Description

Loyalty Ventures Inc. (“Loyalty Ventures” or “LYLT”) is a loyalty solutions company that runs the most recognized coalition marketing program in Canada and campaign-based loyalty solutions for grocers and other high-frequency retailers. The company’s primary operations are in Canada and Europe and the business is headquartered in Dallas. LYLT was spun-off from Alliance Data Systems Corporation (ADS) on November 8, 2021. Loyalty Ventures is comprised of two operating segments:

Air Miles ($488M revenue, $143M Adj. EBITDA in 2020): Air Miles is a coalition loyalty program in Canada. The program provides all marketing, customer service, rewards and redemption management for clients who have opted into the program (sponsors). Sponsors are typically granted exclusivity in their market category (e.g., grocery, hardware, banking, etc.) enabling them to realize incremental sales and increase market share as a result of their participation in the program. Consumers (the company calls them collectors) earn reward miles as they spend money with the sponsors. These Air Miles (Air Miles is the name of both the loyalty program and the currency garnered from spending within the program) can be redeemed by collectors for travel, entertainment, experiences, merchandise, or other rewards. The value of the program resides in the extensive reach of the program (2/3rds of Canadian households participate), the brand recognition of the program to drive sales given how long it has been present in Canada, the amount and quality of the sponsors which contributes to the network effect, and the ability to gather data about consumer behavior to help sponsors better reach consumers. Air Miles’ primary competition is sponsors insourcing the loyalty program as well as PC Optimum, a relatively new program started by Loblaws.

BrandLoyalty ($275M revenue, $42M Adj. EBITDA in 2020): BrandLoyalty is a campaign-based loyalty solutions business. BrandLoyalty designs, implements, and conducts digitally-enhanced, bespoke loyalty campaigns for high-frequency retailers in Europe and Asia. An example of a program is a grocer who wants to incentivize increase spending levels during a promotional period. In concert with the customer, BrandLoyalty would design a program designed to increase shopping behavior from a segment of its customers (for example shopping frequency). During the promotion customers receive rewards if they hit the performance standards set by the company. The rewards are licensed products from companies such as Disney that have contracts with BrandLoyalty. The customer is guaranteed a certain baseline productivity from the program and BrandLoyalty earns revenue based on achievement above these levels. BrandLoyalty was purchased by ADS in 2013 at a 10x EBITDA multiple.

We became interested in Loyalty Ventures because of the insider buying by the CEO and a director of the company at prices materially higher than today, as well as the low valuation with the stock trading at around 6x 2022 adjusted EBITDA. Our investment thesis in LYLT is based on the following components:

·         Favorable spin off dynamics: We think the rationale for this spin off is compelling for both the parent and Loyalty Ventures. As it pertains to Loyalty Ventures, the business is different from the primary operations of the parent company which is a U.S. consumer finance retail credit card lender. LYLT also only accounted for approximately 15% of ADS’ pre-corporate EBITDA in 2020. As such, the business was underinvested in and did not receive the c-level support it needed. We also suspect there is considerable selling from shareholders of the parent company as most ADS holders owned the business for the credit card operations.

·         Ability to augment growth / low hanging fruit for incremental investment: Due to the lack of investment within ADS, LYLT can make some incremental investments out of the gate that will enhance growth. For example, within the Air Miles business, the cash back rewards or the merchandise rewards are run as two separate programs. Bringing these two programs together would make the program more flexible and customizable which would increase engagement. It would also simplify and streamline the operations of the program (and reduce costs). On the marketing side, Loyalty Ventures can make the program more current by going digital / mobile first. Today collectors must go through a catalogue to redeem / match their rewards. Rewards should be available instantly on a mobile phone and they should be marketing individual rewards to customers over mobile. We believe the CEO is aware these changes have to be made which should lead to incremental revenue growth above historical levels.

·         Normalization of the market environment post covid: Loyalty Ventures stands to benefit from a normalization of its end market post covid. While the Air Miles program in Canada does offer cash back rewards programs, the primary and most profitable rewards type are air mile rewards that are redeemed for aspirational international destinations such as the Caribbean. Demand for international travel has been reduced during covid which has reduced incentives to collect miles and thus revenue for LYLT. From a revenue recognition perspective, the company also recognizes a considerable amount of revenue as earned when the miles are redeemed. Therefore, as people are redeeming less miles due to a lack of international travel, a large component of Loyalty Venture’s revenue and EBITDA is delayed. On the BrandLoyalty side, the groceries end market makes up a considerable amount of the demand for the product. The reduced mobility and increased prevalence of eating at home in the geographies in which Loyalty Ventures operates has reduced grocer needs for promotional activities. We expect this promotional spend to return once the market returns to normal and mobility increases. These dynamics have had considerable effects on Loyalty Ventures revenue and profitability. Pro forma adjusted EBITDA was $231 million in 2019 and is expected to be approximately $160 million in 2021.

·         Opportunity to create value through capital allocation: As part of the spinoff, Loyalty Ventures raised $675 million in debt to fund a distribution to the parent company. At normalized earnings, the business will generate well in excess of $100 million in free cash flow and we expect the majority of that to go paying down debt, thus creating a strong deleveraging story for equity holders. The opportunity also exists to buy smaller, subscale companies at relatively low multiples on the campaign loyalty side.

Valuation

There are 24.5 million shares outstanding. At $30 per share, the market cap is around $735 million, and the EV is around $1.2 billion. We assume $200 million in 2022 adjusted EBITDA and therefore the stock currently trades at a valuation of approximately 6x 2022 adjusted EBITDA and approximately 5x a more normalized adjusted EBITDA of around $225. As the spin off dynamics clear we expect the market to more fully capture the extent of the potential improvement in the business fundamentals from investments in digital customer experiences, the earnings potential of the business in a more normalized operating environment, and the significant potential to create equity value through deleveraging the business. As such we would expect the company to rerate materially. If we assume a conservative 7x EBITDA multiple on a 2023 figure of $225 million and the cash generated in the meantime, the stock would trade at $54 per share, implying an upside of approximately 90%. If the market doesn’t rerate the stock on its own, we believe the management team would be aggressive buying back stock to take advantage of the valuation as we have seen management buying shares personally at well north of these levels. It is also worth noting the company is very cash generative. With EBITDA around $200 million, we expect FCF around $100 million and therefore the stock trades at a 2022 FCF yield of 13.7%. We assume capex of $35 million, interest of $30 million and taxes of $35 million.

Risks:

-          The idea of coalition loyalty programs is more unique to Canada than other parts of the world. If sponsors were to start insourcing their loyalty programs, this would have negative ramifications for the business. Based on our due diligence, we don’t believe this is likely at this point.

-          The large sponsors in the Air Miles program account for a material amount of miles generated and revenue at Loyalty Ventures. If these partners can negotiate better pricing given their size, it could hurt Loyalty Venture’s growth and profitability.

-          Poor M&A on the BrandLoyalty side. Based on our discussion with the CEO who is the former ADS CFO, we believe he gets it and wouldn’t overpay.

Catalyst

1. End market normalization 

2. Debt paydown, initiation of dividend or share buyback