Description

We are resubmitting The J.G. Wentworth Company (“JG Wentworth”, “JGW” or the “Company”) as one of our top ideas, as we believe there have been material changes to the name since the November 2013 write-up.  We believe that JGW is currently a broken IPO with the potential for significant improvements to valuation as investors gain more comfort with its core business and appreciate management’s leveraging the business platform to expand into logical fee-based businesses.

JGW’s core business has been and continues to be a very high cash flow yielding business.  Up to a point JGW’s core business is sensitive to dramatic interest rate shifts, however its core business is uncorrelated to the rest of the economy.  As a result, this business is very efficient at doing dividend recapitalizations (i.e. JGW incurs significant new debt in order to pay a special dividend to its shareholders).  Interestingly, private equity firm JLL Partners (“JLL”), the Company’s largest single investor with over 70% of the vote, has been notorious at doing this over the near 15 years it has owned the Company.  During the crisis, as securitization markets jammed up, JGW found itself in breach of some of its debt covenants on its newly issued dividend recap debt.  However, within just a little time and some debt adjustments, the Company was back to doing its high cash flow business.  Given the favorable uncorrelated nature of structured settlements, the market has remained very open for JGW product.  Therefore, with some lessons learned on tightening up its securitizations, JGW has continued to generate outstanding cash returns.  In fact, we believe that JLL and the other private investors have already made exceptional IRRs on its JGW investment to date.  The reasoning for going public was to allow some of the original private equity investors to close up long-dated legacy funds that had originally made investment between 1999 through 2006.

Historically, the core business model is very lumpy and hard to understand.  Add to this complexity (i) an IPO whose lumpy business got off to a slow start, (ii) a previous senior management team that was “weak” (at best) at conveying and allaying significant issues in its core business, (iii) illiquidity in the stock due to its thin float, and (iv) a large legacy private equity investor base (e.g. DLJ Merchant Banking, Candlewood, etc.) that is continually seeking to liquidate nearly 10 year investments, and it is no wonder that the stock is down hard from IPO levels.  We believe that all of this noise has been the cause of great investor concern.  As a result, we believe that JLL has taken a more hands on approach by restructuring the senior management team and leveraging JGW’s business strengths into logical fee based businesses.  In addition, JLL has been working hard on converting Class B unregistered shares into publicly traded Class A shares to improve liquidity for larger investors (see more on this below).

For reference and background, we encourage readers to review the November 24, 2013 post by casper719 as well as the lengthy report published by Kerrisdale Capital found here:

http://kerrisdalecap.com/wp-content/uploads/2014/02/JGWPT-Holdings-JGW.pdf

Additionally, we have posted our model in excel and pdf write-up here:

1)  https://drive.google.com/file/d/0B4xbUnte_0Q2RFVWeTI3dTF3S00/view?usp=sharing

2) https://drive.google.com/file/d/0B4xbUnte_0Q2RktaVWFVdnNTbnM/view?usp=sharing

These reports and the model should help in both clarifying the unit economics behind a structured settlement securitization transaction as well as illustrating the positive cash flow dynamics of the business.  GAAP accounting obfuscates the true economics given both the consolidation of the underlying SPVs as well as the closing timing of the securitization transaction themselves (i.e. JGW typically completes 3 securitizations a year, leaving one quarter without one). Further, JGW management often uses the cash received from closing one securitization to fund its next round of structured settlements (in lieu of putting them into the warehouse and financing them) in order to save on interest expense.  Thus, the cash flow statement is misleadingly negative and the CFO often reports “cash equivalents and receivables to be financed” during the conference calls as it takes into consideration the assets that are on the balance sheet that management could warehouse and generate immediate cash from if so needed.

At under $10 per share, JGW offers investors an extremely attractive risk/reward profile. We believe the core structured settlement business is worth at least $17 per share (arguably $20-22) and there is additional upside from the launch of new business initiatives described below. JGW’s core structured settlement business is lumpy, but we believe that the market will recognize its value as cash continues to build on the balance sheet and the term loan debt is gradually repaid.

Additionally, we note the following developments: (i) management and board changes initiated in July 2014; (ii) new business lines including (a) developing a personal lending marketplace; (b) launching pre-paid cards; and (c) entering the mortgage origination space through the acquisition of WestStar; (iii) management is taking steps to improve communication and clarify financials; and (iv) we believe existing Class B shareholders are in the process of converting to Class A shares which will substantially help the liquidity issue.

Management Changes

In July 2014, Stewart A. Stockdale was named Chief Executive Officer succeeding David Miller. Stockdale was previously at Western Union in a variety of capacities including heading the Global cards business. The Company also announced that the Board of Directors elected Alexander Castaldi as Chairman (Managing Director at JLL Partners for the last eleven years and of the Board of JGW since 2005).  Finally, on February 12, 2015, Randi Sellari resigned as COO.  With this latest management restructuring, JGW placed Randy Parker as President of JGW’s core settlement business, and placed Steven Sigman as Senior Vice President of new initiatives (i.e. non-structured settlement business). Both new group heads will be reporting directly to Mr. Stockdale.

New Business Initiatives

In 2014, JGW management announced expansion into three new business lines: (i) Personal Lending Marketplace; (ii) Mortgages (via acquisition of WestStar); and (iii) Prepaid cards:

First, JGW launched personal lending in Q1 2015 with its partner AvantCredit to address the personal lending needs of its current and new customers (Exhibit 2). Personal lending complements JGW’s core business and provides a solution for customers who are already contacting the Company through the 877-Cash-Now campaign looking for personal loans. JGW will leverage its extensive marketing engine on the front end to generate customer acquisition opportunities. AvantCredit's platform makes the credit process easier, faster and more customer friendly with real-time approval. The goal is to leverage the strength of the J.G. Wentworth brand to refer current and new customers for their potential personal lending needs thereby creating a “lending marketplace.”

We view this initiative has a logical and positive step for the Company. Historically, customers are already contacting JGW based on its existing 877-Cash-Now campaign, and now the Company has begun the process of directing consumers to the Avant platform instead of turning them away. As management continues to analyze data from this initiative, the team will refine its process and add new partners to address the distinct credit needs of its customers. Over time, the intent is to create a robust lending marketplace powered by the J.G. Wentworth brand. Under a lending marketplace model, JGW will not be assuming additional risk to the Company’s balance sheet as it will serve as a front end, connecting consumers to the right lenders.

Second, JGW has entered the prepaid market through partnerships with Visa, MetaBank, and FIS.  MetaBank, a federally charged institution, provides a compliance infrastructure along with innovative solutions and is a recognized leader in the prepaid category. FIS will serve as JGW’s payment processor and has experience with more than 14,000 institutions across a wide range of payment processing capabilities.  We note this segment is also a logical extension of existing business. JGW customers are often issued paper checks to fund the purchase of their structured settlement. Issuing a debit card instead reduces administrative expenses for JGW, especially in cases of repeat customers. Initially, JGW will offer general purpose reloadable and incentive cards to select prospects and customers as part of its marketing and servicing initiatives. Management plans to enter retail distribution and online channels with a general purpose reloadable product and a patented and innovative gifting solution that will be new in the marketplace.   

Finally, in March 2015, JGW announced its acquisition of WestStar for $54 million in cash and Class A Common Stock, (with a minimum of 75% of the transaction in cash).[1]   The Company has earmarked 1.6 million shares for this transaction.  JGW has stated that the transaction will be accretive to adjusted net income by 15-20% on an ongoing basis.

WestStar was founded in 2000 and has over 300 employees in 15 states across the country. Headquartered in the Washington, D.C. suburb of Woodbridge, VA., WestStar specializes in originating Conventional, VA, and FHA loans and is licensed to operate in 40 states. In 2014, WestStar closed $1.6 billion of new loan originations, and sold or securitized approximately half of the loans it originated to government backed organizations and half to third party institutional investors in the secondary market.  Following origination, WestStar predominantly transfers mortgage loans into pools with Ginnie Mae and Fannie Mae and various other third party investors in the secondary market. Recently, WestStar has been approved as a Freddie Mac seller/servicer. WestStar expects to begin active whole loan sales to Freddie Mac during the third quarter of 2015. WestStar’s principal revenue channels include (i) gain on sale of mortgage loans from loan securitizations and whole loan sales, (ii) fee income from mortgage originations and (iii) fee income from loan servicing.

Exhibit 5: WestStar Mortgage Inc. Summary Financials

Source: Company Filings, ENDUR Estimates

http://www.sec.gov/Archives/edgar/data/1580185/000110465915034854/a15-7770_1s4.htm#InformationAboutWeststar_045015

In 2014, WestStar’s top five states for origination volume were Virginia (22.0%), California (19.7%), Texas (8.1%), Florida (6.8%), and Maryland (6.1%). WestStar’s Distributed Retail Channel operates through 19 branches in 11 states.  WestStar’s Distributed Retail Channel accounted for approximately 20.8% of its production volume in 2014.  Through WestStar’s Direct Lending Channel, which operates through five (5) offices across the country, WestStar originates mortgage loans in reliance upon leads purchased through lead generators, such as the LendingTree Network, and an affinity relationship with CostCo Wholesale.  WestStar’s Direct Lending Channel accounted for approximately 78.2% of its production volume in 2014.  In 2013, WestStar re-launched its Wholesale Channel, which originates loans brokered from third parties.  Presently the Wholesale Channel only conducts activities in the Washington, D.C. and Mid-Atlantic regions.  The Wholesale Channel accounted for approximately 1% of WestStar’s production volume in 2014.

Management believes combing WestStar with the J.G. Wentworth national brand, competitive call center expertise, underwriting and back-office capabilities, ability to operate in a highly regulated environment and access to capital markets, will create a leading direct-to-consumer mortgage vertical that can be a viable competitor in a large national marketplace.  

As shown in

Exhibit 5, adding WestStar's contribution in 2014 to J.G. Wentworth's earnings for the same period would have resulted in a 26% accretion to earnings for the full year. For the first quarter 2015, WestStar delivered a strong performance with approximately $553 million in loan originations, revenues of $19.9 million, and $4.5 million of net income.

Improved Liquidity Publicly Traded Shares

Since the 2Q of 2014, JGW has continuously been converting its large Class B legacy shareholder base into publicly traded registered Class B shares.  Class A shares have a 10-to-1 vote advantage versus Class B shares.  Beside the low number of Class B shares outstanding, we believe that this large “control” imbalance has made it difficult for larger investors to get interested in owning JGW, because taking a “backseat” in voting to legacy private equity investors (seeking to constantly sell rather than buy shares) just aggravates the private equity overhang.  We should note that, JLL has been buying shares in the open market since the IPO, giving us further evidence that the stock, at current levels, might be highly undervalued.

The tables below demonstrate the evolution of Class B shares converting into Class A shares.

Exhibit 6: J.G. Wentworth Co. Ownership Summary as of November 2014

Source: Company Filings, Endur Estimates

Exhibit 7: J.G. Wentworth Co. Ownership Summary as of June 2015 (Pre-Secondary)

Source: Company Filings, Endur Estimates

Exhibit 8: J.G. Wentworth Co. Ownership Summary as of June 2015 (Post-Secondary)

Source: Company Filings, Endur Estimates

Earnings Outlook

Our normalized earnings analysis consists of valuing the core structured settlement business with the following assumptions:

• Yearly Total Receivables Balances ("TRB") of $1,078 billion.  $1,125 million of TRB was purchased in 2013 and $1,078 billion of TRB purchased in 2014.  Management has indicated, however, that it intends to significantly reduce purchases of finance receivables associated with pre-settlement funding transactions. Thus, to be very conservative we assumed a slight reduction/no growth scenario in TRB balances.

• Cash on cash spread of 20.6%, slightly below historical levels of 21% to 22%. We note that the spread level may face near term pressure due to the rising interest environment; however, on a “normalized” basis, we believe this level is achievable. Even flexing this assumption to 20% yields a fair value of $15 per share, or 50% above current prices.

• Slightly increased advertising spend from current levels

• Slight decline in interest expense reflecting gradual pay down of term loan debt until next dividend recap transactions

• Tax rate = 10%, reflecting federal and state income tax net operating loss carry forwards of $110.8 million and $110.8 million, respectively.

Valuation Analysis

The assumptions above suggest JGW should be able to earn at least $1.50-$2.00 in EPS on a normalized basis.  This level is below the yearly average of $1.78 earned in adjusted net income per share since 2011.  As we’ve mentioned, the business is lumpy, and some years will be materially stronger than others, but over time, it evens out.  We apply a 10x earnings multiple to our EPS estimates suggesting a fair value of at least $17 per share.  We believe 10x is a conservative multiple for a dominant player in a limited growth industry.  Additionally, the valuation gives no credit for the continuous cash growth which will eventually be used to pay a large dividend to shareholders once the debt is retired.  Separately, we believe that P/E multiples should expand as investors gain more comfort with the business and outlook.

Finally, if we apply a valuation of $2-3 per share for the additional verticals, valuations get closer to between $20-22 per share.

Exhibit 9: Normalized Earnings Valuation Analysis (cores structured settlement business)

Source: Company Filings, ENDUR Estimates

Recommendation and Rationale

Catalysts

Risks

Catalyst

Catalysts include: 1) conversation of Class B shares to Class A improving liquidity; 2) increased earnings; 3) continued cash build, share repurchases, and debt reduction; 4) clearer communication highlighting business economics as opposed to GAAP financials