenly had a unique insight (after the stock had plunged), or perhaps they jumped ship because they weren't in agreement with the rest of the board re divestments and possibly a sale of the whole company. It's not inconceivable that ValueAct were pushing for a quick flip to recoup their investment/improve IRR versus holding for plus five years.

 

but as you guys pointed out its just speculation. My point is that being at the Board gives you so much more insight. There is simply no substitute to talking to managers about the business and the market they are in. You won't find this stuff in any research reports, etc.

 

 

[undervalued]

I think everyone brought up good points about there could be many reasons as to why ValueAct could be selling. Based on ValueAct's history related to BHC/Valeant saga, they hold their companies for the long term since they're still holding on to their shares even now. But who knows what the real reason is, I guess time will tell.

[kab60]

There is simply no substitute to talking to managers about the business and the market they are in. You won't find this stuff in any research reports, etc.

Lots of investors prefer not to speak with management to avoid alot of classic traps. And their timing in this case was horrific, so they probably should've read some of the bearish reports instead, because they were obviously drinking the same management Kool-Aid as I was. Didn't they also miss the a multibagger in Microsoft, and didn't they also stick around VRX a bit too long? From the outside they seem to have made a ton of mistakes - just like everyone else. I like to listen to Ubben, he's obviously extremely smart, but they were wrong all along on this one as well.

 

We all were it seems, but it's funny how a 50 pct. drawdown and ValueAct blowing out of their position has people dumping the stock. Perhaps the risk/reward has never been better? What's the downside here? (I already listed some, but it would be nice to get that ball rolling, because there might be money to make).

[nafregnum]

I'm glad to hear ValueAct may have bailed for other reasons (conflict of interest, Citi)

 

In my experience, boards of directors don't contribute much or even understand the business better than an outsider might.  The ones I've seen just get together for a meeting once or twice a year and watch manicured PowerPoint slide shows that the CEO and CFO put together.  They barely interact with anyone else in the company beyond the CEO, CFO, and controller.

 

My experience is only limited to what I've seen at three companies, but what I saw resonated with what Buffett once wrote about board members being as useful in the room as a potted plant because of what he called "boardroom culture" (a good old boys club of people who don't want to offend anyone else in the room)

 

This would be a separate topic maybe that belongs in the general discussion area, but does anyone watching ADS here have an example of a high functioning board of directors that really does contribute to the steering of a company?

 

Bull thesis:

I got interested in ADS after seeing it's one of Allan Mecham's bets, and then more interested after each time it fell since he started buying.  Currently my thesis sounds like this: "There is pessimism for ADS because the sale of the other business unit didn't fetch the price that some had hoped for, and there's pessimism about the future of branded credit cards.  The cash from the sale of the other business unit can be used to buy back shares at depressed levels."  I remember when there was a lot of pessimism about Target's future prospects a few years back -- I'm trying to decide whether this is the same kind of irrational pessimism ... so, the question for me is "Do these levels represent the correct valuation based on where the company will be in 2 years?" 

 

Bear thesis:

It sounds like the management team isn't very credible.  That brings up bad memories of some of my losers like OUTR (another Mecham bet) ... but I don't think branded credit cards are really a melting ice cube like OUTR.

[NotSoWise]

My experience comes from Boards of private companies in Europe. It might be different to what you have described as US or other public companies. However, given ValueAct involvement with selling Epsilon/ getting rid of Ed, I thought they were more involved than typical public company Board.

 

As for the current valuation I have no clue... On the one hand it looks cheap, but at the same time there is a myriad of reasons why the current price could be the right one (e.g. more reserves to come for old portfolios, lower IRRs for new ones, already high niche real penetration/ market share, further deterioration of retail customers, etc).

 

As for buybacks, my observation is they work best for good/ cash growing companies (e.g. Charter), however not so well for cash poor, bad or pressured business (e.g. Hertz).

 

I have a pretty bad track record with value plays (50% right, which might be close to random). So my view is worth close to nothing here.

[buffetteer1984]

Valueact has a good long standing track record of being on the board and making changes.  But they also have shown to exit at bad times leaving plenty on the table even AFTER having board seats ie selling out of MSFT in the 70-80s and ADBE under 100 (now 290).  I think the point is never depend your investment thesis on another investor because some can easily suggest arlington being a better investor and they've been building a massive stake while others are selling.

[kab60]

As for the current valuation I have no clue... On the one hand it looks cheap, but at the same time there is a myriad of reasons why the current price could be the right one (e.g. more reserves to come for old portfolios, lower IRRs for new ones, already high niche real penetration/ market share, further deterioration of retail customers, etc).

I'm still trying to flesh out the bear case. On the last call an analyst triangulated that they took at 60m hit to their portfolios held for sale (2b). I'd assume they're getting rid of their worst clients/portfolios, but even if one assumed all their receivables were impaired, that would be a 600m hit. Hardly threatening. I'd also expect their costs to fund their receivables portfolios would increase - I've seen nothing in their filings to suggest so.

 

We'll see about ROE, despite a bad performance and little credibility, they committed to +30 pct. ROE. Their overoptimistic ways means we shouldn't take that at face value, but they'd be stupid as hell when they could kitchen sink (but hey, they seem stupid as hell communication wise, so hardly would be surprising).

 

Anyway, I'd say a decline in ROE is pretty much baked in. So I think we'd be good at these levels. So do they have a viable future - are their services needed?

 

Ulta Beauty has 33m loyalty members, and their members are much more valuable than non-members (last Ulta investor day has some interesting info), so it does seem like the value they create for their customers is anything but trivial. If it's all just about loose credit and about to unravel, I've somewhat hedged my bet by going long Ulta. :) Perhaps one should go long Lands End as well, since their new agreement should be a meaningful contributor to sales going forward. :)

[Ten7suited]

Hi, I appreciate everyone's comments and have read through the entirety of this thread.  Early on in the thread, someone pointed out that there is some detail about the receivables in the filings of the trusts, with extra detail when the trust issues a new note (most recent is $653mn offering called "Series 2019-C asset Backed Notes").  See ][https://www.sec.gov/Archives/edgar/data/1139552/000119312519243894/d794693d424b5.htm#tx794693_101].  The details in the "trust portfolio" section of this prospectus relate to $7.576bn of the average receivables that have been securitized as of 6/30/19 (average for 6 months ended 6/30/19).  However, I'm unable to find similar disclosure about the remaining $5bn or so of total receivables restricted for securitization investors as of 6/30/19 per the 10-Q.  I've searched SEC filings for "World financial network" and "world financial capital", but all the data point to the same group of $7-8bn in receivables.  Has anyone found data on the missing ~$5bn? 

 

Also of note is page 79 where they discuss "loss experience" in the trust.  I'm having trouble reconciling the pretty significant rise in "net charge-offs as a percentage of average receivables outstanding" with the numbers reported at the parent level.  For example, the trust reports 8.52% net charge-off as % of avg receivables while the parent is reporting 6.1% (both for 2018).  Obviously the former relates to just $7.4bn (as of 12/31/18) worth of receivables and the latter relates to the full $17.4bn, but it seems surprising that the economics would be so different on the $10bn in question.  Any ideas? 

 

Thanks in advance. 

[abitofvalue]

Iirc not all receivables are secured by ABS trusts. They also have equity, Corp debt and most importantly deposits financing a load of receivables.

 

The NCO difference is as you point out - diff NCO rates in the trust portfolio and remaining.  Yes diff portfolios perform very differently. Look at SYF - Walmart was a 9-10% loss rate portfolio while overall syf is a 6% loss rate portfolio.

[abitofvalue]

As for the current valuation I have no clue... On the one hand it looks cheap, but at the same time there is a myriad of reasons why the current price could be the right one (e.g. more reserves to come for old portfolios, lower IRRs for new ones, already high niche real penetration/ market share, further deterioration of retail customers, etc).

I'm still trying to flesh out the bear case. On the last call an analyst triangulated that they took at 60m hit to their portfolios held for sale (2b). I'd assume they're getting rid of their worst clients/portfolios, but even if one assumed all their receivables were impaired, that would be a 600m hit. Hardly threatening. I'd also expect their costs to fund their receivables portfolios would increase - I've seen nothing in their filings to suggest so.

 

We'll see about ROE, despite a bad performance and little credibility, they committed to +30 pct. ROE. Their overoptimistic ways means we shouldn't take that at face value, but they'd be stupid as hell when they could kitchen sink (but hey, they seem stupid as hell communication wise, so hardly would be surprising).

 

Anyway, I'd say a decline in ROE is pretty much baked in. So I think we'd be good at these levels. So do they have a viable future - are their services needed?

 

Ulta Beauty has 33m loyalty members, and their members are much more valuable than non-members (last Ulta investor day has some interesting info), so it does seem like the value they create for their customers is anything but trivial. If it's all just about loose credit and about to unravel, I've somewhat hedged my bet by going long Ulta. :) Perhaps one should go long Lands End as well, since their new agreement should be a meaningful contributor to sales going forward. :)

 

Let me give you a few less optimistic points to consider - don't believe all of these but I do think a lot are plausible..  in general the thesis can be summed up as don't believe management or at least don't give these guys the benefit of the doubt...

 

1) held for sale portfolio - why assume they are their worst portfolios? They used to say it was M&A / bankruptcies.. now it's just ppl who weren't focused on card.. maybe it's struggling retailers we signed that we shouldn't have renewed..or had to renew for strategic reasons. Also if they have a shitty portfolio that would be a pain to sell they won't.. they know ppl look at this..  the fact that they are taking writedowns suggests they were way too optimistic in valuing them. Financial companies taking writedowns rarely have one bad mark.. it's usually a series of bad marks. Maybe ONLY these portfolios had bad marks.. maybe more who knows.

 

2) growth - what's the growth rate on receivables (not active receivables.. just receivables on balance sheet) in the next 3-5 yrs? Is it single digits as the new team said or is it mid teens that the old team said was likely.  What changed to basically halve it.. off a depressed base that has a ton of 'spooling' baked in..

 

3) why does their ROE have to be 30% vs SYF at 25% - decompose the individual line items and you will see it's all revenue driven.  They actually do worse on credit and Opex efficiency on a fully loaded baisis.. so what gives them the right to earn higher revenue yields.  Is it as the management team claims there is less competition cause they play in small retailers the big boys don't want or is it the other claim of better marketing...  Seems dubious to me.  Why wouldn't the bigger retailers want better marketing if ADS could deliver that? And seeing some of the subscale crap SYF has in the payment solutions and carecrdit them not being interested in small retailers seems like a maybe at best to me.    More likely it's the lower balances on ADS accts which drives yields as the fees (which are typically fixed $) are a bigger part of the yield.  This theory has the nice benefit of also being consistent with their worse credit..  so are 30 percent ROEs guaranteed as loan sizes increase ? I don't know but I question if the bulls are prepared for consistent ROEs below 30%..

 

4) nearterm guidance is going lower not higher (lower interest rates).  yes yes it's bullshit and we value investors care about intrinsic value.  But stocks go down when guidance is lowered or actual results miss guidance

 

5) CECL - bears expect either the actual results will be worse than guidance on day 1 or longer term. Lots of reasons for this but two are - their competitors are not stupid and all pointed to much bigger reserve building and some of ADS new clients / categories clearly have longer loan lifes than their old so the portfolio shift will drive day2 reserves higher than ppl are assuming.

 

6) relatedly they keep saying the new categories should perform the same as their historic in terms of credit but a jewelery or furniture deferred interest loan may not.. especially in a downturn. It's certainly a longer life loan which even they acknowledge.

 

7) loyaltyone - who is the buyer? Why do they want it.. other than PE that is.. since the cash flow profile is decent..  but PE firms aren't in the business of paying high multiples for a business with limited growth and some regulatory risk from a forced seller.  Their execution on epsilon reduces confidence

 

8) their non-gaap metrics are crap and on a gaap basis they aren't all that much cheaper than syf.. (well at least they didn't used to be)

 

9) competition for plcc is increasing - whether it's bnpl, non-plcc rewards or Just better gpcc rewards. The fact is plcc purchase volume as an industry has been anemic for the last two yrs. And the growth in. Non-card related rewards programs reduce the value prop of card programs.  Are Ulta's 33M members going to go get Ulta cards? Will Ulta reward those that dont to a lesser degree - yes but will it matter? .

 

10) well I don't have one of the top of my head but 10 is a nice number for a list -  so let's just go with cyclicall business with low quality management whose biggest customer is struggling so y would own late in the credit cycle. Can just buy cheaper if credit event occurs or if they work through issues.. will have lots of time to buy don't need to bottom tick. Sell now buy once fixed or credit overhang goes.

 

 

Who knows though.  Maybe they did kitchen sink with new managemebt coming in and things will get better from here. Don't really feel strongly one way or another. But think dismissing the bears who have been very very right for the last few quarters - on both trajectory of business and stock price - is a mistake.

[KCLarkin]

3) why does their ROE have to be 30% vs SYF at 25% - decompose the individual line items and you will see it's all revenue driven.  They actually do worse on credit and Opex efficiency on a fully loaded baisis.. so what gives them the right to earn higher revenue yields.  Is it as the management team claims there is less competition cause they play in small retailers the big boys don't want or is it the other claim of better marketing...  Seems dubious to me.  Why wouldn't the bigger retailers want better marketing if ADS could deliver that?

 

Maybe product mix? I haven't looked at SYF but my impression is that they have more co-brand cards which are less lucrative than private label.

[Peregrine]

3) why does their ROE have to be 30% vs SYF at 25% - decompose the individual line items and you will see it's all revenue driven.  They actually do worse on credit and Opex efficiency on a fully loaded baisis.. so what gives them the right to earn higher revenue yields.  Is it as the management team claims there is less competition cause they play in small retailers the big boys don't want or is it the other claim of better marketing...  Seems dubious to me.  Why wouldn't the bigger retailers want better marketing if ADS could deliver that?

 

Maybe product mix? I haven't looked at SYF but my impression is that they have more co-brand cards which are less lucrative than private label.

 

SYF has way lower yields...again it's mostly about the RSAs. And the retailer sharing agreements tend to be higher for the larger retailers since they have the scale and resources to do the data, marketing and loyalty in house - relegating SYF to a more balance sheet role. I think it's quite simple why SYF earns lower ROEs.