Marlin Business Services (MRLN: $22)

Marlin’s business performance and prospects are good and getting better. The core small-ticket equipment leasing business is performing well and is somewhat underleveraged, yet self financing at a mid-teens ROE/growth rate.  Importantly, two new growth initiatives, Factoring and Capital Lending, leverage MRLN's core credit underwriting/transaction processing strengths and could drive ROE/growth towards the high end of the 15-20% range as their combined contribution becomes meaningful over the next few years. MRLN is self financing and should get at least a 16X mult on '08 eps of $2.15, implying $34, or 50% upside from here over the next 12-18 months. Alternatively, 2.5X BV ($12.85 at yearend ‘07E) seems a fair value if we are right about MRLN’s ROE heading into the high-teens from 15% currently, implying a $32 price in a year.  Expect 07/08 eps of $1.85/$2.15 and LT eps of +15%.  The company reported ’06 eps of $1.59 last night, in line with expectations. Note reported #s include a 7 cent hit for executive severance.

MRLN is a small ticket lease provider to small businesses, with a $9,800 average ticket and an average lease term of 4 years at inception (less than 2 year duration on the current book). The core business appears capable of sustaining and self-funding a mid-teens ROE and eps growth rate, with salesforce training and development as the primary governor on growth.  The core direct financed lease business is performing well with mid-teens portfolio growth and below trend loss rates (1.74% and 1.56% in '05 and '06 vs. LT avg. 2.0% and prior '01 peak of 2.20%). Largest lease categories include copiers (21%), phone systems (7%) and computers (6%).  MRLN is arguably under-leveraged at 4.6X debt/equity versus typical leasing/finance companies at 6-9X, however, the niche focus and efficient operations allow a 16% ROE/growth rate, even at the current leverage level.  Although annual loss rates will eventually revert towards the LT 2% average, efficiency gains and funding cost adjustments should help preserve a low-to-mid teens ROE throughout the cycle (assuming cycles have not actually been cancelled by the Fed!)  Loss rates and funding costs are somewhat negatively correlated. 

Credit Stats:

Net investment in leases totaled $694M at yearend 2006 and consisted of 110,000 active leases to 87,000 small business customers. Net charge-offs were 1.56% of avg. leases in 2006, while 0.71% of the lease portfolio was 60+ days delinquent and allowance for credit losses was 1.21% at yearend, vs. 0.58% and 1.21%, respectively, in 2005.  (See the company website www.marlincorp.com for more detailed static pool data.)

 

MRLN is still largely undiscovered by investors as only 2 firms (Wm Blair & Piper) provide coverage and the current $270M market cap and somewhat limited trading liquidity restrict interest.  We expect continued growth of 15% or better to drive increased interest and valuation over time.

Management recently launched 2 growth intiatives, each of which leverage the company's core credit analysis and transaction processing strengths, serve MRLN's core small business customer base, and represent large, fragmented markets.  These 2 initiatives should begin impacting MRLN's results by the end of '07 as they ramp activity following their Q3-06 launch.

Factoring: A fee based business in which MRLN will purchase discounted short term (45 day) accounts receivable from eligible small businesses.  The upfront facility fees and the 3-3.5% purchase discount should provide meaningful profitability, while the 20% holdback (80% advance rate) and the company's core credit underwriting/collection expertise should produce modest loss experience.  Given the short term nature of the capital commitment (typically 30-45 days), the ROE/ROA performance should exceed that of MRLN's core leasing business, with limited capital requirements.  At yearend 2006, Marlin had $1.8M of purchased receivables balances for Marlin Trade Receivables. 

Capital Lending: This loan based business utilizes direct mail to market fixed rate, fixed amount ($15K/$25k), fixed term (3 yr) 12-14% commercial loans to MRLN's existing leasing customer base (87K at yearend).  Conceptually, this business competes with higher rate/yield corporate credit cards. This business should produce 2.5% ROA / 20% ROE performance, above the core leasing business, while utilizing some of MRLN's current/future "excess" capital.  AMEX has a $6B small business lending division (to somewhat larger customers) through its Utah Bank.  MRLN's Utah Bank application is currently pending with regulators and may be one of the first through the door when the "Wal-Mart Freeze" is lifted in early '07. At yearend 2006, Business Capital Loan Product had $2M of loan balances outstanding.  If Marlin lent to just 10% of their existing 200K approved customer database at the minimum loan size, the Business Loan book would grow to $300M and contribute at least $7.5M or $0.60 to current EPS.

Clearly both initiatives are in startup mode but both leverage Marlin’s core strengths and should contribute to rising ROE and earnings growth over time.

 

Possible Acquisition Candidate:

As the leading player in a highly fragmented, but profitable market, Marlin would be an interesting acquisition for a larger institution with a lower/internal funding cost.  A 100 bps reduction in Marlin’s year-end securitized funding cost of nearly 5%, would add nearly 20% to pretax income, based on the yearend lease book.

 

 

Accounting:

The accounting is relatively straightforward, with no gain-on-sale issues and static pool credit data posted on the company’s website.

Note: The late 2006 secondary offering reflects 1M shares sold by Primus, the company's early VC backer, out of its 9-year old Primus Fund IV. The remaining 1M Primus shares are likely to come to market in early 2007.

 

Caveat: Not Research, My Opinion Only, May Buy/Sell (UNLIKELY!) at Any Time.