ADS - Alliance Data Systems

[bennycx]

Their focus on "core" EPS rather than EPS seems strange to me.. the two numbers are very different

[KCLarkin]

Whoever owns it doesn't change the fact that its a subprime credit card company.

The stock doesn't know who owns it so this clearly true. But when you see investors like Ubben, Greenberg, and Arlington, it is worth understanding why. And then you look at the growth rate and the performance during the GFC and it is pretty clear that this is not just a subprime credit card company. This is similar to saying that NVR is just a home builder or CACC is just a subprime auto lender. There is clearly something very unique about ADS. I haven't figured it out yet.

One thing that I find interesting is that they are on-boarding very high-end clients like IKEA but the stock price is the same as the end of 2013. This looks like a compelling setup -- though obviously the credit and funding risks are significant. And this is a very complex company.

[Spekulatius]

Their focus on "core" EPS rather than EPS seems strange to me.. the two numbers are very different

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.

[HJ]

Their focus on "core" EPS rather than EPS seems strange to me.. the two numbers are very different

Core earnings appear backmout 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.

If you think of their customers as just the subprime borrowers, these individual customer relationships may not have a lot of long term value.  If you think of their customer as the retailers, then there is some long term value in the retailer's ability to originate these credits profitably. 

[Spekulatius]

Just by looking at their website, they regard the retailers as their customers, not the individual account holders, which is quite telling, IMO. I think there has been quite a bit of churn in their retail customer base as well, possibly due to a lot of retailers going out of business.

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?

[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