Hit, Stand, Double Down Or Split- How Will Alliance Data(ADS) Play Its Cards Following Board Seat For ValueAct?

In the nine years after since a scuttled $6.4 billion acquisition by private equity firm Blackstone, Alliance Data Systems(ADS) has done well, with a current market capitalization of $13.5 billion. The company has attracted the interest of ValueAct Capital which has acquired a 10.5% stake.  In an amended 13D filed with the SEC on Monday, ValueAct disclosed that Alliance Data has agreed to add Kelly Barlow, a ValueAct partner, to its Board.

On March 16, 2017 the Reporting Persons were informed that the board of
directors of the Issuer unanimously recommended the nomination of Kelly
Barlow for election as a director at the Issuer's 2017 annual meeting. Mr.
Barlow is a Partner of ValueAct Holdings and ValueAct Holdings GP.

ValueAct’s stake, and the addition of Mr. Barlow to the Board have led to speculation as to what ValueAct might push Alliance Data to do in order to unlock shareholder value. ValueAct has been busy, recently acquiring a stake in the newly independent Bioverativ(BIVV) Even before it gained a Board seat, Susquehanna Financial Group speculated that ValueAct might be poised to push for a break up of the company.

With ValueAct ownership rising to over 10%, could an Alliance Data Systems separation be underway?

Our sense is that management’s tone has begun to soften regarding inter-segment dependencies. Would it make sense to split up Alliance Data ?

n 2016, Card Services had adjusted earnings before interest, taxes, depreciation and amortization (Ebitda) growth of 14%. LoyaltyOne Ebitda also grew 14% (driven by the ramp-up of BrandLoyalty and offset by declining air-miles revenue). Epsilon’s adjusted Ebitda declined 6% due to reduced client spending. Card-services revenue rose 24% in 2016, versus down 1% for LoyaltyOne and up 1% for Epsilon. Though management believes LoyaltyOne and Epsilon will get past these hurdles in future periods, Card Services is the perennial revenue powerhouse of the firm.

Per the third-quarter 10Q, Alliance Data has “more than 160 private-label retail and co-brand credit card programs.” Given the approximate $14 billion of credit receivables in that period, this contemplates average receivables of about $88 million per merchant partner. Despite some partners with cyclical exposure (e.g., jewelry, home renovation), Alliance Data typically does not serve the department-store sector, avoiding secular declines seen in the category. So the card segment looks generally diversified to us, with many smaller merchants that exhibit less negotiating power. For each $10 lent by [PayPal Holdings (PYPL) unit] PayPal Credit (which ties ecommerce and credit), Alliance Data underwrites all $10 and keeps $1 on its books. This has helped lift Alliance Data e-commerce exposure, helping diversify its physical presence at the point of sale. Even when backing out Alliance Data’s higher net charge-off (NCO) rate (Synchrony Financial ’s (SYF) NCO rate was 4.5% in 2016 versus Alliance Data’s 5.1%), Alliance Data maintains a 700-plus basis-points lead. Card Services also leads Synchrony in yields and in loan growth (though off a smaller base that is just one-fifth the size of Synchrony’s).

With Epsilon’s 2016 revenue growth just below 1% year-over-year, Alliance Data’s marketing division has had to adjust to a changing marketplace. Per Chief Executive Ed Heffernan’s comments in a February conference, massive loyalty programs are on the decline as customers now demand a less customized, “shrink-wrap product” with 80% of the traditional functionality and a turnaround time of three months (versus 12 months for a customized program). Management expects its outsourcing of labor to India and a shift in focus to standardized products to help grow 2017 revenues by 4% year-over-year and adjusted Ebitda by 4% year-over-year (versus adjusted Ebitda of negative 6% in 2016).

With the backlash of customer anger in Canada (due to then-expiring air miles) mostly in the rear-view mirror, management is relying on its BrandLoyalty grocery program to carry the LoyaltyOne division in 2017. Early redemptions of air miles in 2016 has management expecting an approximate 19% year-over-year decrease in Canada revenue and a negative 11% year-over-year decline in adjusted Ebitda. Management does not expect a full recovery to positive revenue and adjusted Ebitda until 2018. — James E. Friedman

TheStreet.com followed up subsequent to the director addition, suggesting that it increased the likelihood of a spinoff and that the company might break into three parts.

Alliance Data Systems on Monday reached an agreement to add a partner from Jeff Ubben’s activist fund ValueAct Capital to its board, in a move that could signal breakup or sale down the road for the maker of Victoria’s Secret and Pottery Barn branded credit cards.

In July, analysts suggested that ValueAct may be looking to see if Alliance Data Systems could break up its three distinct business units in a move to extract shareholder value. The company has a marketing and data business, Epsilon, a loyalty merchant coalition program, known as LoyaltyOne, in Canada and Europe, and the private-label card issuing business for brands, which represents a majority of its total revenues.

A spinoff of Alliance’s private label credit card business might look similar to GE’s(GE) spinoff of Synchrony Financial(SYF), and might attract a number of interested parties looking to acquire a quality credit card portfolio. We can’t say what the future will bring for Alliance Data, but we have a feeling that we will be hearing about a spinoff in the coming quarters.

Disclosure: The author holds shares of GE



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