ADS - Alliance Data Systems

[KCLarkin]

Core earnings appear back out amortization from intangibles. It looks to me that I’d they acquire a business, they acquire some good will as well. That goodwill seems to me most customer relationships, which I don’t think have that much long term value, so they need to get replaced constantly. I don’t think they backing them out is entirely expensive right way to look at economic earnings and may the market has figured out thw thr GAZP earnings are the correct way to look at stock. Based on GAAP earnings, ADS doesn’t look that cheap.

 

It looks like when they purchase a collection of receivables at a premium, it is because of the long term value to signing that retailer. If they buy a collection of receivables from Williams-Sonoma, they are expecting the ongoing relationship with Williams-Sonoma to replenish those A/R. So they don't need to get replaced constantly.

 

Having said that, there is certainly churn in the portfolio as brands go bankrupt or falter. So perhaps amortization is a real expense. But IIRC, they said in the last call that they expect the core portfolio to be roughly flat. And any new customers would contribute growth. In which case, some of that amortization is non-economic.

[KCLarkin]

I just noticed going back, that ADS seem to purchase assets with goodwill attached to it even when their business didn’t really show increases YoY, which sort of tells us that this goodwill is not all growth expense. Do they pay their customer upfront when they initiate a customer relationship?

 

Going back to 2009, every year showed material growth in revenue and A/R. Which could be consistent with these acquisitions being growth not maintenance.

[Spekulatius]

I just noticed going back, that ADS seem to purchase assets with goodwill attached to it even when their business didn’t really show increases YoY, which sort of tells us that this goodwill is not all growth expense. Do they pay their customer upfront when they initiate a customer relationship?

 

Going back to 2009, every year showed material growth in revenue and A/R. Which could be consistent with these acquisitions being growth not maintenance.

 

I think the intangible depreciation is very likely a combination of both growth and Capex. I am not even sure that customer retention matters too much. Depending on thr contract length, I think it is very likely, that the customer will demand another pound of flesh so to speak to extend a contract.  I did notice they intangible depreciation has been rising faster than revenue during thr last few years.

 

Then ADS has negative tangible equity. Their captive bank sub Comenity has about $1.8B in equity, ( which equals total ADS equity) which has to be mostly tangible (didn’t dig into FDIC records too far), so this means that the debt and the intangibles mostly reside at the Holding Company Level or another operating sub. This could be an issue if the FDIC disallows distributions to the holding company from Comenity.

[KCLarkin]

I think it is very likely, they the customer will demand another pound of flesh so to speak to extend a contract.

 

Private Label credit cards should have substantial switching costs. So ADS would have better negotiating power on renewal than new bookings.

[vinod1]

Switching costs vary by size of retailer. They are high for smaller retailers which is the market ADS focuses on. Still their two largest customers make up 30% of the card segment revenue. These customers probably have a lot more leverage and likely less profitable.

 

If it is purely private label card, then switching costs are not all that much. Citi (with exception of Costco) and Capital One can onboard a new retailer pretty efficiently. Where ADS has increased switching costs is by integrating marketing with cards. Epsilon and LoyaltyOne makes it a pain for smaller retailers to move their private label cards.

 

It is difficult to know from outside what percentage of the business has switching costs. They do not share this data, quite understandably.

 

As far as amortization goes, I agree with Spekulatius. It is part economic and part non-economic. If they do not make any portfolio acquisition say over the next 10 years, can they grow their portfolio in inflation adjusted terms? I doubt it.

 

So personally I add back only about 2/3 of intangible amortization and further tax it.

 

Vinod

 

 

[cmlber]

Switching costs vary by size of retailer. They are high for smaller retailers which is the market ADS focuses on. Still their two largest customers make up 30% of the card segment revenue. These customers probably have a lot more leverage and likely less profitable.

 

If it is purely private label card, then switching costs are not all that much. Citi (with exception of Costco) and Capital One can onboard a new retailer pretty efficiently. Where ADS has increased switching costs is by integrating marketing with cards. Epsilon and LoyaltyOne makes it a pain for smaller retailers to move their private label cards.

 

I don't think this is true.  Look at SYF.  Lowe's has been with them for ~40 years.  Most of their large retailer relationships are 10-20 years, and their ROE's are very high.  It's not a simple switch for the retailer.

[racemize]

Switching costs vary by size of retailer. They are high for smaller retailers which is the market ADS focuses on. Still their two largest customers make up 30% of the card segment revenue. These customers probably have a lot more leverage and likely less profitable.

 

If it is purely private label card, then switching costs are not all that much. Citi (with exception of Costco) and Capital One can onboard a new retailer pretty efficiently. Where ADS has increased switching costs is by integrating marketing with cards. Epsilon and LoyaltyOne makes it a pain for smaller retailers to move their private label cards.

 

I don't think this is true.  Look at SYF.  Lowe's has been with them for ~40 years.  Most of their large retailer relationships are 10-20 years, and their ROE's are very high.  It's not a simple switch for the retailer.

 

Citi did take the card from AmEx for Costco though, so it is definitely doable.

[cmlber]

Switching costs vary by size of retailer. They are high for smaller retailers which is the market ADS focuses on. Still their two largest customers make up 30% of the card segment revenue. These customers probably have a lot more leverage and likely less profitable.

 

If it is purely private label card, then switching costs are not all that much. Citi (with exception of Costco) and Capital One can onboard a new retailer pretty efficiently. Where ADS has increased switching costs is by integrating marketing with cards. Epsilon and LoyaltyOne makes it a pain for smaller retailers to move their private label cards.

 

I don't think this is true.  Look at SYF.  Lowe's has been with them for ~40 years.  Most of their large retailer relationships are 10-20 years, and their ROE's are very high.  It's not a simple switch for the retailer.

 

Citi did take the card from AmEx for Costco though, so it is definitely doable.

 

Agreed. But doable and low-switching costs are two very different things. For SYF to have the ROE's they have with the length of relationships they have tells you there are meaningful switching costs. 

[racemize]

Yeah, the Citi transition certainly wasn't as smooth as desired...

[HJ]

Citi paid up for the Costco relationship.  While undisclosed on detail, by Amex's account, Citi paid up a lot.  It is certainly fair to say that Costco relationship is likely worth a lot more than the typical retailer relationship in ADS portfolio.  Pre crisis, when credit card portfolio transactions are more common, they routinely trade 10+% premium to underlying balance, to be amortized over a 4-5 year period, even if it's a subprime portfolio.  The latest exercise in the headlines had Capital One paying roughly $200MM premium to buy the Cabela's portfolio of $5.7 billion, which is not a subprime portfolio.  But prior to that, they sold the Best Buy credit card portfolio (to Citi), reportedly at book.  Not saying all of these trades are at the right value, but these are some of the yard sticks out there. 

[vinod1]

What I am trying to say is compared to larger companies, smaller companies have higher switching costs.

 

Credit cards (general purpose or private label single store) have wonderful economics. They are like legalized mafia. High teen NIM gives you a lot of MOS. As long as a company has scale and sticks to basics, they can make pretty good money.

 

ADS and SYF, basically share these profits with their customers. If you look at SYF, they disclose how much they pay their customers (retailers,etc). It is pretty close to 50/50 profit sharing on a pre-tax basis.

 

I think ADS has a slightly stronger moat than SYF as they focus on smaller companies.

 

Length of relationship and having ROE is a good data point but does not tell us conclusively either about switching costs (they could be sharing more of the profitability to retain the relationship or ROE could be coming from some other set of companies within their customer base).

 

Vinod

[Saluki]

Does anyone know how the Air Miles and other rewards work with ADS and the merchant and customers? Do the rewards come out of ADS' split of the profits, or the retailer's? 

 

In learning about Berkshire's experience with the float at Blue Chip Stamps, it occurs to me that miles that a customer earns, but won't be redeemed for years would have the same characteristics as the float at BCS.

[glorysk87]

Does anyone know how the Air Miles and other rewards work with ADS and the merchant and customers? Do the rewards come out of ADS' split of the profits, or the retailer's? 

 

In learning about Berkshire's experience with the float at Blue Chip Stamps, it occurs to me that miles that a customer earns, but won't be redeemed for years would have the same characteristics as the float at BCS.

 

ADS is paid a fee per mile earned.  On the rewards side, they are responsible for purchasing/paying for any rewards that are redeemed by the consumers.

 

To your point, the business operates with a float seeing as ADS is paid upfront per mile but some time elapses before that mile is redeemed for a reward.

[Cigarbutt]

Does anyone know how the Air Miles and other rewards work with ADS and the merchant and customers? Do the rewards come out of ADS' split of the profits, or the retailer's? 

 

In learning about Berkshire's experience with the float at Blue Chip Stamps, it occurs to me that miles that a customer earns, but won't be redeemed for years would have the same characteristics as the float at BCS.

Th

 

Just to add some details:

 

Loyalty programs tend to report results with some variations but there are some underlying principles. I am relatively familiar with the Loyalty One sub but don't know much about other ADS subs.

 

Basically, sponsors pay "fees" to ADS when collectors use their loyalty cards during a purchase. This gives rise to a promise for rewards to collectors which results in deferred revenue (ADS recognizes immediately some revenue as a "service" component). Accounting profit will be generated if the cost from suppliers is less than revenue recognized. Estimates are influenced by breakage (points that will never be redeemed, about 20%) and average "life" of the reward (about 40 months).

 

You are correct in saying that funds can be held for some time between the accumulation phase and the redemption phase but, contrary to insurance float which is regulated and supervised, loyalty programs have more flexibility so due diligence is important.

 

How the float is invested can make a difference too as I understand that, with Blue Chip Stamps, return from invested float was the main ingredient for success and not the underlying business which was essentially in a run-off mode.

 

[Saluki]

Thanks for the help!

[tol1]

What I am trying to say is compared to larger companies, smaller companies have higher switching costs.

 

Credit cards (general purpose or private label single store) have wonderful economics. They are like legalized mafia. High teen NIM gives you a lot of MOS. As long as a company has scale and sticks to basics, they can make pretty good money.

 

ADS and SYF, basically share these profits with their customers. If you look at SYF, they disclose how much they pay their customers (retailers,etc). It is pretty close to 50/50 profit sharing on a pre-tax basis.

 

I think ADS has a slightly stronger moat than SYF as they focus on smaller companies.

 

Length of relationship and having ROE is a good data point but does not tell us conclusively either about switching costs (they could be sharing more of the profitability to retain the relationship or ROE could be coming from some other set of companies within their customer base).

 

Vinod

 

SYF share a ROA basically, but in bad times the share is in favour of SYF. It is not necessarily 50/50 all the time and depends on the individual client.

[abitofvalue]

 

SYF share a ROA basically, but in bad times the share is in favour of SYF. It is not necessarily 50/50 all the time and depends on the individual client.

 

correct. SYF is 50/50 after SYF earns a preferred return (believe ~1.5% ROA).

 

 

[abitofvalue]

 

Citi did take the card from AmEx for Costco though, so it is definitely doable.

 

not sure Citi / Costco is the best example - that was a co-brand card deal and a huge deal where the non-Costco spend was very important not just the actual in-Costco spend . Co-brand has more players and much easier to manage then a private label card.. ADS is more competitive in private-label.  Fewer large banks want / compete here and that has helped keep the costs of acquiring relationships in check... that said clearly the costs of acquiring customers is increasing and ADS seems to be willing to pay up for this - see for example the Children's Place deal that they won last year. 

 

IMO - The bear case is two pronged - 1) this is a credit card company masquerading as a marketing / IT company by indexes and if valued like credit card companies its overvalued and 2) Management is growing card receivables late in the credit cycle so losses will go up as the cycle turns.

[tol1]

 

Citi did take the card from AmEx for Costco though, so it is definitely doable.

 

not sure Citi / Costco is the best example - that was a co-brand card deal and a huge deal where the non-Costco spend was very important not just the actual in-Costco spend . Co-brand has more players and much easier to manage then a private label card.. ADS is more competitive in private-label.  Fewer large banks want / compete here and that has helped keep the costs of acquiring relationships in check... that said clearly the costs of acquiring customers is increasing and ADS seems to be willing to pay up for this - see for example the Children's Place deal that they won last year. 

 

IMO - The bear case is two pronged - 1) this is a credit card company masquerading as a marketing / IT company by indexes and if valued like credit card companies its overvalued and 2) Management is growing card receivables late in the credit cycle so losses will go up as the cycle turns.

 

Something I have never understood is ADS trying so hard to be perceived as tech / data monetization company. They take credit risk like SYF / Citi / JP and other peers, period. Hence, ADS should be valued in line with SYF IMO if not lower given distant #2.

 

 

[Spekulatius]

 

Citi did take the card from AmEx for Costco though, so it is definitely doable.

 

not sure Citi / Costco is the best example - that was a co-brand card deal and a huge deal where the non-Costco spend was very important not just the actual in-Costco spend . Co-brand has more players and much easier to manage then a private label card.. ADS is more competitive in private-label.  Fewer large banks want / compete here and that has helped keep the costs of acquiring relationships in check... that said clearly the costs of acquiring customers is increasing and ADS seems to be willing to pay up for this - see for example the Children's Place deal that they won last year. 

 

IMO - The bear case is two pronged - 1) this is a credit card company masquerading as a marketing / IT company by indexes and if valued like credit card companies its overvalued and 2) Management is growing card receivables late in the credit cycle so losses will go up as the cycle turns.

 

Something I have never understood is ADS trying so hard to be perceived as tech / data monetization company. They take credit risk like SYF / Citi / JP and other peers, period. Hence, ADS should be valued in line with SYF IMO if not lower given distant #2.

 

Agreed. it’s not an asset light business like a software company. The economics should drive the valuation, not a fancy label from management.

[KCLarkin]

Agreed. it’s not an asset light business like a software company. The economics should drive the valuation, not a fancy label from management.

 

ROE suggest the economics are very good and much better than SYF.

[vince]

The nice thing about buying a company at 10 times cash earnings is you can still do very well with no multiple expansion, assuming the earnings are stable and growing a few percent.  In ADS's case there is strong evidence that receivables will grow at least high single digits for a good amount of time...there is obvious demand for their services. They use maybe 500 million out of 1.5 billion fcf to support the lending growth. And assuming that its managed similar to the past their card services earnings should grow right along with receivables growth.  When you add the cash flow yield to their growth rate you get a very nice return using conservative estimates (historical card services growth rate is well above 8-10 percent) with a constant earnings multiple.  I dont understand all the negativity about this business...they have a fantastic long term record and every reason to believe it will continue.

[tol1]

Agreed. it’s not an asset light business like a software company. The economics should drive the valuation, not a fancy label from management.

 

ROE suggest the economics are very good and much better than SYF.

 

Misses the point vs P/B. On that basis ADS is fairly valued and SYF undervalued.

[vince]

Agreed. it’s not an asset light business like a software company. The economics should drive the valuation, not a fancy label from management.

 

ROE suggest the economics are very good and much better than SYF.

 

Misses the point vs P/B. On that basis ADS is fairly valued and SYF undervalued.

 

Can you explain your post please, how did you come to that conclusion?

[tol1]

Agreed. it’s not an asset light business like a software company. The economics should drive the valuation, not a fancy label from management.

 

ROE suggest the economics are very good and much better than SYF.

 

Misses the point vs P/B. On that basis ADS is fairly valued and SYF undervalued.

 

Can you explain your post please, how did you come to that conclusion?

 

Returns on absolute level not meaningful, but rather vs the market price.