Description

Summary:

ECN recently announced the sale of its Service Finance home improvement POS installment loan business. The stub consists of a misunderstood US capital-light manufactured housing prime and super prime loan originator with no recourse and a credit card advisory business. The stub company can grow EPS at 15% over the next 4-5 years. Re-rating of the stub + special dividend yield 40%+ upside. The stub is trading at <8x 2024 EPS.

Short history overview:

·       Element Financial split Element Fleet and Element Capital in 2016. Element Capital acquired Infor, a SPAC, and began trading separately. Element Capital became ECN Capital and operated on-balance sheet commercial finance business in three segments: Commercial and Vendor Finance, Rail Finance, and Aviation Finance.

·       The management team decided to shift focus and redeploy capital into mid-market spec fin businesses. In Feb 2017, the team sold the Commercial and Vendor Finance business to PNC. They also began winding down the rail and aviation businesses. In June 2017, the company acquired home improvement installment loan originator Service Finance. In October 2017, the company acquired Triad Services, a loan originator in the manufactured housing industry. In 2018, ECN bought a stake in Kessler, a service provider to credit card issuers, banks and credit unions. In 2019, it acquired all of Kessler. By 2020, the majority of the legacy loan book had run off.

·       The company is selling Service Finance for 18x 2021E EBITDA. The company will pay a gross special dividend of 7.5 CAD to investors in Q4. The stub will consist of Kessler and Triad.

Core Thesis: Triad used to play in the $6-8bn chattel loan market (~12-14% share) but in Q4 2020 expanded into the $12-15bn “land owned” market (2-3x in TAM). Triad was finally able to get into this business because they signed up Fannie and Freddie and got access to much cheaper funding (relative to banks). It should “easily” win low teens share in this market over time (from 0% in early 2020) given both products share the same dealer base, which already has a multi-decade relationship with Triad. This is a higher quality, faster growing business than the market thinks.

1.     For reference, business model:

a.     Triad originates and manages prime manufactured housing loans through a network of 3k+ dealers. It sells its loans to partners that include banks, insurance companies, credit unions, and GSEs.

b.     Manufactured housing loans are ~70% of originations with average FICO of 746, interest of ~6-7%, 16% down payment, 20 year term

                                               i.     The majority of the loans originated within this vertical are known as chattel loans (roughly 83% of the total), which finances only the manufactured home as it is not permanently attached to land. As security, the lender holds a lien against the home. Thus, chattel loans come with a higher interest rate than a conventional mortgage but are lower cost than an unsecured personal loan. Average loan size is ~$80k.

                                             ii.     The remaining ~17% of originations within this vertical are Land Plus loans (customer owns the land on which the manufactured home will be situated and uses that land in lieu of a cash down and Land Home loans, in which the customer finances both the owned land and manufactured home together. Land Home loans will be priced more in line with a conventional mortgage with funding provided by GSEs. Average loan size ~$140k.

c.       Managed Only

                                               i.     In this segment, Triad helps third parties in servicing, underwriting, and originating manufactured home loans, which are fully funded by the third-party client and have no recourse to Triad. This business line accounts for ~30% of total originations for Triad and targets slightly higher-risk clients that have an average FICO score of ~610, with an average loan interest rate of ~8.4%, a down payment of ~10%, and a term of ~19.5 years. All of these loans are structured as chattel loans.

d.     Floorplan

                                               i.     Provides relatively short-term financing to manufactured home dealers for both display inventory (approximate two-year duration) and construction (less than 30-day duration for homes that are completed and awaiting the final onsite inspection). The program is offered only to established dealers and provides an additional benefit to Triad by helping to build loyalty with the dealer, which in turn drives stronger originations. This is an 8% interest rate/40-50% ROE business with essentially 0 losses, thus this is the only business ECN holds on its own balance sheet.

2.     Expansion of TAM

a.      Triad plays in two markets: Chattel loans and land own

b.     Chattel loans is a $6-8bn market growing MSD to HSD a year (5% shipment, a couple of pts of price)

                                               i.     Triad has been gaining share here and is currently 12-14% of the market

                                             ii.     ~50% of the market is Berkshire’s Clayton homes. They focus on profitability, not market share gains. They also focus on subprime while Triad focuses on prime/super prime. The rest of the market is a long-tail of lenders (e.g. thousands of lenders do 1-2 loans a year)

                                            iii.     Going forward, Triad is expanding into subprime to capture more of the remaining 38% of the market.

c.      Land own is a $12-15bn market.

                                               i.     Triad did not play here until Q4 2020 because they did not have low cost funding to play in this lower gross yield paper (4% for land own vs. 7% for chattel). Banks are happy buying 7% paper but do not want to fund 4% interest rate land own paper through Triad because land own paper is essentially a normal mortgage and banks can do that themselves.

                                             ii.     Land own adds high incremental dollars to earnings. Land own loans are bigger at $140k while chattel loans are ~$80k, loss rates are similar, and Triad doesn’t need incremental sales people because they’re selling into the same accounts.

                                            iii.     Triad should be able to gain double digit share in this market because the same dealers who were going to Triad for chattel loans also serve customers who need land own loans. Now, a land own borrower can get financing at the dealer rather than going to a bank.

3.     Competitive advantage of Triad

a.      Advantaged channel relationships

                                               i.     Manufactured homes is an old school industry. The dealer and the Triad sales guy have probably been friends for 20 years. That’s a hard relationship for someone else to steal.

                                             ii.     Triad is advantaged because it doesn’t have a manufacturing arm like Clayton. Thus dealers (who are often associated with a manufacturer) don’t like giving loan business/data to the competition and will give more business to Triad.

b.     Tenure in the industry

                                               i.     Triad (and Clayton) have the longest tenure within the industry. Triad has been around for 60 years. Stability and conservativeness is what you want in a lender if you’re a manufacturer.

4.     Future sources of growth:

a.      Land own loans flowing into the P&L

                                               i.     Triad is currently doing $300m annual run-rate in originations. However, there is a lag in recognizing this as revenue. Triad needs to wait 6-9 months in order to recognize revenue from its originations because Triad can only do so when the MH is set up on site, not at origination. Close rates are 95%+ so this backlog has high visibility.

                                             ii.     They are expected to recognize $150-200m of land owned this year (vs $700m total Triad origination in 2020)

b.     Continued share gains in chattel loans

c.      This business can easily do $75m pre tax in 2-3 years from $40m today

Future takeout optionality:

1.     Eventually, Triad will also likely be sold. Banks exited manufactured housing financing after the late 1990s bust and home improvement financing after the GFC. They didn’t want to spend another decade signing up dealers to build the business. But they would definitely buy lenders that have $10bn (Service Finance in a few years) or $3bn (Triad in the future) loan books.

Kessler is a provider of advisory and portfolio management services to credit card issuer and other financial institutions. The company has created 6,000 co-branded credit card partnerships since 1978. Kessler manages and advises a total of ~$28bn in credit card assets.  This is a flat to LSD growing business in a base case and is not a value driver for the thesis.

Valuation

1.     US$0.48 of EPS in 2024, 15x multiple = $7.1 core business

2.     Add $6 of distribution and take out 66 cents of withholding tax

3.     ~$12.5 price target, ~40%+ upside

Catalyst

·       On CapIQ, the company’s valuation and financials are exhibited as though it’s a financials, balance-sheet heavy business with a focus on book value of common equity. P/B is not the way to look at this company given its asset-light nature. At some point, this will be changed to a normal services business, which should surface this on screens.

·       Continued beating of earnings should lift estimates and multiple.

·       More sell-side coverage would educate the market. CS just initiated in Feb.