ADS triple clone

Cost Basis: $196
Clone(Cost basis): Greenberg($196), Mecham($224), Ubben($197)

Operation:
Alliance Data Systems is made up Credit Card Service and Loyalty one.
ROE > 30%, increased earnings during ’08-’09 recession. Metrics I am watching are charge off rates, addition of new clients, increase of receivables, return of cash to shareholders via buybacks and dividends, preservation of moat.

Credit Card Service: $18B Receivables CAGR 17% from  ’11-’20

• Private label credit services w/ 160 retailers in small-mid(average $100m) size businesses.
• Creates individualized programs for customers based on skew data, demographic data and marketing.
• Marketing is successful as customers who have one of their branded cards spend 2-3x more than customers without a card. New brands added to their portfolio see an increase of 20-30% in their program.
• Low balances, high quality users, and short payback period. Quality users(upper class women)with average card balance of $700@ 22% annual rate. Payback period is short and dulling the pain of the high interest rate.
• 80% of spending is from customers +2 years
• Revolve rate 80-85% vs Peers 40-50%
• ROA 6% vs Peers 2-3%. This is because they don’t have to share as much revenue w/ retailers(only share 2% of receivables vs 6% SYF)
• Customer purchases a year: 8-10 vs SYF 2-3
• Comenity Bank Tier 1 capital ratio 15.6%
• Charge offs have normalized at 6%
• 30% of addressable market share($250B)
• responsible for 30% of existing clients sales
• Is switching from disrupt-able non strategic clients(retail) to more resilient clients(e-commerce, furniture, beauty, travel etc). Will still add healthy brands that are still winning in brick and mortar. Really likes brand that have a brick and mortar and online presence. Has a high filter for what brands they will accept in order to aim for ROE >30%.
• Top 10 brands make up 40% of their receivables.
• Expect a share repurchase plan of about $500M/year(q2 2019)

Moat:

• Private label competitors are SYF & Citi Retail Services(70% ofmarket). They focus on large retailers(Walmart, Costco, Lowes etc.) to move the needle. Small ones don’t move the needle for these companies.
• High retailer retention rate(99%) d/t high switching costs, no interchange fees and initiatives to stay due to increased revenues
• Marketing can’t be achieved by the bigger banks due to regulation or by the companies themselves because of the high cost for small-mid companies.

Management:

• “For us, what we would say is that we are really creating a maniacal focus on how we create value for all of our stakeholders.” -Melisa Miller Ceo
• Valueact(Director) has a 11% stake

Loyaltyone: composed of Canada Air miles and Brand Loyalty
Canada Air miles: >70% of Canada’s population uses it
BrandLoyalty: Loyalty program for grocers in Europe, Canada and Asia. Expected to grow low double digits at a chunky pace.

Valuation: I believe a high quality company growing it’s receivables in low double digits deserves a higher PE ratio of 10. A modest re-rate to PE 15 with estimation of $23eps by 2021–>$345. A 20% CAGR. A lower price until then is beneficial for buybacks. Average analyst 2019e eps: $19. 2020e: $23

Bear:
1. Charge offs: increased to 6%(2017-present). This is up from 4.5%
(2012-2017). 6% is a normal rate for them. It was 8% during the Financial Crisis. It decreased to 4.5% due to lopping off the weakest card holders post 2008/2009 recession. Analysts are anchored to 4.5% as normalized charge offs.
2. Low Quality Credit Customers: ADS has one of the most charge off’s in the industry. How can this be with high quality credit customers.
3. Retail clients are going bankrupt: ADS is switching to non disruptive industries and divesting companies that are in industries that can be disrupted.
4. Competition: New payments types in the marketplace are emerging in the web and digital environment. A lot of these fintech companies don’t have their own bank charter. The current moats still stands.

Q1 ’19
Sold Epsilon for $3.5B Net to be used for…
-$1.1B Buybacks
-$2.4B Debt payment
Selling Epsilon will not change the value or the nature of the relationship with brands. They have had an arm’s length agreement with Epsilon and extended that contract. It’s really the 30 years of experience and data scientists/analysts/marketers within the card service business that have leveraged these capabilities and they won’t miss a beat on their marketing.
1. Raised guidance to proforma $22.67-23.17(at buybacks of $170 & $190) proforma taking out Epsilons earnings/overhead etc. Expect higher if the price continues to be $140.
2. Mecham and Greenberg decreased their positions by 23% and 35% respectively.
3. In 2018 completed divestiture of non-strategic clients which accounted for $3B of $18B total receivables and signed new strategic clients. The ramp up of signed new strategic clients will be felt in Q2 ’19.
4. LoyaltyOne is tracking to plan.
5. In anticipation of the Épsilon transaction we spent $223M during the first quarter to repurchase 1.3 million shares of ADS

Q2 ’19
-Cash and cash equivalents $4B
-Proforma guidance stays the same at $22.67, Reported guidance is at $19.5-$19.75
-Initiated new $1.1B(14% of current market cap, 7/10/2019) buyback plan to start 7/5/2019 through 6/2020. Funded by free cash flow and Epsilon sale. $700-750Million to be used within the next few days via dutch tender auction(posted 7/18/19) This is 8.5-9%. The rest to be used as dry powder for opportunistic buyback purchases.
-Paid off $500M of 6% senior debt, $30M of interest payments to go straight down to the earnings, pending they do not reinvest it or spend it on anything else.
Credit Card Services:
-Credit sales/account receivables improving, Credit quality is normalized, continued high ROE 31%
-Acquired new clients which are estimated to bring in $900M in receivables.(Sephora, Burlington, Academy’s, Carters, Houzz)
-Still awaiting new clients receivables to kick in. Tracking to $20B at the end of the year.
LoyaltyOne: Nothing new to discuss this quarter. everything is tracking to plan.
ValueAct: converted exchanged 1.5M of common shares of 5.2M of non-voting convertible preferred stock to accommodate banking ownership rules. “We continue to have strong conviction in the strategy outlined by the management and board of Alliance Data. The transaction today has no bearing on our commitment to Alliance Data or our conviction in its long term strategy.”
Mecham: Add 24%
Greenberg; Sold out

Q3 ’19
Dutch tender auction complete 8/16/19 $750M @ $148/share.
Post Mortem: Sold for a 46% loss @ $106.
This was my first big position. As a beginner to investing and a self proclaimed cloner, this seemed too good to be true. It had been processed through 3 superinvestors filters and each had made it a large position in their potfolio.. This alone created enough safety for me to put 10% of my portfolio in it. As I dug into the company and learned more about it, I could see why they all had confidence in it. As time went on, the metrics seemed to stay intact, but the price kept going down. I continued to add to it like a euphoric drug addict. I recently came across a discussion post by thistle933. He had previously written an elegant analysis of ADS on VIC. But in this discussion post on someone elses write up, he discussed that he had made a mistake and sold out. His reasons were that the 1) ROA were going to decline due to “servicing fees” 2) PLCC market were more penetrated than anticipated 3) the new additions of clients were not as valuable as presented by management due to the nature of their large balances and consumers not wanting to to pay 26% APR. 4) High roe, attracting competition. I went back and validated the facts. They all seemed to be true or at least plausible to a good degree. But my clone bias was on alert. How could Jeffrey Ubben and Allan Mecham both be wrong? Glennberg had already dropped out of the race, perhaps he saw this coming. I decided to wait until Q3 earnings, being blinded by my bias. They underperformed, the stock tanked, and I broke the first rule of investing, “never lose money.” I bought high, and sold low. I could be wrong about selling, and I guess time will tell. But currently, my IRR is suffering. It’s odd to think, that if I literally just did the exact opposite of every transaction, that I would be up right now.

Disclosure: We are/I am long ADS