Motley Fool, Tom Brown and CompuCredit (CCRT)
This is an interview with Motley Fool's Emil Lee and Tom Brown of Bankstocks.com about CCRT. I got to it from this link:
http://www.fool.com/investing/value/2006/12/27/rounding-the-second-curve-part-2.aspx
Emil Lee: Can you tell us about the bull case for CompuCredit?
Tom Brown: CompuCredit's primary business is the issuance of subprime borrowings. [It has] two main products. One is a fee-based card with a $300 line of credit, where it makes more money off fees than the net interest income. The other is at the upper end of the subprime market, where CompuCredit makes more money off the balance with a $1,000 to $1,500 line of credit. That business has grown nicely as a result of portfolio acquisitions, and primarily on the basis of organic growth.
CompuCredit has emerging businesses -- such as payday lending, subprime auto financing, and debt collection. Those businesses are growing wildly, and they're turning profitable. The real wild card is the $700 million of liquidity -- $100 million of cash and $600 million they could draw down. What are they going to do with that liquidity? If, in the next six months, they don't find anything, my prediction is they'll buy back more stock. Management and the board own 60% [of the company].
Emil Lee: It seems CompuCredit might be underleveraged.
Tom Brown: Tangible equity to assets is at about 33%; 20% is where they feel comfortable.
You can buy this company at eight times 2008 [Second Curve's estimated] earnings -- plus the excess liquidity. CompuCredit has managed earnings and GAAP earnings. This year, the consensus earnings estimate is around 4 bucks; that's the GAAP estimate. The managed [earnings] estimate, which is what Bloomberg uses, is $3.63 per share. My feeling is next year it'll do $4.50 to $5.00 per share. In general, the difference between GAAP and managed earnings is that the managed earnings acts as if securitizations stay on a company's books. This gives a more holistic view of the company.
Emil Lee: It seems as though CompuCredit has a built-in hedge -- when credit is tight, and advance rates on securitization and warehouse facilities dry up, that means favorable pricing for the debt-collection segment. What are your thoughts on this?
Tom Brown: I must be careful what I wish for! [In those circumstances], it'll be the best time for CompuCredit to be making acquisitions, and for the debt-collection segment to be making credit card receivable acquisitions [in other words, buying up bad debt] -- but it'll be the worst time for CompuCredit's stock price.
Emil Lee: Why don't other credit card lenders do this?
Tom Brown: There's reputational risk. With two-year delinquent borrowers, you have to get aggressive. That person may never pay you. Lousy collection practices affect the performing business because of word of mouth and media headlines. Another issue is that large card issuers can book gains [from selling charged-off debt] right up front. It's a way of shoring up weak earnings.
Emil Lee: Why is CompuCredit able to exploit the subprime segment better than its competition? It seems that CompuCredit's 22% net interest margin would attract competition, so is there a long-term competitive advantage?
Tom Brown: Right now, that's one of the thing I like about CompuCredit. To issue Visa and MasterCard cards, you have to be a member of the network. CompuCredit works with three different banks that house new credit card receivables. The banks that are issuers of the cards, such as JPMorgan and Bank of America, are heavily regulated, and the regulators don't like the subprime business -- that walls off competition. It's very difficult [for competitors] to serve CompuCredit's customers.
Emil Lee: CompuCredit says its loans must make sense for the borrower. Is this warranted, given the seemingly heavy fee structure and 22% net interest margins? Do you see CompuCredit's customers climbing the FICO ladder -- and does CompuCredit retain the customers that are able to improve their credit scores?
Tom Brown: CompuCredit is expending an increasing amount of its effort to retain those "moving up" customers. [CompuCredit] would really like to migrate customers from fee-based cards to balance-driven cards. It has specific rewards programs. For example, if a borrower makes timely payments, [CompuCredit] will increase the line of credit. The program works to increase timely payments.
Emil Lee: CompuCredit has only a 10-year operating history. Is that enough credit cycles to judge the company?
Tom Brown: Senior management came from the collections business, so management has a longer history of dealing with collections. When you're lending money to subprime borrowers, underwriting is more important than the economy.
Emil Lee: How do you judge whether a merger will create real synergies or not?
Tom Brown: First, we have to understand the buyer. Does [the merger] make sense? What [is the buyer] trying to do, and does what the seller wants to do make sense? I go in knowing historically that two-thirds to three-fourths [of acquisitions], from the acquirer's standpoint in banking in corporate America, destroy value. The burden of proof is on the acquirer. We know most [acquisitions] fail, so let's figure out why this is going to fail.
Emil Lee: How do you value the residual value a company retains in securitizations?
Tom Brown: We go through the assumptions -- there's enough information in the trust, such as prepayment [assumptions]. Sometimes, we need to know from management what their models are, the lumpiness with prepays -- [such as] right after graduation -- but there is data to track the actual performance of trusts versus the gain on sale calculation.
Emil Lee: CompuCredit is expanding into other subprime segments, such as auto financing and payday lending. How does this build the company's moat?
Tom Brown: Well, that's what we'll see in 2007 -- which could cause CompuCredit to be a home run. It's testing in a Texas storefront location whether it can cross-sell these services.
Emil Lee: It seems CompuCredit has recently had an uptick in charge-offs and delinquency. Is this a cause for concern? Do you think defaults will stay reasonable?
Tom Brown: I think defaults will go up. The fastest-growing part of its portfolio is the fee-based card, which has higher delinquencies but significantly higher revenue. The fee-based card is more profitable. Overall, it's a positive for profitability.
Emil Lee: In the end, it comes down to this: The stock market thinks CompuCredit is vulnerable to a credit crunch when an increasingly debt-laden borrower starts to default, spurred by things such as a possible housing downturn or a weakening economy. What would your rebuttal be?
Tom Brown: I would respond that underwriting is more important than the economy. CompuCredit is going to a higher level of earnings growth and profitability throughout the economic cycle.
http://www.fool.com/investing/value/2006/12/27/rounding-the-second-curve-part-2.aspx
Emil Lee: Can you tell us about the bull case for CompuCredit?
Tom Brown: CompuCredit's primary business is the issuance of subprime borrowings. [It has] two main products. One is a fee-based card with a $300 line of credit, where it makes more money off fees than the net interest income. The other is at the upper end of the subprime market, where CompuCredit makes more money off the balance with a $1,000 to $1,500 line of credit. That business has grown nicely as a result of portfolio acquisitions, and primarily on the basis of organic growth.
CompuCredit has emerging businesses -- such as payday lending, subprime auto financing, and debt collection. Those businesses are growing wildly, and they're turning profitable. The real wild card is the $700 million of liquidity -- $100 million of cash and $600 million they could draw down. What are they going to do with that liquidity? If, in the next six months, they don't find anything, my prediction is they'll buy back more stock. Management and the board own 60% [of the company].
Emil Lee: It seems CompuCredit might be underleveraged.
Tom Brown: Tangible equity to assets is at about 33%; 20% is where they feel comfortable.
You can buy this company at eight times 2008 [Second Curve's estimated] earnings -- plus the excess liquidity. CompuCredit has managed earnings and GAAP earnings. This year, the consensus earnings estimate is around 4 bucks; that's the GAAP estimate. The managed [earnings] estimate, which is what Bloomberg uses, is $3.63 per share. My feeling is next year it'll do $4.50 to $5.00 per share. In general, the difference between GAAP and managed earnings is that the managed earnings acts as if securitizations stay on a company's books. This gives a more holistic view of the company.
Emil Lee: It seems as though CompuCredit has a built-in hedge -- when credit is tight, and advance rates on securitization and warehouse facilities dry up, that means favorable pricing for the debt-collection segment. What are your thoughts on this?
Tom Brown: I must be careful what I wish for! [In those circumstances], it'll be the best time for CompuCredit to be making acquisitions, and for the debt-collection segment to be making credit card receivable acquisitions [in other words, buying up bad debt] -- but it'll be the worst time for CompuCredit's stock price.
Emil Lee: Why don't other credit card lenders do this?
Tom Brown: There's reputational risk. With two-year delinquent borrowers, you have to get aggressive. That person may never pay you. Lousy collection practices affect the performing business because of word of mouth and media headlines. Another issue is that large card issuers can book gains [from selling charged-off debt] right up front. It's a way of shoring up weak earnings.
Emil Lee: Why is CompuCredit able to exploit the subprime segment better than its competition? It seems that CompuCredit's 22% net interest margin would attract competition, so is there a long-term competitive advantage?
Tom Brown: Right now, that's one of the thing I like about CompuCredit. To issue Visa and MasterCard cards, you have to be a member of the network. CompuCredit works with three different banks that house new credit card receivables. The banks that are issuers of the cards, such as JPMorgan and Bank of America, are heavily regulated, and the regulators don't like the subprime business -- that walls off competition. It's very difficult [for competitors] to serve CompuCredit's customers.
Emil Lee: CompuCredit says its loans must make sense for the borrower. Is this warranted, given the seemingly heavy fee structure and 22% net interest margins? Do you see CompuCredit's customers climbing the FICO ladder -- and does CompuCredit retain the customers that are able to improve their credit scores?
Tom Brown: CompuCredit is expending an increasing amount of its effort to retain those "moving up" customers. [CompuCredit] would really like to migrate customers from fee-based cards to balance-driven cards. It has specific rewards programs. For example, if a borrower makes timely payments, [CompuCredit] will increase the line of credit. The program works to increase timely payments.
Emil Lee: CompuCredit has only a 10-year operating history. Is that enough credit cycles to judge the company?
Tom Brown: Senior management came from the collections business, so management has a longer history of dealing with collections. When you're lending money to subprime borrowers, underwriting is more important than the economy.
Emil Lee: How do you judge whether a merger will create real synergies or not?
Tom Brown: First, we have to understand the buyer. Does [the merger] make sense? What [is the buyer] trying to do, and does what the seller wants to do make sense? I go in knowing historically that two-thirds to three-fourths [of acquisitions], from the acquirer's standpoint in banking in corporate America, destroy value. The burden of proof is on the acquirer. We know most [acquisitions] fail, so let's figure out why this is going to fail.
Emil Lee: How do you value the residual value a company retains in securitizations?
Tom Brown: We go through the assumptions -- there's enough information in the trust, such as prepayment [assumptions]. Sometimes, we need to know from management what their models are, the lumpiness with prepays -- [such as] right after graduation -- but there is data to track the actual performance of trusts versus the gain on sale calculation.
Emil Lee: CompuCredit is expanding into other subprime segments, such as auto financing and payday lending. How does this build the company's moat?
Tom Brown: Well, that's what we'll see in 2007 -- which could cause CompuCredit to be a home run. It's testing in a Texas storefront location whether it can cross-sell these services.
Emil Lee: It seems CompuCredit has recently had an uptick in charge-offs and delinquency. Is this a cause for concern? Do you think defaults will stay reasonable?
Tom Brown: I think defaults will go up. The fastest-growing part of its portfolio is the fee-based card, which has higher delinquencies but significantly higher revenue. The fee-based card is more profitable. Overall, it's a positive for profitability.
Emil Lee: In the end, it comes down to this: The stock market thinks CompuCredit is vulnerable to a credit crunch when an increasingly debt-laden borrower starts to default, spurred by things such as a possible housing downturn or a weakening economy. What would your rebuttal be?
Tom Brown: I would respond that underwriting is more important than the economy. CompuCredit is going to a higher level of earnings growth and profitability throughout the economic cycle.
posted by Never-Limp at 11:14 AM
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