Description

Marlin Business Services (“MRLN”) is a small capitalization bank growing EPS 15% annually with a 14% ROE trading at 1.4x BV and 7.8x 2020E EPS (a 30% discount to other banks with similar ROEs).  In addition, it is the last remaining leasing platform of size that is operating independently, with recent transactions occurring at over 2.0x BV.

Background:

The company was founded in 1997 by Daniel Dyer to serve small business customers by providing financing on commercial equipment, such as copiers, computers, cash registers, security systems, etc., through a network of equipment dealers.  Eventually they went public in 2003 and received their bank charter in 2009. 

In 2015, Dyer retired and Jeffrey Hilzinger was appointed as CEO.  Having successfully built a commercial finance platform for Everbank and growing that business from $400 million in assets to $4 billion, he was an ideal candidate to take MRLN to the next level.

After joining the company, Hilzinger created a plan called “Marlin 2.0” with the goal to transform MRLN from a small ticket leasing platform, into a small business financing solutions platform by leveraging the company’s key strengths: (i) 20 years of credit data on more than 300,000 small businesses; (ii) a stable funding platform; (iii) and the ability to create credit models that accurately forecast small businesses.  The Marlin 2.0 business plan has expanded the company into new areas of financing, such as transportation, working capital loans, franchise lending, and direct lending. 

Since Hilzinger joined, he’s meaningfully impacted the business.  Average loans have increased from $13,000 to $16,000; the company’s portfolio has grown to more than $1 billion in assets; and he will have increased ROE to approximately 15%.  Most importantly, these improvements have occurred without sacrificing credit quality.

Value:

We believe MRLN is undervalued with all of the improvements that Hilzinger has made and the trajectory of earnings growth for the business.  We estimate 2020 EPS to be ~$2.76/sh (17% growth).  Other small capitalization banks generating ROE’s in excess of 10% trade at 13x forward P/E, which would value MRLN at $35.88/sh. 

In addition, there’s a hidden call option in the company.  The company’s largest shareholder, Red Mountain, is a defunct activist fund that owns 24% of the company and holds a Board seat.  MRLN is by far the fund’s largest remaining position and it has limited options in exiting their position.  Selling into the open market would not make sense as it would take over 8 months to sell their position in the open market at 100% of volume.  The lack of liquidity in the name also makes a secondary offering unlikely as there is not a core base of shareholders who would participate in the offering.  The most likely exit strategy for Red Mountain would be a sale of the company to another bank, which makes sense as a bank would receive a number of benefits such as improved ROEs, lower cost of funding, expense synergies, and cross-selling opportunities.  Lowering the cost of funds alone could drive an incremental $1.00 in EPS to a bank buyer. 

While there are no publicly traded peers similar to MRLN (in fact, MRLN is the only publicly traded vendor financing firm in the top 20, with 16 of the top 20 being owned by a bank and the remaining three either owned privately or by a private equity firm), there have been a number of transactions over the last two years that highlight MRLN’s value.  The average P/BV multiple of transactions over the last two years have been 2.5x P/BV, which would value MRLN at $40.65/sh.    

Risks:

As with any bank, the largest risk is the macro picture.  Any economic recession in the US will cause a contraction of credit demand and deterioration of credit quality leading to lower EPS.  Another key risk would be the departure of the CEO as he’s been the architect behind the improvements at MRLN and driving the growth of the new platforms.  We’ve met the CEO a number of times and he’s fully committed to the company and understands the value of MRLN to another bank.  The last risk is an upward shock in interest rates as MRLN funds the business with wholesale deposits which would reprice faster than the asset side of the book causing EPS growth to slow. 

Catalyst

• Continued earnings growth
• Sale of the bank