ADS - Alliance Data Systems

[chompsterama]

You are either really brave or really gullible to believe anything Tim King (or anyone else at ADS) says about the business.  The guy has been so wrong about his business so many times.  He is also the guy that defended and was proud of a giant share repurchase at 100% above today's price.   

Do you have a position?

Had.

[bizaro86]

Collecting air miles is just one of those things that Canadians do.

This is what I like about the business.

[widenthemoat]

Question for the board -  given they have excess capital at the bank levels, could they dividend out some cash and use this to pay down a portion of their  current debt?

Thanks in advance.

[kab60]

Not sure how much they can dividend out, as you say, the banks are well capitalized. Either way, why would they? The risk is in the credit card business. They recently said how they could draw their revolver and pump liquidity into the banks if shit hits the fan.

[widenthemoat]

Fair point. I guess my concern was the banks get hit with charge offs that wipe out profits for the next two years (extreme scenario in my view but certainly possible). In that situation banks would be fine from a capital standpoint but we would have a $2.0 billion debt payment due end of 2022 right? Been lurking on the boards for years and the discussions are fantastic btw so thanks everyone.

[kab60]

Fair point. I guess my concern was the banks get hit with charge offs that wipe out profits for the next two years (extreme scenario in my view but certainly possible). In that situation banks would be fine from a capital standpoint but we would have a $2.0 billion debt payment due end of 2022 right? Been lurking on the boards for years and the discussions are fantastic btw so thanks everyone.

If the banks are fine in 2022, I don't think it'll be an issue to refi. Think the only question now, if one wants to make money here, is whether or not they survive. I recall Mecham saying he invested in cockroach-like businesses (those that can't be killed - and he bought more in Q4). We can always debate relative value, growth prospects etc, but how do you guys kill ADS?

They recently refinanced and brought leverage down to 1,5x.

Unlike their clients - mainly retailers - fixed costs are low. Loss of sales will obviously increase credit losses due to fewer fresh receivables, but on the other hand gas prices are low, spending on travel, restaurants, experiences etc. goes down.

Generally, the consumer seems to be in a better spot than a lot of large indebted corporates. Obviously, if things get bad, some of their end customers will be out of jobs, thus increasing credit losses. And I suppose, while they were profitable during the GFC, their clients have changed. While B&M will be hard hit, their online clients might be in a better spot.

I definately understand, given the track record, why people are staying away. But how do you guys kill the Company? (I haven't seen any indications that credit standards are better or worse than before - outstanding credit balances 811$ per account)

[widenthemoat]

Fair point. I guess my concern was the banks get hit with charge offs that wipe out profits for the next two years (extreme scenario in my view but certainly possible). In that situation banks would be fine from a capital standpoint but we would have a $2.0 billion debt payment due end of 2022 right? Been lurking on the boards for years and the discussions are fantastic btw so thanks everyone.

If the banks are fine in 2022, I don't think it'll be an issue to refi. Think the only question now, if one wants to make money here, is whether or not they survive. I recall Mecham saying he invested in cockroach-like businesses (those that can't be killed - and he bought more in Q4). We can always debate relative value, growth prospects etc, but how do you guys kill ADS?

They recently refinanced and brought leverage down to 1,5x.

Unlike their clients - mainly retailers - fixed costs are low. Loss of sales will obviously increase credit losses due to fewer fresh receivables, but on the other hand gas prices are low, spending on travel, restaurants, experiences etc. goes down.

Generally, the consumer seems to be in a better spot than a lot of large indebted corporates. Obviously, if things get bad, some of their end customers will be out of jobs, thus increasing credit losses. And I suppose, while they were profitable during the GFC, their clients have changed. While B&M will be hard hit, their online clients might be in a better spot.

I definately understand, given the track record, why people are staying away. But how do you guys kill the Company? (I haven't seen any indications that credit standards are better or worse than before - outstanding credit balances 811$ per account)

kab60 - Please correct me if I'm wrong here, but don't charge offs need to hit ~12% just for ADS to start losing money? And based on my numbers they wouldn't need to add capital to the banks unless charge offs hit ~17% (as you previously mentioned, even in this situation the parent company could draw down on their revolver to appease the regulators.)

So let's say the first scenario plays out and ADS charge-offs are 12% for the next two years and they are able to re-finance their debt at some point over the next two years as well. After that, if they can pay me only $10 per share into perpetuity, the math tells me I would be getting better than a 10% return at these prices.

Ironically, I've been re-reading the Buffett letters on my way to/from work and recently came across this regarding his 1999 purchase of Wells Fargo.

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.

[kab60]

Yes, I think that math is directionally correct. There's a rate drop to take into account which should compress NIM in the short term. But like lower gas prices that should be a plus for consumers, lower rates probably means people refi like crazy and get more disposable income all else equal. On the other hand, increased medical costs due to coronavirus will probably be a hit.

[Spekulatius]

Yes, I think that math is directionally correct. There's a rate drop to take into account which should compress NIM in the short term. But like lower gas prices that should be a plus for consumers, lower rates probably means people refi like crazy and get more disposable income all else equal. On the other hand, increased medical costs due to coronavirus will probably be a hit.

I think the consumer not shopping at those dinky retailer ADS serves is a bigger problem than medical costs.

[kab60]

Yes, I think that math is directionally correct. There's a rate drop to take into account which should compress NIM in the short term. But like lower gas prices that should be a plus for consumers, lower rates probably means people refi like crazy and get more disposable income all else equal. On the other hand, increased medical costs due to coronavirus will probably be a hit.

I think the consumer not shopping at those dinky retailer ADS serves is a bigger problem than medical costs.

You mean Ulta Beauty and Sephora?

I know, I know, I should dump this POS, it's only costing me money. I know you definately don't like it. So how about you kill it?