ADS - Alliance Data Systems

[dbuch]

As far as valuation goes, I think ADS seems cheap even if you simply consider it a financial company and forget the tech label which is a red herring. The average bank trades at 1x P/B but is lower growth and P/B is tied to ROE. If your earn 10% ROE and your cost of capital is 8% you should be 1.2x book. If you earn 25% and are expected to maintain that level you should be 3.5x.

ADS bank equity should be around $3.5B this year which I think is worth close to $220/share. All in debt of $17B versus $3B of bank equity is 5.7x which is well capitalized. If you value Epsilon and LoyaltyOne at 10x EBITDA that would be $90 a share or about $310.

Obviously it comes down to what you think happens to the growth of card services. If card services can continue to add portfolios and earn 25-30% ROE's then earnings will continue to rise rapidly every year. If you think L brands or some large retailer blows up and they can't replace the receivables fast enough or delinquencies rise to 9% or smaller retailers no longer see value in their SKU level marketing then the higher P/B doesn't make sense.

[flesh]

From the recent earnings presentation: Card Services

• YTD:
• IKEA – home dιcor
• Wyndham – hospitality
• Academy Sports – sporting goods
• Floor & Decor – home dιcor
• Adorama – consumer electronics (store/e-commerce)
• Appliances Connection – consumer electronics (e-commerce)

• Announced signing of $2.0 billion vintage plus signed-not-yet-announced of $2.0 billion vintage puts 2018 at $4 billion vintage (2x recent record years)

• 100 percent away from mall-based specialty apparel

• Credit quality continues to improve
• Q1: 6.7 percent → Q2: 6.4 percent → Q3: 5.9 percent
• Recovery rate: Q1: ~9 percent → Q2: ~15 percent → Q3: ~18 percent (higher than Q3, 2017 rate)

• Strategic Review of Businesses
• We believe current stock price does not reflect intrinsic value of our business
• We are evaluating which assets could thrive under a different steward, while also unlocking value for
stockholders
• We will have a crystallized game plan of “what & how” before year-end and will communicate this path at that time
• Overall, this will be an aggressive and significant effort

Aggressively prune clients in liquidation, bankruptcy or M&A
• ~50 percent already addressed; remainder to be addressed in fourth quarter
• Eliminates drag over next two years and frees up regulatory capital
• No renewal risk in 2019 safeguards our base

^^^The slate is being cleaned for 19'

[kab60]

Didn't think the results were particularly good, but they took a couple of smart steps in how to tell their story. Seems market was surprised by upcoming decision on Epsilion and Loyalty One but they actually said that on a recent investor conference. I was a bit disapointed they didn't announce anything specific as well as continued weakness in Epsilon, but I think both are temporary and card segment looks really strong. They expect to grow mid double digit there, so if they sell off the rest I think it would get a rerating  (plus a shitload of cash).

[peterHK]

I was also a little disappointed on results. They had said we'd hear about strategic direction on the Q3 call, and their "update" was effectively "more, later. Stay Tuned!".

I still think the company is an interesting special situation play with some catalysts coming up shortly.

[kab60]

I was also a little disappointed on results. They had said we'd hear about strategic direction on the Q3 call, and their "update" was effectively "more, later. Stay Tuned!".

I still think the company is an interesting special situation play with some catalysts coming up shortly.

I see it as a GARPy way to play the retail space where you might actually benefit from Amazon (forcing retailers to better know their customers but need to outsource) and you get those options thrown in.

[peterHK]

I was also a little disappointed on results. They had said we'd hear about strategic direction on the Q3 call, and their "update" was effectively "more, later. Stay Tuned!".

I still think the company is an interesting special situation play with some catalysts coming up shortly.

I see it as a GARPy way to play the retail space where you might actually benefit from Amazon (forcing retailers to better know their customers but need to outsource) and you get those options thrown in.

Question is why do I want to play the retail space (with leverage) right at this point in the cycle with rising rates/potentially slowing economy? I struggle to get above $270/share in value, so for 22% upside over maybe a year it's interesting, but it's not making me salivate really.

[abitofvalue]

Didn't think the results were particularly good, but they took a couple of smart steps in how to tell their story. Seems market was surprised by upcoming decision on Epsilion and Loyalty One but they actually said that on a recent investor conference. I was a bit disapointed they didn't announce anything specific as well as continued weakness in Epsilon, but I think both are temporary and card segment looks really strong. They expect to grow mid double digit there, so if they sell off the rest I think it would get a rerating  (plus a shitload of cash).

Think the surpirse was the size and timing of divestures not the announcement itself which was somewhat expected.. Not often you have companies say 'major' and 'next few weeks' when it comes to announcements of divestures. That signals something is close to being finalized. Think the market was expecting them to say the typical - "we are going to review strategic options.".  Their comments at conference were not as definitive. In fact just 3 mths back they were saying - Q3 results will resolve credit issue and epsilon underperformance and then if stock remains cheap we will ahve to think about things. I thought their announcement on warnings call moved the timeframe up considerably and implied a big price for the upcoming divestures.

In terms of the quarter - I thought it was actually pretty ordinary. Tax rate and lower provisions were the main reason for the beat vs consensus. Loyalty one only marginally improved on last qtr in terms of core trends... Would have expected the turnaround to have more upside. Epsilon remains a disaster - which likely forced their hand in timing. I suspect absent the announcement shares would have been crushed..

[vince]

Crushed is right, that's one reason they announced their intentions.  Can anyone take a stab at how much those 2 businesses would sell for with some decent comparables or other recent examples that may shed some light on the multiples they will receive.  I guess all their corporate debt will be attached to the 2 assets they are divesting.  I do know they were offered 6.7 billion for equity and 7.8 billion for EV in 2007.  They have more debt now but every other financial metric is multiples of where it was in 07.  Would love a good sum of the parts analysis from someone that hs paid lots of attention to this one.

[flesh]

I don't have access but I'd be surprised if there isn't a vic write up very soon considering the last call/clear intentions.

Maybe someone who has instant access can share with us anything interesting when it
pops up?

[vince]

Like are we talking 9-10 ebitda multiples for those assets or more like 13-14.  The difference in those numbers are night and day because the first 5 billion is going for debt paydown (or maybe not, it's just my understanding) so they will be left with a value for the remaining equity of 10 billion or 6.5 billion (all rough numbers).