Description
Financial services retailer with 20%+ EBITDA margins, recurring revenue, 8% FCF yield, and good historical and better future growth. Trades at discount to peers.
FINANCIAL SUMMARY
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Fiscal year ending June 30
(millions, except per share)
6/02 6/03 6/04 6/05(b) 6/06(c)
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Revenue $229 $234 $246 $269 $311
EBITDA(a) 49 50 53 59 67
Margin 21.6% 21.5% 21.5% 21.8% 21.5%
Net Income(a) 10 13 17 27 33
EPS $1.00 $1.25 $1.55 $1.98 $2.44
FY2004 ROIC, and ROE is 12.7%, and 11.7%, respectively.
Ticker Nasdaq: AACE
FD Shares 13.661
Price (mid-day 10/7) $26.80
Market Value $366.4
Net Debt (d) 37.1
Enterprise Value $403.5
(a) Adjusted for certain non-recurrings
(b) Mid-point of Company guidance
(c) My base case projection (see assumptions herein)
(d) Excludes $100 million of cash in Working Capital not deemed to be excess cash.
6/04 6/05E
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EV / EBITDA 7.6x 6.9x
EV / EBIT 9.7x 8.4x
EV / EBITDA-CAPX 8.9x 8.2x
MV / NI 18.9x 14.1x
BUSINESS SUMMARY
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ACE Cash Express, Inc. (“ACE”, “AACE”, or the “Company”) sells fee-based financial products through a network of 1,200 (1,000 Company owned, and 200 franchised) retail stores, in 37 states. In aggregate the Company has 38 million customer visits annually. The Company offers the following products:
1. Check Cashing (54% of 2004 Sales).
ACE is the largest owner/operator of check cashing retail stores in the United States. For a fee of approximately 2.3% of a check’s face value, the Company cashes payroll checks (primarily), government assistance checks, tax refunds and insurance checks. Check Cashing revenue has grown at a 5-yr CAGR of 10.4%. Growth has been seen both in the number of checks cashed, as well as the average face value, and hence the average fee revenue per check cashed.
ACE takes the risk that a check bounces. They maintain a proprietary decision support system to make real-time credit decisions. Historically their write-off percentage has been about 0.15% (considered low for industry) of the face value of the checks, or about 6.5% of check cashing revenue (6.5% = 0.15% / 2.3%). The Company recognizes Gross Revenue, and shows an allowance for bad-debt as an expense.
2. Payday Loans (31% of Sales)
ACE is 4th largest provider of short-term consumer loans (“Payday Loans”) in the United States.
How does a Payday Loan Work?
The Company provides customers with cash in exchange for the customer’s personal check. ACE agrees to wait until the customer’s next payday to deposit the check (typically two to four weeks later). The average face value of a Payday Loan is $277 and average fee is $42.90. Prices are quoted as fees per $100 face – e.g. “$15 per $100 face”. The Payday Loan business is the fastest growing product that the Company offers; revenue has grown at a 5-year CAGR of 40%.
Maximum fees for Payday Loans are regulated on a state-by-state basis. The Company offers these services ONLY in the 20 states where they are explicitly permitted under law. In 3 states, Payday Loans are offered through marketing agreements with Republic Bank & Trust Company (“Republic”) who makes the loans. The Loans made through republic have a slightly higher fee, and therefore, net of Republic’s share, ACE’s gross margin is substantially the same as the loans they make.
3. Bill Payment and Other Services (20% of Sales).
Through an alliance with MoneyGram (NYSE: MGI, recent spin-out from Viad), the Company also provides money transfers, bill payment, and money orders. ACE locations also serve as MoneyGram-agents as part of MoneyGram’s network of 80,000 worldwide agents. MoneyGram is the second largest wire transfer provider (Western Union being the largest). The MoneyGram money orders are private labeled with ACE’s logo and ACE receives a commission on each wire transfer that is sent through the MoneyGram Network. ACE charges $1 per bill payment. Some customers cash checks at ACE and then use the bill payment service – ACE collects multiple fee streams on those dollars. This business has grown from $10mm in 2001 to $17mm in 2004.
4. New Products
ACE’s new products are very exciting:
(a) ACE recently introduced a prepaid debit MasterCard where customers can load cash onto a MasterCard and use it wherever MasterCard is accepted. A fee is collected when customers (i) purchase the card, (ii) load cash on the card, (iii) use it for a purchase, or (iv) use it at an automated teller machine for a withdrawal.
In 2004, the Company sold approximately 150,000 cards and loaded a total of $270 million. Customers love this product because it’s “self-policing”, i.e., you cannot spend anymore than you put on it. Many customers in the un-banked/under-banked demographic (see CUSTOMERS section below) have had bad experiences with credit cards because of late fees and/or over-credit-limit fees. These cards are another example of how ACE can earn multiple fee streams on a single dollar; i.e. a customer may cash a check or take out a Payday Loan, and then use that cash to load onto a pre-paid.
(b) ACE will also be offering a pre-paid “payroll card” that can be filled by employers. This is marked that will have considerable growth. Similar to direct deposit for people who don’t have checking accounts, employees will receive the value of the paycheck immediately on their cards. The value proposition for employers is that it is cheaper for them to distribute payroll this way than with checks. The market for these cards is experiencing rapid growth and ACE has just hired a new VP of marketing to focus on this product. Sales of this product would have a very high recurring nature. David Robertson, publisher of The Nilson Report, an industry newsletter, was quoted as saying that, “It creates value for both the corporate clients and the employees -- especially those customers who are unbanked." The unbanked employee, or an employee without a traditional bank account, stands to benefit because he can avoid fee-based check-cashing outlets..... It's a billion-dollar industry right now and I expect it to grow to five or 10 times larger."
From the check cashing business, ACE maintains a database of employers that they cash checks from. The Company can mine this data to find logical customers to target for their payroll card product. I spoke to the Company about how this product cannibalizes their check cashing business. “It certainly will, but this is a good thing.” Check cashing customers see ACE on average 5-6x a year, a payroll card user will put 24 paychecks on the card. Since the Company’s capital is not being loaned with a payroll card, there are lower working capital requirements.
COMPANY STORES
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In addition to the Company’s 1,200 full-service ACE Cash Express (“Express”) stores that offer the full suite of products (check cashing, money orders, loans, bill payment, and pre-paid debit cards), the Company recently opened 11 ACE Cash Advance (“Advance”) stores – smaller stores that only offer payday lending. In fiscal 2005, the Company plans on building 60 new Express stores and 25 Advance Stores.
UNIT ECONOMICS (full service Express stores):
Start-up Costs
* $75k Capital Inv. (leasehold, computer, security)
* $100k W/C for loans.
* $20k in Startup losses for first 12m of operation.
Average Store Gross Margin (based on stores opened in 2001 – includes store level depreciation)
Year 1: $(21.3) (can you include a margin % here too?)
Year 2: 8.4
Year 3: 39.4
Year 4: 52.0
*Company claims that on a 10-year basis with no terminal value stores have a 30-35% IRR>
CUSTOMERS
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The primary customers for the Company’s products are un-banked or under-banked people. According to Federal Reserve statistics, approximately 25% of Americans are un-banked or under-banked.
These people typically do not have a bank account, usually because the individual spends most of their paycheck in a matter of days and therefore never has enough cash to meet the minimum deposit requirements, or has cancelled their bank account after repeatedly being charged overdraft, and minimum deposit shortfall penalties. Check cashing stores are willing, for a fee, to assume the risk that checks bounce.
For customers who do have bank-accounts, banks require an account holder to maintain sufficient funds to cover a check to be cashed or to wait several days for the check to clear. Check cashing stores provide an economically attractive alternative to these customers. They can cash their checks and immediately attend to their obligations. Although these customers would clearly save money by depositing their checks in a bank and waiting for it to clear, many people prefer to a convenience fee, in order to have the cash immediately available to meet their obligations, and avoid other fees that they may pay for late bills. Payday Loan customers however, must have a checking account. These customers fit more into the “under-banked” category.
INDUSTRY AND MARKET
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According to the Company, there are 11,000 check cashing stores nationally. However, only 5 operate networks of over 100 locations, and only 5 operate networks between 50 and 100 locations. There are approximately $35 billion of Payday Loans are issued each year, and approximately 22,000 locations offering them. (ACE’s stores as well as many competitors are included in both these numbers). The highly fragmented nature of the market provides substantial acquisition opportunities for the Company to expand in areas that it is not currently operating.
ACE competes with other check cashing stores, grocery stores, banks and savings and loans. ACE has also been facing competition from automated check cashing machines in supermarkets and convenience stores.
Wal-Mart has recently entered the business. ACE has conducted an analysis of stores near Wal-Mart’s locations and has not experienced any impact from Wal-Mart. The only noticeable decline is that ACE has seen a decline in the number of Wal-Mart Employee checks cashed (Wal-Mart is cashing for free). Advance America, Cash Advance Centers, Inc. (“Advance America”), is a pure-play Payday Loan Company that recently filed an S-1 (Morgan Stanley). Advance America is the largest provider of Payday Loans in the United States.
GROWTH STRATEGY
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The Company’s growth strategy is four-fold:
(i) Open more company stores
In 2004, ACE opened 53 new stores and is targeting 60 new Company stores for 2005 (net gain of 40-45 after closures). ACE’s target is to open 200 additional company-owned stores (net of closures) in aggregate for the 2006-2008. Further, the Company believes there is an opportunity to add 1,000 Company owned locations and 2,000 franchises over the next 10-15 years.
(ii) Growth through acquisition
Since 1991, ACE has acquired over 500 stores. Acquiring stores provides access to an existing customer base and is the primary method by which the Company enters new markets. Of the 11,000 check cashing stores nationally, more than 90% of them are part of networks smaller than 50 stores. And many of them are single store operations - when these owners decide to leave the business, ACE is one of few logical buyers.
Historically, the Company has been able to pay 3.1x EBITDA for acquisitions (before revenue enhancements and cost savings) and even after conversion costs, they are immediately accretive. They need to provide working capital for acquired business, which brings the multiple closer to 4-5x. ACE is able to achieve revenue enhancements because most of the acquired stores do not offer the full suite of products that ACE can offer, and therefore ACE can add to their product offerings, and increase revenue and cash flow. There are also significant economies of scale for a larger player like ACE, which include: (a) cash management (e.g. armored cars), (b) district supervision, (c) technology infrastructure, and (d) brand awareness.
(iii) Organic Growth.
ACE has been successful in achieving positive comp store growth, which is attributable to both increased sales in existing products and the introduction of new products. Revenue growth on a comp store basis for stores opened in 2001 and earlier was 6.5% and 5.3% for 2004 and 2003, respectively. For the 6-year period ended 2004, same store CAGR is 8.1%.
Over 25% of the Company’s customers are Hispanic. This is a large and growing market that the Company has identified as an opportunity for growth. This demographic has grown 58% from the 1990’s and now is 35 million large, and is expected to grow to 59 million by 2010. To address this, the Company offers services in both English and Spanish in many markets.
(iv) New products.
The company’s debit card and payroll will be an additional source of increased comp store sales. Payroll cards are an increasingly popular wage distribution alternative for employers that do not want to go through the weekly or biweekly process of printing and distributing individual payroll checks.
REGULATION, LAWSUITS AND OTHER RISKS
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Check Cashing, the Company’s largest product, is not highly regulated. However, the Payday Loan business is subject to substantial regulation mostly relating the exploitation of interest rates and consumer groups have called the practice usury.
In about 20 states, the Company operates under state law. In other words, these states license and dictate how a Payday Loan works and what fees the Company can charge. ACE, unlike many of its competitors (such as Advance America), has a policy of only operating in any states where they can get EXPLICIT licenses to offer their products. The Company feels that in recent years the regulatory environment has gotten better, not worse. For instance, 10 years ago only 6 states permitted Payday Loans, now there are 30. The Company is continuing lobbying with states to pass laws to regulate Payday Loans and open new markets for the Company.
There are some lawsuits (which ACE is not a party to) on-going in GA and NC regarding Payday Loans. ACE is not involved in these suits. There is no proper way to get licensed in these states and therefore per Company policy, ACE doesn’t lend in these states because there is no way to get licensed.
I think the risk of ACE being party to a lawsuit surrounding Payday Loans is relatively low, as long as ACE continues to operate within the guidelines set by each of the states they operate in. The biggest regulation risk for ACE is the risk that a state changes its mind and ban’s Payday Loans – revoking licenses. This product is one that is demanded by consumers.
OTHER RISKS:
- Write-offs. Primary risk in check cashing business is bounced/forged, checks. The Company historically has written of 6% of Check Cashing Revenue, or 0.15% of face-value, in write-offs. This number has been flat to declining over the last several years.
- Competition. Highly competitive with new entrants opening shops everyday. A quick web-search on the internet will also reveal a slew of on-line competitors. (see previous COMPETITION section). While the barriers to open a check cashing store are relatively low, to do it right requires the proper systems in order to maintain low bad-debt expense.
In addition to price, the Company competes on service and depth of product offering – two areas where ACE in strong. Further, the Company believes that it has a superior cost structure and operating controls (such as daily monitoring of revenue on product-by-product, store-by-store, and employee-by-employee basis). Because their inventory is cash, limiting shrinkage is very important. They pay close attention to operation statistics that affect customer satisfaction, e.g., track how many times a store is open late or closes early.
INVESTMENT HYPOTHESIS
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Company will use free cash flow and excess debt capacity to execute growth strategy, while continuing to achieve positive same-store growth.
I ran a model with the following assumptions:
i. FY 2005: 45 new company owned stores (net of closures), 25 new Advance stores
ii. 5% average Revenue per store growth
iii. Flat margins
iv. 0 Acquisitions
v. 0 new franchises
With these assumptions the Company will beat management’s guidance of $1.92-$2.00 per share for FY 6/05. and FY 6/06 EBITDA and EPS would be $2.44. Cumulative FCF for 2005 and 2006 is $67 million or $4.93 per share. However, I believe the Company’s guidance to be conservative because they don’t include:
i. Acquisitions or new franchises. Last year the company bought 34 stores and plans to continue this strategy. Recent secondary offering cleaned up balance sheet which provides ample capacity.
ii. Comp store growth. The addition of the payroll card and debit card could accelerate comp store growth beyond 5%.
iii. Multiple expansion. The comparables are trading 25% higher than AACE (SEE BELOW).
A scenario, which includes 10 acquisitions, and 8% comp store growth and 100 bps margin improvement, generates $76mm in EBITDA, and $38million in Net income ($2.79/share) for FY2006E. Before any multiple expansion we’d be looking at a $50 stock based on these numbers in 18-moths.
COMPARABLES
I looked at the set of publicly traded cash checking stores, pawn shops, and MoneyGram. Collectively, this peer group is trading at 10x 2004 EV/EBITDA, 12.8x EV/EBIT, 15.4x EV/EBITDA – CAPX,
(trailing multiples)
EV/EBITDA EV/EBIT EV/EBITDA-CAPX
EZPW 7.4x 12.0x 10.5x
FCFS 12.0x 15.2x 15.2x
PWN 11.2x 12.5x 15.3x
WRLD 10.5x 13.5x 19.0x
MGI 10.1x 10.9x 17.0x
Average 10.2x 12.8x 15.4x
AACE 7.6x 9.7x 8.9x
INVESTMENT HIGHLIGHTS
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- Growth. The Company has grown from sales of $122mm in FY99 to $247mm in FY2004. Stores in the network have grown from 900 to over 1,200 during the same time period. The Company’s growth plan continues this pace. Most of the growth will come from the high margin Payday Loan business.
- Acquisition Opportunities. ACE is able to make immediately accretive acquisitions. Average price is 3.1X EBITDA (plus working capital). Acquisitions have significant opportunities for revenue and cost synergies.
- Operating leverage. Economies of scale.
- High margins that are improving. ACE has historically enjoyed 20%+ EBITDA margins that have been increasing slowly over the last few years. Margin improvement is attributable to both operational improvement, economies of scale and product mix.
- Recurring revenue. ACE sees its typical customer 5-to-6 times per year. The Payroll card is a growing market that could be a source of true recurring revenue.
Catalyst
- Successful execution of growth plan and increased EBITDA. Successful opening of new company stores, upside and continuing acquisition strategy.
- New product offerings to continue comp store growth. Payroll card could be significant.
- Increased Wall Street coverage. The Company is covered by Roth Capital and Morgan Keegan (initiated coverage on 9/21/04). The Company recently presented at Thomas Weisel’s consumer conference. TW doesn’t write on the Company anymore because their Analyst retired. It is likely that it will be picked up by a new one. Further, Morgan Stanley is the lead underwriter for Advance America, one of the Company’s competitors. This could bring interest from other larger investment banks.
- Multiple expansion.