Description

“I’d go to an auction, I’d run up the price of a medallion, then I’d run to my bankers and say, ‘Look how high the medallions priced! Let me borrow against my portfolio.’ And they let me do that.”

‘Taxi King’ Gene Freidman

Bloomberg interview, August 2015

1. Thesis Overview

1.1. Sell short common shares of Medallion Financial Corp. (ticker MFIN, formerly TAXI)

We believe that the common shares of Medallion Financial Corp. (“MFIN”) will either go to zero or option value within 18 months:

• Taxi markets are increasingly being disrupted by ride-share apps like Uber, Lyft and others.

• Taxi medallions serve as collateral for 45.2% MFIN’s consolidated loan portfolio and medallion prices have dropped significantly since the end of 2014.

• MFIN’s current valuation is already expensive assuming their current medallion valuations and credit loss provisioning are correct.

• However, MFIN is marking its medallions too aggressively; we estimate a real medallion loan portfolio LTV of 132% instead of the 82% disclosed by MFIN.

• Based on comparable portfolios at competitors, recent delinquencies and market developments, we expect an accelerated deterioration of MFIN’s loan portfolio resulting in steep NAV write-downs.

• MFIN has a large amount of debt coming due in 2016, while repayments from its medallion loans are drying up fast.

• Its subsidiary Medallion Bank will not be able to provide additional cash flows as it faces its own credit and capital issues.

• MFIN’s freedom of movement is also severely curtailed because of regulatory restrictions due to its BDC status.

As the above scenario unfolds MFIN’s access to capital markets will be cut-off – leading to a funding squeeze that will result in a complete loss of equity value or a massively dilutive recapitalisation.

This write-up was our VIC application.

1.2. Company intro

Medallion Financial Corp. (IPOed in 1996) is a specialty finance company structured as a closed-end, non-diversified investment company. It finances taxicab medallions, mainly in New York and Chicago. The company also engages in small business lending and has a sizable high yield consumer loan book. The Murstein family have been running the business since its inception in 1979 and own 13.3% of the shares.

MFIN currently has 645m medallion loans outstanding out of a total portfolio of 1.5bn. The reported book value of its equity is 279m.

2. Background

2.1. Medallion boom and bust and the disruption from ride-sharing apps

Medallions are tradable taxi permits that have been appreciating in value for decades, easily outperforming the S&P 500 since at least the 1970s. In 2000 prices started to rise even faster and they went exponential in 2012-13.

This extreme price inflation has been driven by:

• Historically restricted supply of medallions e.g. NYC has 13,619 medallions today vs. 11,787 in 1937 when they were first issued

• The conviction that medallion prices will always go up

• Availability of generous financing at low interest rates

The monopolistic barriers to entry that a medallion permitting system provided have recently been eroded by ride-share apps like Uber, Lyft and others, which provide ever decreasing waiting times thanks to their unconstrained and flexible capacity. This has allowed the medallion price bubble to implode. Metrics are showing an undisputable and increasing effect from ride-sharing apps:

• NYC yellow cab trips per day have been trending down since August 2012 and the trend has accelerated recently. The rolling twelve month average number of yellow cab trips per day has decreased by 12% compared to the same number one year ago.

• Ride-share apps continue to take market share in NYC. During 2015 the trips per day evolved as follows:

• Uber: increase of 89.7k to a total of 150.3k trips per day

• Yellow cab:  decrease of 59.4k to a total of 351.8k trips per day

• Lyft has started providing data only recently and is currently taking 19.9k trips per day, starting from almost zero in April of 2015.

   

For further supporting data and excellent visualisation please see: Taxi Uber Lyft usage NYC.

The operating and financial leverage of medallion owners causes limited declines in revenue to have a large impact on their bottom line. An 11% drop in revenue from March 2014 to March 2015 decreased estimated income by 24% (see: How Uber is actually killing the value of a NYC taxi medallion). In the meantime, taxi graveyards have become a common urban sighting (see: Brooklyn neighbors demand action over so called taxi graveyard).

2.2. Group structure and legal/regulatory status

MFIN conducts its loan origination, funding and servicing businesses through various wholly owned subsidiaries. All of the wholly subsidiaries are fully consolidated onto MFIN’s balance sheet except for Medallion Bank (“MB”), a regulated bank that shows up as an equity stake. MB was formed in 2003 to provide low cost, FDIC insured funding for MFIN’s taxi and commercial loan businesses and has subsequently expanded into sub-prime consumer lending. For the remainder of this discussion we use “Holdco” to refer to the MFIN business excluding the MB portfolio.

MFIN has elected to be treated as a business development company (“BDC”) - the main benefit of which is that it can subsequently qualify as a regulated investment company (RIC) and not pay any US corporate income tax.

BDCs/RICs have a number of conditions that need to be satisfied. The most important ones for our thesis are:

• Minimum income distribution: 90% of “investment company taxable income” needs to be distributed.

• Asset Coverage Ratio: the investment company needs to maintain a 200% asset coverage ratio.

2.3. Breakdown of MFIN’s 1.5bn loan and investment portfolio as of Q1 2016

• 644.6m medallion loans

• Residing at Holdco and MB with an average yield of 4.0%

• Geographic split of notional exposure: NY 74% / Chicago 14% / Other 9%

• 128.7m commercial loans

• Small business lending book, residing at Holdco and MB with an average yield of 10.3%

• 652.3m consumer loans

• Recreational vehicles and home improvement loans to subprime borrowers, growing rapidly 31.8% yoy, residing at MB with an average yield of 14.0%

• 59.0m investments

• A medley of wholly owned and participating equity participations in small businesses, residing at Holdco and MB. Generating zero income but still good for a TTM re-valuation based return of 17.2%.

2.4. Typical medallion loan product mechanics

Medallion loans generally require monthly payments covering accrued interest and a small amortization of principal. MFIN and other lenders have usually originated 1 to 5 year maturities with the borrower refinancing the remaining balloon payment. When medallion prices were rising, borrowers tended refinance early and often increased loan amounts in order to support other investment or consumption. Borrowers can be individuals or businesses.

3. Base Case Financials

3.1. MFIN is already overvalued based on current financials

As a BDC MFIN calculates its total earnings using NAV increases/decreases.

• For Q1 of 2016 MFIN’s reported NAV increase was 6.8m (for an annualised rate of NAV increase of 27.2m) while the company also paid 6.1m in dividends.

• The majority, or 5.7m, of the Q1 NAV increase resulted from a revaluation of 3 small subsidiaries: Medallion Fine Art Inc., Medallion Motorsports LLC and LAX Group LLC. These are all non-income producing investments and the first two entities have large high interest PIK loans from MFIN outstanding. We will remove this source of NAV increases from any future projections.

• The company issued a 33.6m 9% senior unsecured bond in April 2016, this will result in extra interest cost of 757k/quarter.

• The company has valued 159 Chicago medallions at 36.3m implying a mark of 228k per medallion. Q2 saw market prices stabilising in the 50-60k area. Using a mark of 60k per medallion implies a NAV loss of 26.8m to MFIN.