You may not know the name, but this company likely knows you, or at least the details of your spending. It gathers all kinds of data about our buying, works with and makes sense of that information, and then passes it along to its clients. Those clients, in turn, can personalize the offers they make to us in retail and other arenas.
Alliance Data Systems Corporation (ADS, Financial) deals in credit cards obviously, loyalty cards, and more. It’s part of the new world of digital or data marketing that has made huge strides in the past few decades.
ADS is on the Undervalued Predictable screener at GuruFocus, on the strength of its ability to consistently generate increasing earnings and because it is, by at least some metrics, selling at a discount. Observe the blue line (EBITDA, a form of earnings) and the green line (price per share), giving particular attention the share price over the past year:
History
1996: Alliance Data created by the merger of JC Penney's credit card processing unit and The Limited's credit card bank operation.
1998: acquires LoyaltyOne, previously known as The Loyalty Group Canada
2001: goes public on the New York Stock Exchange at $12 per share
2004: acquisition of Epsilon
2005: acquisition of Bigfoot Interactive
2006: acquisition of DoubleClick Email Solutions, Inc.
2007: acquisition of Abacus
2008: Alliance Data's Network Services business sold to Heartland Payment Systems; Alliance Data’s Utility Services sold to Vertex
2008/2009: repurchased one-third of company shares at $50/share
2012: acquisition of the private label credit card portfolio of The Bon-Ton Stores, Inc.
2014: acquisition of BrandLoyalty, and acquisition of Conversant (by Epsilon)
2014: Makes a repeat appearance on Fortune Magazine’s list of Most Admired Companies.
History based on information provided at Wikipedia and the company website.
Takeaways: Acquisitions, and strategic divestitures, play an crucial role in this company’s rapid growth and market positions.
The business
In the broadest sense, ADS is a marketing company, but within that universe describes itself as a “data-driven marketing and loyalty solutions” company. Further, it is a business-to-business company, helping other companies connect with consumers. In its words, “We focus on facilitating and managing interactions between our clients and their customers through all consumer marketing channels, including in-store, online, catalog, mail, telephone and email, and emerging channels such as mobile and social media.” (10-K for 2013)
It does this by offering the following types of services:
- customer loyalty programs
- database marketing services
- marketing strategy consulting
- analytics and creative services
- direct marketing services
- private label and co-brand retail credit card programs
The business reports all of this activity through three segments:
- LoyaltyOne: operates the AIR MILES Reward Program in Canada, as well as similar programs in Brazil and Europe
- Epsilon: Database design and management, data services, analytical services
- Private Label Services and Credit (also referenced as AllianceData): receivables financing, processing of accounts and billing, remittance processing, and marketing services
Here’s how each of the segments is expected to contribute to 2015’s expected $6.5 billion in revenue:
Competition
The company reports in its 10-K for 2013 that it faces intense competition from “marketing services companies, credit card issuers, and data processing companies.” In addition, it competes as well with the in-house staff of its current and potential clients. Put another way, it is an outsourcing company.
As a conglomerate type of company, even though its product lines are in generally the same area, each individual piece will each have its own competitive ecosystem. There’s no indication that any of the individual lines face undue pressure, and we further note that this company has been prepared in the past to sell any subsidiary that is no longer a good fit.
Yahoo! Finance lists ADS’s competitors as American Express Company (AXP, Financial) and Discover Financial Services (DFS, Financial). American Express has a market cap of about $82.5 billion; Discover clocks in at just over $27 billion, so ADS is up against a couple of giants.
Other information:
Alliance focuses its own marketing on big corporations, including the world’s biggest retailers. According to a presentation on September 29, 2014, Epsilon has 259 existing large clients; Alliance Data has 135 existing large clients, and LoyaltyOne/AirMiles has 120 sponsors.
According to its 10-K for 2013, it is incorporated in Delaware and is headquartered in Plano, Texas,
16,000 employees as of the end of 2014 (Roadshow, 2015)
Does not, nor does it intend, to pay any cash dividends in the foreseeable future.
Takeaways: A company that specializes in using data and financial services to help its clients market more effectively; whether through loyalty cards, credit cards, or data mining, it provides infrastructure and information its clients can use for sales growth. It has exposure to the financial services industry and international markets. Competition is strong, but not overwhelming.
Opportunities and risks
The company expects traditional marketing to remain flat in at least the short term, while direct (targeted) marketing grows at a rate of more than 5% a year, according to its Roadshow presentation for the first quarter of 2015. That difference reflects the increasing uptake of online or digital marketing, which offers greater efficiency. Alliance does not have much exposure to traditional marketing.
In its 10-K for 2013, ADS says it expects to sell more of its integrated, end-to-end marketing solutions; this will allow it to generate more business from existing clients, most of whom do not subscribe to a full suite of services.
Expanding the global footprint also is expected to be a key growth driver. In the past couple of years it has seen strong growth in Brazil and Europe, as it leverages the expertise it has built in North America.
And, in its words, it plans to optimize its business portfolio. This means evaluating its current businesses, and “...we will consider select acquisitions of complementary businesses that would enhance our product portfolio, market positioning or geographic presence.” (10-K, 2013)
Risks
In 2013, its 10 largest clients accounted for 42.5% of its revenue; a loss of any of its major clients could have a material effect on revenue and earnings. And while data integration does provide something of a moat, it is not a complete moat.
Some of ADS’ business is rooted in the financial sector (credit cards, for example), and it faces the potential for losses if more customers stop or slow the payment of their bills. In this sense, the company depends on good economic conditions in the countries in which it operates.
As a major borrower, and as the company behind a number of credit cards, the company feels the effects of changes in interest rates. It notes in the 10-K, “ In 2013, a 1.0% increase in interest rates would have resulted in a decrease to fiscal year pre-tax income of approximately $23.9 million. Conversely, a corresponding decrease in interest rates would have resulted in a comparable increase to pre-tax income.”
Alliance operates in areas that garner lots of regulatory attention, including the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Most of the bank restructuring arising out of the 2008 financial crisis should be past, but the company warns there is still a possibility of more capital contributions.
As a company in the data business, it faces financial, operating and reputational risks if it experiences any data breaches or infringements on end-user privacy.
Comments on opportunities and risks: the company has a strategy for moving forward with new growth on both the top and bottom lines. And while there are certainly risks, there are none at the moment that should upset its growth plans.
Growth
Here’s some context for Alliance’s growth to date, with EBITDA (blue line) and the stock price (green line):
In the recent past, all three segments have contributed to revenue and earnings growth (Roadshow presentation):
For 2015, the company offers guidance of 23% growth in revenue and 18% growth for Core EPS (it does not provide guidance for EBITDA). That would be a big jump in revenue growth, mainly because of the Conversant acquisition.
Once the full effect of buying Conversant is realized, the company expects it to increase earnings by $2.00 per share; half from accretion and half from synergies arising out of the acquisition.
In the longer term, Alliance appears well positioned to take advantage of the growing interest in "scientific" marketing, marketing that is more accountable for sales and earnings results.
Comments on growth: A well balanced portfolio of companies has generated strong and consistent results in the past, and as noted above, there appear to be no pressing reasons for thinking this momentum will be lost.
Management
President, Chief Executive Officer, Director: Edward J. Heffernan, age 51, previously an executive vice president and chief financial officer of Alliance Data. Also held senior roles at First Data Corporation, Citicorp, and Credit Suisse First Boston
Chief Financial Officer & Executive Vice President: Charles L. Horn, age 53; from 1999 to November 2009, he served as senior vice president and chief financial officer for Builders Firstsource, Inc.; he is a certified public accountant in the state of Texas.
Independent Non-Executive Chairman of the Board: Robert A. Minicucci, age 63, has served as a director since August 1996. Mr. Minicucci is a general partner with Welsh, Carson, Anderson & Stowe, an investment firm.
A board of eight directors, including seven independent, non-employee directors and CEO Heffernan. Board members have experience or expertise in investment strategies, staffing/outsourcing, academia (management), business/strategic consulting, engineering, and data processing outsourcing.
ISS Governance QuickScore: A score of 8 on a scale on which 1 indicates a lower governance risk and 10 represents higher governance risk. The board receives red flags for board practices, use of equity and termination. It receives one green star, for other issues.
Unless otherwise noted, information on management and the board of directors came from Reuters.com
Comments: Current management and board have been fully involved in growing the company and should be able to keep growing it at this pace.
Ownership
Gurus: Six of the gurus followed by GuruFocus have holdings in Alliance Data Systems; the biggest holding belongs to Ronald Muhlenkamp (Trades, Portfolio) with 121,330 shares. Other gurus with holdings are Joel Greenblatt (Trades, Portfolio), Steven Cohen (Trades, Portfolio), Jim Simons (Trades, Portfolio), RS Investment Management (Trades, Portfolio), Pioneer Investments (Trades, Portfolio), Ray Dalio (Trades, Portfolio), and Columbia Wanger (Trades, Portfolio).
Institutional investors: As the following chart from nasdaq.com shows, institutions (including pension funds, mutual funds, banks, and insurance companies) hold almost 94% of ADS stock:
Short interests: Low, at 3.45% of the float, according to GuruFocus.com. And the following chart shows short interest in historical context:
Insiders: Relatively high ownership by insiders, which GuruFocus puts at 6%. It also provides the following table and chart showing the holdings of individual insiders:
Comments on ownership: This company is almost entirely owned by institutional investors and insiders. That, in turn, suggests a company that should not make any dramatic moves, whether up or down. However, as we saw in a chart at the beginning of this article, the company has seen some volatile times in 2014.
ADS by the numbers
Comments on the key statistics: A market cap of more than $16.5 billion, not too far off its 52-week high, trailing P/E over more than 35.00, ROE of almost 30%, no dividend, and the share count went up in the past year.
Financial strength
The automated rating system at GuruFocus gives ADS a 7/10 rating for Financial Strength, and an 8/10 for Profitability & Growth.
For a company owned mainly by institutions and insiders, it displays a surprising amount of red. And, two Severe Warning Signs. To account for the red and one of the warning signs, we take a look at long-term debt, which is flagged at least twice on the Summary page:
You may have noticed in the History section of this article that the company bought back a third of its shares in 2008/09; what we didn’t tell you at that time was that the company borrowed to do it. Let’s now take a look at the share count in an historical context:
So, our first observation should be that while debt did go up, the number of shares outstanding went down. By reducing the share count dramatically, Alliance was able to set the stage for strong earnings performances in the years ahead.
Second, we note on the graph that debt has declined by about a quarter in the last couple of years (while the share count began going down as well).
Now, looking specifically at the Cash to Debt ratio (flagged on the Summary page), let’s put it into context, too:
In the larger scheme of things, the Cash to Debt ratio has not changed significantly, so we’ll set it aside as a concern at this point.
Finally, let’s look at the history of free cash flow:
Referencing the 10-Year Financials, we see free cash flow for fiscal 2014 comes in at just under $1.2 billion –Â interest expense for the same period is listed at $160 million.
Comments on financial strength: The big concern going in was the company’s long-term debt, but we can see the company used it strategically and took it on at a time when interest rates were at long-time lows. After reviewing the history of the company’s debt, interest expenses, and free cash flow we go away without undue concern about Alliance’s financial strength.
Valuation
ADS came to our attention because of its inclusion in the Undervalued Predictable screener:
The numbers to the right of the stars refer to, respectively, the current share price, the discount cash flow valuation and the current price’s percentage discount to that valuation. We note that the discount cash flow valuation shown here differs from the traditional Discounted Cash Flow value, which can be calculated elsewhere.
Now, let’s ask if that lofty discount cash flow valuation of $543 is reasonable. At first glance, it seems to be awfully large. Yet, perhaps not if we consider a couple of factors: first, the acquisition of Conversant delivers an accretive $2.00 per share in Year 3 after acquisition, as estimated in its presentation of September 29, 2014. Second, if the company can continue to grow EPS at the same rate for the next three years as the past three years (12.4%), that would add an additional $3.31 per share. Both of these factors are speculative at the moment, of course.
Turning to the Predictability rating, we see ADS enjoys a 5-Star rating, which is as good as it gets for consistency. Testing by GuruFocus shows the average annual gain for a 5-Star stock is 12.1%. Applying that to Alliance’s current price (close of trading, February 24, for five years, generates a potential price of $489 in 2020. That’s about 10% below the $543 number generated by the discount cash flow calculation.
As we’ve seen in the charts, price stopped tracking EBITDA about a year ago, and a ‘normalization’ of this relationship would give the stock price a significant boost.
One final note: the current PEG ratio is 1.66, which indicates a fairly valued stock (PEG ratios between 1.0 and 2.0 are considered fairly valued).
Comments on valuation: Starting with the fair valuation coming from the PEG ratio, we can begin by saying the current price is a reasonable price. Building on the Conversant acquisition, previous EPS growth as a proxy for future growth, Predictability, and discount cash flow valuation, a price of $500 or more in three to five years seems reasonably possible.
Conclusions
A strong history of top and bottom line growth, combined with as high a predictability rating as possible, suggests Alliance Data Systems Corporation is a very good bet for investors seeking capital appreciation.
It does not pay a dividend, so income investors need not apply.
As we’ve seen on the charts, the share price has been range-bound for the past year while earnings/EBITDA continued to grow, making this an even more interesting candidate for investors who take a longer view.
