ADS - Alliance Data Systems

[vince]

Haven't their buybacks and acquisitions impacted tangible book value? Not sure it's the right metric for ADS.

 

$5B for epsilon? Would be nice but is it realistic? I think the market would react very very positively to any number above $3.5B. The challenge is epsilon has been challenged for sometime and buyer knows ADS needs to sell. Also the buyer will likely have to sign a TSA or other long-term contract with card services likely limiting true profitability of epsilon.

 

Don't understand why they differentiating between active accounts and voluntary cancellations. At the end of the day - revenue depends on total receivables. If you signed shitty retailers that you are now culling, you don't get to pretend they don't exist and growth is actually higher.. the revenue is the the revenue. This massaging of numbers does not help management credibility - which is already low given constant promises of turnarounds and credit mishaps.

 

Still think their announcement on Q3 call of upcoming strategic announcements was fool hardy given they hadn't even started the sale process.  All it did was raise expectations and further cemented market view that this is a very promitional managemt team that can't be trusted.. bSeems like they were trying to open a window for insider sales by releasing all information they had.

 

Good post Abit, Spec, when they say 15% growth I believe they mean over a period of years.  Kind of hard to fault them for being at the top of the cycle....funny how this 15% is one of the only things that mgmt will be right on imo

[vinod1]

My concern is that the recent problems might be symptoms of the fact that it is running out of businesses that are a close market fit for its services.

 

Why did they target specialty retailers and not some other segment? I would argue it has to do with consumer behavior. Store cards benefit customers (invariably women) who shop frequently at their favorite stores which adds up to significant savings. The cards also benefit retailers who can target these same frequent shoppers to buy more vis targeted marketing.

 

ADS essentially followed a niche strategy that is based on serving specialty retailers. This is a market they served better than the Citigroup’s and Capital One’s of the world.

 

The retailers ADS targets have only a transactional relationship with their consumers and hence need ADS to help them with marketing. Online only and digital businesses have a relationship (via an online account) that makes ADS much less useful to them.

 

Businesses that are not retail are not a good market fit for ADS. They signed up Wyndham this year. I just cannot imagine how a hotel chain could be a good fit. It assumes that people would fly out to a distant city, make a hotel reservation by providing an existing credit card and then apply for the hotel card after they get there. It goes against the grain of how consumers behave. This applies equally well to Digital/eCommerce only businesses.

 

ADS attempt to move away from “mall-based specialty apparel” only reinforces the suspicion that it might be close to hitting the limits of its addressable market. As it signs up larger retailers, the economics would be much less favorable to ADS.

 

If you look at their growth strategy and management has laid this out pretty well. When they onboard a retailer, the 3-4% same store sales growth for the retailer, translates into a 3-4% growth for ADS as well. Now, they typically are starting from zero at the retailer, since the retailer does not have a store card in place. ADS would get this to say 10-20-30% of their customer base and this translated into another 3-4% growth. New retailers who they sign up then generated a further 5-6% growth on top.

 

The growth math above stops working at some point and the problems facing their end customers (retailers) could mean they are getting closer to that point.

 

The concern is around management ability to recognize when their business turned into a cash cow and allocate capital appropriately. Management believes they still have a long runaway to growth. So this could be an issue.

 

Anyway, ADS reminded me of a mistake I made a couple of years ago and the similarities are striking. So I decided to pass up unless I am able to address my concerns mentioned above.

 

Vinod

 

[vinod1]

At a higher level

 

1. Having a niche strategy means limiting yourself to a particular market segment. You get to have high returns on capital but the size of your market is small. This is the reason why we do not see Citigroup and Capital One not playing much in this market. They are going after a much larger market.

 

2. A companies initial customers are going to those would are a good product market fit. As the company grows, the customers are going to be less and less a fit for your product. This increases the marginal costs to serve these customers and reduces the return on capital.

 

I am trying to figure these out for ADS. Where is the boundary for ADS as far as product market fit is concerned?

 

Vinod

[KCLarkin]

ADS attempt to move away from “mall-based specialty apparel” only reinforces the suspicion that it might be close to hitting the limits of its addressable market. As it signs up larger retailers, the economics would be much less favorable to ADS.

 

I think your concerns are valid but isn't a better explanation that mall-based retailers are in secular decline? ADS is trying to grow receivables at 15% per year and to do that, they can't be signing up new retailers that are shrinking.

[LowIQinvestor]

vinod1,

 

You realize that they have digital loyalty cards right?

Go to wafair.com and put something in your cart & try to check out. You'll see an option to save x % by signing up for their loyalty card ( that's ADS ).

 

Still buying ADS today!

[vinod1]

ADS attempt to move away from “mall-based specialty apparel” only reinforces the suspicion that it might be close to hitting the limits of its addressable market. As it signs up larger retailers, the economics would be much less favorable to ADS.

 

I think your concerns are valid but isn't a better explanation that mall-based retailers are in secular decline? ADS is trying to grow receivables at 15% per year and to do that, they can't be signing up new retailers that are shrinking.

 

Just think about the sentence highlighted above.

 

How can it be good business to turn away customers who are a good fit for your service, just because they cannot grow?

 

It is like if Microsoft refuses to license HP its Windows 10 OS because HP is had a declining PC sales or say Visa declined to work with Citigroup when they are ramping down their credit card portfolio during the financial crisis. I know the marginal costs are quite different from these examples, but you get my drift.

 

They can price the product accordingly, but to me at least it does not make much sense.

 

Vinod

[vinod1]

vinod1,

 

You realize that they have digital loyalty cards right?

Go to wafair.com and put something in your cart & try to check out. You'll see an option to save x % by signing up for their loyalty card ( that's ADS ).

 

Still buying ADS today!

 

Yes. You need to look at their competitive advantage and why it works. It does not translate well for digital/online sales.

 

Sears had eCommerce too :)

 

Vinod

[flesh]

I don't believe we'd see downside here with 5% growth in card, ceteris paribus. There are many moving parts under the rev line that will become clear cy 19.

 

 

[abitofvalue]

 

Businesses that are not retail are not a good market fit for ADS. They signed up Wyndham this year. I just cannot imagine how a hotel chain could be a good fit. It assumes that people would fly out to a distant city, make a hotel reservation by providing an existing credit card and then apply for the hotel card after they get there. It goes against the grain of how consumers behave. This applies equally well to Digital/eCommerce only businesses.

 

 

Vinod

 

 

Hotel loyalty credit cards are actually a great business - chase / axp wanted to stay with Marriott and Starwood they agreed to split portfolio post hotel merger.  Why Wyndham chose ADS over the larger guys is an interesting question but I think hotels are well served for loyalty based cards as there is an easy value proposition by way of room upgrades, discount on meals etc..

 

The historical focus in specialty retail is likely just a function of the history - ADS came out of the limited's credit card business. Over time they grew to add more retailers. Now specialty mall based retail is more challenged so they have changed focus to other segments. Success remains to be seen but early signs suggest clients/consumers are interested in their cards - if anything ADS has said these new programs tend to scale much faster than old mall based concepts - receivable files of $200M in 3 yrs vs $50m under the old system. Not surprising given the retailer is likely also growing much faster than a mall based retailer could open stores and grow.

[glorysk87]

 

Just think about the sentence highlighted above.

 

How can it be good business to turn away customers who are a good fit for your service, just because they cannot grow?

 

It is like if Microsoft refuses to license HP its Windows 10 OS because HP is had a declining PC sales or say Visa declined to work with Citigroup when they are ramping down their credit card portfolio during the financial crisis. I know the marginal costs are quite different from these examples, but you get my drift.

 

They can price the product accordingly, but to me at least it does not make much sense.

 

Vinod

 

This makes absolutely no sense. In fact much of what you've said about the company makes absolutely no sense. Microsoft isn't taking on credit risk for each Windows license it sells. If Microsoft sells Windows into a declining PC vendor, they're not at risk of having a large receivables portfolio get hit with a wave of defaults.

 

It absolutely makes sense for ADS to turn away retailers that are in secular decline. I went through a bunch of your responses in this thread and much of what you've said about this company is at best misguided and at worst just flat out wrong.

[vinod1]

 

Just think about the sentence highlighted above.

 

How can it be good business to turn away customers who are a good fit for your service, just because they cannot grow?

 

It is like if Microsoft refuses to license HP its Windows 10 OS because HP is had a declining PC sales or say Visa declined to work with Citigroup when they are ramping down their credit card portfolio during the financial crisis. I know the marginal costs are quite different from these examples, but you get my drift.

 

They can price the product accordingly, but to me at least it does not make much sense.

 

Vinod

 

This makes absolutely no sense. In fact much of what you've said about the company makes absolutely no sense. Microsoft isn't taking on credit risk for each Windows license it sells. If Microsoft sells Windows into a declining PC vendor, they're not at risk of having a large receivables portfolio get hit with a wave of defaults.

 

It absolutely makes sense for ADS to turn away retailers that are in secular decline. I went through a bunch of your responses in this thread and much of what you've said about this company is at best misguided and at worst just flat out wrong.

 

The company has very little credit exposure to its clients. It does not lend money to its clients (retailers). It lends money to its clients customers.

 

I can see why it makes no sense to you when you have fundamentally misunderstood how the company works.

 

Vinod

[vince]

My concern is that the recent problems might be symptoms of the fact that it is running out of businesses that are a close market fit for its services.

 

Why did they target specialty retailers and not some other segment? I would argue it has to do with consumer behavior. Store cards benefit customers (invariably women) who shop frequently at their favorite stores which adds up to significant savings. The cards also benefit retailers who can target these same frequent shoppers to buy more vis targeted marketing.

 

ADS essentially followed a niche strategy that is based on serving specialty retailers. This is a market they served better than the Citigroup’s and Capital One’s of the world.

 

The retailers ADS targets have only a transactional relationship with their consumers and hence need ADS to help them with marketing. Online only and digital businesses have a relationship (via an online account) that makes ADS much less useful to them.

 

Businesses that are not retail are not a good market fit for ADS. They signed up Wyndham this year. I just cannot imagine how a hotel chain could be a good fit. It assumes that people would fly out to a distant city, make a hotel reservation by providing an existing credit card and then apply for the hotel card after they get there. It goes against the grain of how consumers behave. This applies equally well to Digital/eCommerce only businesses.

 

ADS attempt to move away from “mall-based specialty apparel” only reinforces the suspicion that it might be close to hitting the limits of its addressable market. As it signs up larger retailers, the economics would be much less favorable to ADS.

 

If you look at their growth strategy and management has laid this out pretty well. When they onboard a retailer, the 3-4% same store sales growth for the retailer, translates into a 3-4% growth for ADS as well. Now, they typically are starting from zero at the retailer, since the retailer does not have a store card in place. ADS would get this to say 10-20-30% of their customer base and this translated into another 3-4% growth. New retailers who they sign up then generated a further 5-6% growth on top.

 

The growth math above stops working at some point and the problems facing their end customers (retailers) could mean they are getting closer to that point.

 

The concern is around management ability to recognize when their business turned into a cash cow and allocate capital appropriately. Management believes they still have a long runaway to growth. So this could be an issue.

 

Anyway, ADS reminded me of a mistake I made a couple of years ago and the similarities are striking. So I decided to pass up unless I am able to address my concerns mentioned above.

 

Vinod

 

Vinod, a couple points....your statement around digital clients sounds like a sensible argument but the fact is every quarter they highlight that their online penetration is higher (roughly 30% if I remember correctly) than the overall online retail penetration rate (15-20% if I remember correctly).  So, at least according to management increasing online sales is a positive to the business model.  Secondly mgmt has emphasized multiple times their addressable market, they call it their "sandbox" and they claim that they can at least double their sales because of it ( Don't recall specific numbers but I do remember it was more than a double).  Thirdly, and this assumes you believe mgmt which isn't the easiest thing to do, their recent sign-ups make it very likely they will grow receivables by more than 15% over next 3 years, including customers lost over same time.  Lastly, KCLarkin is absolutely right when he says it is a rational business decision to shed customers in this case, no question!

[glorysk87]

 

The company has very little credit exposure to its clients. It does not lend money to its clients (retailers). It lends money to its clients customers.

 

I can see why it makes no sense to you when you have fundamentally misunderstood how the company works.

 

Vinod

 

Not even sure how to respond to this profoundly misguided comment. GL.

[BeerBBQ]

My take from reading the conf call: ValueAct sold because of the 10% treshhold which is very annoying.  They told the CEO they were happy at the actual level and would not sell more.

The CEO gave a 'profit warning', saying that results would be disappointing (flat) until the second half of 2019.  From then on +15% and 2020 +20%.  So, what should have happened in the second half of 2018 is delayed by one year.  It is clear that they have retailers that are really suffering and they have decided to get rid of them. There are many new signings which should replace the old clients.  Epsilon, chances are high something will be done during the first quarter. BrandLoyalty is also for sale at the right price.

So, all in all a very nice cash machine at a very nice price.  But business has evolved and they have to adapt. 

 

Is a transcript available somewhere?

[kab60]

My take from reading the conf call: ValueAct sold because of the 10% treshhold which is very annoying.  They told the CEO they were happy at the actual level and would not sell more.

The CEO gave a 'profit warning', saying that results would be disappointing (flat) until the second half of 2019.  From then on +15% and 2020 +20%.  So, what should have happened in the second half of 2018 is delayed by one year.  It is clear that they have retailers that are really suffering and they have decided to get rid of them. There are many new signings which should replace the old clients.  Epsilon, chances are high something will be done during the first quarter. BrandLoyalty is also for sale at the right price.

So, all in all a very nice cash machine at a very nice price.  But business has evolved and they have to adapt. 

 

Is a transcript available somewhere?

Yep, via Thomson Reuthers (can get it through Interactive Brokers for free - PM if you want it).

[LowIQinvestor]

I went back over the last 10 years to see various valuation metrics ( PE, Cashflow multiple, P/S, EV/EBITDA )

 

ADS is currently trading at or below on nearly every metric than it did in the 2008-2009 great recession!

 

 

Hope they are buying back shares right now. This is silly

[frommi]

I went back over the last 10 years to see various valuation metrics ( PE, Cashflow multiple, P/S, EV/EBITDA )

 

ADS is currently trading at or below on nearly every metric than it did in the 2008-2009 great recession!

 

 

Hope they are buying back shares right now. This is silly

 

Lowest P/E was 5 in 2008/2009 and P/B 2.88. Thats around 120$, so still 30% downside.

[brycepeterson]

Categorically it's easy to see ADS is cheap today - the whole short-term voting machine of the market has taken it & many other financials down in '18.  My guess is over course of 2019 earnings will prove stable and, with buybacks, will hover back to $200-$275.  One caveat is if you price-in consumer-led recession.  Example - today's 6% reserving in "normal economy" (per mgmt) goes to wherever you think is necessary (8%-10%?) - that would put shares lower - but some of that is being priced-in here ($175-$180). 

 

My comment is to just be careful using "historical multiples" from abnormal periods.  Comment above mine references 5 PE in '08-'09 and $120 floor (I don't know if 5 PE is true...taking word for it).  Late 2008 to early 2009 was a highly unusual stock price environment, when businesses were trading dirt cheap, thus I would not use that time period as a useful "floor."  Likewise, if analyzing Microsoft or Cisco today, I wouldn't use late 1990's tech bubble multiples to justify a ceiling (unless you're a "financial advisor" trying to earn commission - joking).

[Steven B]

I this Vinod made some good points up thread. Their niche does suggest that there is clear ceiling to where their advantage lies. That being said I can think of a few reasons why you wouldn't sign up dying retailers receivables isn't one of them. Do any of the longs have a rebuttal to this? I'm on the fence on $ADS, need some more work.

 

Also, I thought part of their strategy was to incorporate the epilson marketing capabilities to help middle tier retailers who couldn't afford to do it in their own. Now they're selling it. What gives?

[frommi]

Whats holding me back here is that Debt/EBITDA has gone up at a constant pace since more than 10 years and it looks really troubling to me right now. Any ideas why that is not a problem in the next recession?

 

Debt/EBITDA:

ADS: 5.8 (in 2008: 2-3)

SYF:  1.5

[flesh]

Ya, the 5-6b they'll get for epsilon and the 3.6b in cash on the bs. Ceo already stated that 1.9 b in debt will be taken out post epsilon sale. Also, ebitda will be going up for remainco due to what I stated in the first post of this thread plus growth.

[valuedontlie]

Whats holding me back here is that Debt/EBITDA has gone up at a constant pace since more than 10 years and it looks really troubling to me right now. Any ideas why that is not a problem in the next recession?

 

Debt/EBITDA:

ADS: 5.8 (in 2008: 2-3)

SYF:  1.5

 

How are you getting to those figures?

[frommi]

Whats holding me back here is that Debt/EBITDA has gone up at a constant pace since more than 10 years and it looks really troubling to me right now. Any ideas why that is not a problem in the next recession?

 

Debt/EBITDA:

ADS: 5.8 (in 2008: 2-3)

SYF:  1.5

 

How are you getting to those figures?

 

I included the debt of the card business if that is what you wanted to ask, in fact i was lazy and just looked at the numbers from gurufocus. If they sell off epsilon for 5b and use only 2b for debt reduction debt/ebitda will stay roughly the same. Looks still very aggressive to me and since the returns from the receivables are included in ebitda i prefer to look at the whole amount of debt. In 2008 debt/ebitda was way lower.

[flesh]

Whats holding me back here is that Debt/EBITDA has gone up at a constant pace since more than 10 years and it looks really troubling to me right now. Any ideas why that is not a problem in the next recession?

 

Debt/EBITDA:

ADS: 5.8 (in 2008: 2-3)

SYF:  1.5

 

How are you getting to those figures?

 

I included the debt of the card business if that is what you wanted to ask, in fact i was lazy and just looked at the numbers from gurufocus. If they sell off epsilon for 5b and use only 2b for debt reduction debt/ebitda will stay roughly the same. Looks still very aggressive to me and since the returns from the receivables are included in ebitda i prefer to look at the whole amount of debt. In 2008 debt/ebitda was way lower.

 

Ofc it's up to you to see it that way but it seems you should at least use the cash to lower your estimation of debt. There's a lot of it, and  lots of fcf to add to it as well.

[glorysk87]

 

I included the debt of the card business if that is what you wanted to ask, in fact i was lazy and just looked at the numbers from gurufocus. If they sell off epsilon for 5b and use only 2b for debt reduction debt/ebitda will stay roughly the same. Looks still very aggressive to me and since the returns from the receivables are included in ebitda i prefer to look at the whole amount of debt. In 2008 debt/ebitda was way lower.

 

Net debt is 2.2B. Up from 1.3B in 2008, but not nearly as egregious as your statement implies.

 

On Net Debt/EBITDA, leverage is slightly below 1.0x right now, compared to 2.2x in 2008.