|Shares Out. (in M):||12||P/E||0.0x||0.0x|
|Market Cap (in $M):||167||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||126||EBIT||0||0|
Nicholas Financial, the perennial VIC favorite, now represents both the long-term value opportunity it always has but also in my view a likely take-out candidate. There had been takeout speculation on NICK in early 2011 which led nowhere but I think this time is different which I will detail. And if the take-out doesn’t happen, you have the same great business at an attractive valuation.
Why I Think NICK Will Be Sold This Time:
For those not following it, the prime and sub-prime auto finance industry has been a hot market in 2013 with credit again flowing freely not long after the recession ended. This is and will put pressure on conservative underwriters like NICK in terms of loan volumes, but on the other hand it is an excellent time to be selling an auto finance business. NICK’s two public comps (CACC and CPSS) trade at 4.1x and 2.4x book value respectively. Banco Santander is rumored per industry execs I have spoken to to be considering taking its US auto consumer finance sub public this year at 3x tangible book. Americredit was bought out by GM early in the cycle (early 2010) for 2x tangible book. NICK is a superior asset to most if not all of these comps and trades for 1.3x tangible book.
An acquisition at 3x book (2.3x your money) is supported by comps but more importantly can be theoretically justified as NICK earns strong ROEs despite being much less levered than its peers. For example, NICK is levered about 2:1 assets to equity. That ratio is about 20:1 for CPSS. Or ACF in their last filing (1Q10) before being bought ran at 5:1 assets to equity. You can see how an acquirer when putting their leverage ratio on a business like NICK that historically has earned 15-20% ROEs for decades (see prior VIC write-ups) could see a 30%+ ROE business upon acquisition which would justify a 3x or higher book value multiple. And this is before synergies.
It takes two to tango and I think NICK could finally be ready to sell. The company received an unsolicited indication of interest in late March and has hired an advisory firm to explore strategic alternatives which typically takes a few months to several months to complete which would put a potential event squarely into this summer.
The obvious counter-argument is NICK received an unsolicited offer and hired an advisory firm once before in early 2011 which didn’t lead to sale. However, the market for auto finance assets is much more heated now with comparables at meaningfully higher multiples making now a great time to be a seller. The flip side of this (which I think also makes NICK more likely to sell) is that a great time to sell in auto finance is also a tough time to be an operator if you are a conservative underwriter like NICK – in their last Q, NICK grew revenues only 3% despite having a larger branch network year-over-year. As NICK’s CEO commented: “While competition remains fierce, we are committed to maintaining our conservative underwriting principles.” I think the CEO and founder, having turned 70 this year, may look to sell into this strong deal environment vs. weathering another potential boom and bust period in his industry. As the CEO told me in early 2010, the best time for NICK is the period right after the bust when all industry capacity is gone and NICK can scoop up top talent and underwrite great credits at high rates – that is the time he said he lives for. Given this context, it may not be surprising that NICK wasn’t sold in early 2011 when there was the last unsolicited acquisition proposal. However, 2013 is a very different period in the auto finance cycle than 2011 and if past cycles in subprime auto are any guide, it will be many years before he will get the opportunity to operate coming out of a bust. The CEO and founder, Peter Vosotas, is the largest shareholder with 14% and together with the Mahan family (his initial investors in the early 1980s) the two together control about 20%. The only other meaningful investor is Southpoint Capital at 10% which has been an investor since 2004.
There is obviously a reasonable state of the world where no sale happens, but I think it more likely than not that a sale does happen and that it occurs at 2.0x to 3.0x book. That is a lot of upside in a relatively short period of time (next few months).
What happens to your investment if a sale doesn’t happen? NICK is doing a 15% ROE right now annualizing last quarter’s results which means NICK’s current 1.3x book valuation can compress meaningfully and a capital loss can still be avoided. For example, let’s say in the next 12 months book value compresses from 1.3x to even 1x book, the earnings accretion offsets much of this decline. And of course a 1.3x book valuation for a business currently doing 15% ROEs with a long history of 15-20% ROEs and arguably underlevered is already on the low side. So even if the industry gets more competitive NICK will grow book value per share well and any investor with at least a 1-2 year horizon should do reasonably well even if a sale doesn’t happen. In the last credit boom period when NICK similarly cut back on loan volumes they still were doing 18-21% ROEs.
Finally, NICK’s liquidity has improved from the time of prior write-ups, it’s now roughly $450K a day (3 month average).