Description

Progressive Leasing (PROG Holdings, Inc.)

Progressive Leasing is a lease-to-own fintech that was recently spun-off from Aaron’s and presents a compelling opportunity to invest in a best-in-class, capital-light, rapidly growing company at a reasonable price. We believe that Progressive presents a unique opportunity that has not been fully appreciated by the market. The company reports fiscal results for FY2020 before market open on February 25th. We believe that the earnings release and first independent operating results could act as the first of several catalysts for the market to begin to fully appreciate Progressive’s value and opportunity.  

Long-story short: Impressive, profitable growth company at reasonable valuation that is under-appreciated by the market due to its status as a recent spin-off.

Company Overview

Progressive is a financial technology company that provides virtual lease-to-own (vLTO) services. It pioneered the vLTO industry in 1999 and became the premier point-of-sale LTO provider. Aaron’s acquired Progressive in 2014 for $700M. At the time of the acquisition, Progressive provided LTO services across several verticals, but primarily focused on furniture financing.

Although there was some initial pushback to Aaron’s acquisition of Progressive, it proved to be a tremendous acquisition for the company (growing revenue from $228M in 2012 to $403M in 2014 and improving profitability). Progressive has expanded beyond its initial furniture vertical, which at 41% of revenues is still a material component of revenues, to 5 other key verticals: consumer electronics and appliances (20% revs), cell phones (12% revs), jewelry (12% revs), bedding (9% revs), and wheel and tire (5% revs). Progressive has also been able to become the vLTO provider for multiple national retailers, including Best Buy, Lowes, Big Lots, Ashley Furniture, Overstock.com, Conn’s, etc. It continues to build out the in-store available “doors” or stores that offer Progressive’s LTO offering. There is plenty of runway with existing partners, and Progressive continues to grow its partner base--providing two natural greenfield growth opportunities.

As acknowledged by management over the years, Aaron’s never materially integrated Progressive. It incorporated some of Progressive’s technology into its own vLTO offerings, but there were no material synergies. For example, during last year’s Q419 conference call, Aaron’s acknowledged that Progressive and Aaron’s are “not integrated as much as we could have” and that “from an operational perspective, the companies are largely independent. Generally, the businesses run separately.” Indeed, Aaron’s maintained an independent management team in Atlanta while Progressive maintained its independent management team in Utah.

Recognizing the value of Progressive as a stand-alone entity, the fundamentally different nature of the businesses, the unique growth opportunities, and the structural capital differences, Aaron’s elected to spin off Progressive (technically old Aaron’s was spun out of Progressive, but that’s more semantics than material). The timing of the spin has proven prescient as there has been tremendous focus on the subprime market and alternative payment providers.

Industry Overview

Buy Now Pay Later (BNPL) and Lease-To-Own (LTO) providers target the “underbanked.” While the two financing sources are both “alternative” financing options outside the traditional banking channels, BNPL providers typically offer short-term financing options. BNPL providers target higher-credit-score individuals than LTO providers-- with LTO providers typically targeting weaker credit consumers in the 300-650 range. LTO contracts are often longer (Progressive’s typical agreement is 12 months--though it is beta testing alternatives) than BNPL contracts and typically rely more on financing charges than merchant charges.

The LTO market has historically been dominated by large brick and mortar retailers like Aaron’s, Conn’s, and Rent-a-Center. Progressive effectively started the vLTO market in 1999. Progressive grew as a “save-the-sale” point-of-sale option. Over time, the industry has begun to shift to more online shopping options than traditional in-store POS opportunities. The online vLTO market is compelling for both the retailer and the LTO provider because it still serves the “save-the-sale” historical benefit but without the cost and expense of training sales people about the process and overseeing the application process.

Although it is currently in its infancy, vLTO providers have the opportunity to drive traffic to retailers by approving customers and sending the customers to approved retailers. The low-capital, no-inventory benefits of the LTO industry are equally present in the online space--though with even less training expense and greater opportunity to scale as you no longer have to worry about the “number of doors” and the vLTO option is infinitely scalable.  

There are three primary vLTO competitors: Progressive, Acima, and Katapult with some additional smaller competitors, such as FlexShopper (FPAY) and Snap Finance (private). The Big 3 tout massive and growing TAM opportunities, and interestingly all three are in a state of structural transition:

·       Progressive - spin-off from Aaron’s effective as of December 1, 2020.

·       Acima - acquired by RCII on December 20, 2020 (with RCII doing what Aaron’s did in 2014 and hoping for similar results and potentially greater “synergy” than Aaron’s was unable to achieve).

·       Katapult - recently announced SPAC deal that was also the source of an intriguing write-up on VIC.https://www.valueinvestorsclub.com/idea/FINSERV_ACQUISITN_CORP/5734949911

The following chart from Katapult’s IR presentation shows the various BNPL and vLTO providers across the segments. Katapult touts itself as the only pure-play online vLTO provider. We don’t fundamentally agree with that statement, but more importantly, purely virtual LTO is not necessarily a strength. While the margins are certainly better for ecommerce, stores with ecommerce and in-person options will likely source a different provider, like Progressive or Acima, who can provide both ecommerce and in-store solutions. For example, Katapult can service wayfair but could not service Ashley Furniture, Best Buy, or Target.

While we think that the market is compelling for any of the four public vLTO providers (PRG, RCII (Acima), FSRV (Katapult), or FPAY (FlexShopper)), we believe that Progressive presents the best risk-adjusted reward with the greatest margin of safety. The vLTO market is estimated to have a TAM of between $30-$50B TAM (Progressive estimates it at $30-$40M; whereas Katapult and RCII both estimate it at $40-$50B). Progressive estimates (and this is consistent with the public-company revenue figures) that $7.2B of the TAM is currently being served. The following TAM numbers come from RCII and Progressive IR Presentations, respectively: 

Competitors

As discussed above, the largest competitors to Progressive are Katapult and Acima. BNPL providers are not current competitors, but it is certainly possible they could enter the space--though with the current valuation delta between BNPL providers and vLTO providers, it does not seem to be a space that any of the big BNPL providers would want to stake out. We also think given the competition and regulatory requirements unique to each space, it is unlikely that either segment attempts to cross over.

Katapult is the hot upstart, but it is difficult to obtain material information on its financial history. Some can be gleaned from reviewing CURO’s filings: CURO acquired an interest in Katapult in 2017. Katapult was previously known as “Cognical Holdings, Inc” and operated under the business name “Zibby.” CURO bought 8.9% of “Katapult” for $5M and increased its stake in Katapult over the years to roughly 42.5%. In CURO’s Q320 10-Q, CURO recognized a proportionate share of Katapult’s income of $3.5M for the 3 months ending September 30, 2020, and $2.7M for 9 months ending September 30, 2020; meaning a reasonable estimate of income for CURO of $8.23M for Q320 and $6.35M for the 9 months ending September 30, 2020. Katapult has provided some guidance by way of its recent investor presentation that shows monumental projected growth (but with no material disclosure of its pre-2019 performance). Although the growth is tremendous, the current valuation is stratospheric. We also fear that Katapult is overly reliant on the BNPL trickle-down model with substantial portions of its revenue coming from those who can’t qualify for BNPL-partner Affirm.  

Acima, like Progressive and Snap, is a Utah-based vLTO founded in 2013. Acima has also experienced significant growth and has settled into second in the market. As discussed above, Acima was recently acquired by Rent-A-Center so no longer serves as a pure-play vLTO option (though we do think that RCII presents another interesting opportunity). While Acima is second in revenues, it materially trails Progressive in merchant partners. Both Acima and Progressive offer “find a store” options on their websites. Progressive’s merchants are simply head-and-shoulders above Acima. We tested the options in several markets and found the Progressive partners to be generally the premier vendors in the area.

The following chart shows the main public competitors:

Growth Opportunities, Catalysts, and Underselling by Management

Management has thus far been relatively quiet on Progressive’s growth prospects. While this is often the case post-spin, we think that the silence is particularly telling here given the natural and organic existing growth opportunities and the additional growth channels we can identify. It is interesting to see how dramatically differently Katapult and Progressive have sold future growth prospects. Progressive has not provided any 2021 guidance (much less guidance through 2023 like Katapult). We think that it has been conservative in failing to give guidance or express opinions on growth until after all deferred compensation is set. Progressive’s executive team has the majority of its comp tied to performance; thus, we think that the management team has been intentionally quiet on its forecasts and long-term potential.

We see the following material growth opportunities over and above the natural industry growth and Progressive continuing to execute on its natural growth strategy of increasing existing POS partners and increasing the number of “doors” within each partner:

·       Increased transition from in-store POS to ecommerce. Ecommerce has been Progressive’s fastest growing channel. COVID rapidly accelerated Progressive’s ecommerce vLTO program, and it is beginning to see material increases in ecommerce invoice growth.  

·       Increase of repeat customers - Progressive is beginning to target existing customers in a meaningful way. We do not believe that this channel has been a focus in the past, but management has expressed its intent to meaningfully target previous customers.   

·       Natural filling out of TAM. There is a massive underserved TAM that we think will continue to be filled out (not all of this will be Progressive of course, but we envision Progressive maintaining its pole position in the space).

·       There is also a tremendous growth opportunity to partner with a BNPL. As discussed above, Katapult has demonstrated the benefits of partnering with a BNPL and obtaining the trickle-down leads from the BNPL. There are multiple alternative BNPL providers who may look to establish a similar partnership similar to the Affirm-Katapult partnership. We believe that Klarna and AfterPay, for example, may be reluctant to use Katapult given the close relationship between it and Affirm. Progressive could certainly team up with either option and dramatically increase top and bottom-line growth and margins.

·       Increased development of Vive Financial and other nearer-prime credit offerings. Vive Financial has been a slight drag on Progressive’s earnings, but it does have some upside for customers who move up the credit rating offering from LTO to near-prime.

Of the various growth channels, the most immediate and obvious option is the online transition and further transitioning its retailers from traditional POS solutions to both POS and ecommerce channels. Progressive has partnered with large national retailers who have also expanded ecommerce offerings. Progressive has stated that it will have all retailers integrated by the end of 2021. Many have been integrated already and the process can be seen through overstock.com and Lowe’s:

We think that as Progressive continues to incorporate and integrate its offerings into its national retailers both in-store and online, it will continue to improve both revenues and margins. We also think that as it demonstrates its success with these large customers, its partnerships should continue to accelerate. As it incorporates additional retailers, the cost of implementation decrease, its financing algorithms improve, and margins continue to improve.

Valuation

Progressive is starting from a rock-solid balance sheet. It has $129M in cash and equivalents against debt of $50M. It also has $300M in an untapped credit facility at LIBOR +1.5-2%. Progressive has historically not been acquisitive, but we believe the separation from Aaron’s could provide for some acquisition opportunities in the space.

Ultimately, although we see significant catalysts for accelerated growth, a safe baseline model includes a 20% Revenue CAGR growth rate and 24% EBITDA CAGR growth rate over the next two years. Under a baseline scenario, that would bring revenues to $3.58B and EBITDA to $705B. Applying a 9x EBITDA or 1.5x Revenue multiple gets us to an EV around $6B or close to double today’s valuation.

We also think that Progressive has been underselling its free cash flow, and the market has not fully appreciated Progressive’s cash generation. It did not provide an estimate for 2020 FCF in its investor presentation even though it did so for both revenue and EBITDA:

Similarly, it did not include a pro forma statement of cash flows in its Form 8-K--just a pro forma statement of earnings and a pro forma balance sheet. In digging into the Q3 earnings report and Aaron’s recently reported 10-K, we can glean some information that indicates that 2020 could show meaningful 2020 FCF improvement.

For 2019, Combined Aaron’s reported cash from operations of $317M against $92M of PP&E for FCF generation of $224M (this is generally consistent with both Aaron’s and Progressive’s IR presentations that show $120M FCF for Progressive and $106M FCF for Aaron’s for 2019). 

Aaron’s released its 10-K yesterday, February 23rd. It reported $355M in cash from operations against $69M in PP&E for 2020--resulting in FCF of $286M. For Q320, Combined Aaron’s reported FCF of $501M. Even if we are to assume that there was not an additional dollar of FCF generated during Q4 by Progressive, Progressive should report free cash flow of over $214M--and we wouldn’t be surprised to see FCF generation of north of $225M. The following table demonstrates how we came to this conclusion:

A best-in-class, recurring revenue business, with over 20% annual growth should not be trading at a TTM 7% free cash flow yield, but we will gladly take the opportunity.

Bear Case

·       There are two often-immediate reactions to LTO businesses: (1) you really want to be in the business of lending to sub-prime customers and (2) regulations are going to kill the business. Ultimately, we feel that Progressive mitigates the industry-specific bear concerns --though they are of course not extinguished.

o   We think that betting Progressive as the horse mitigates both risks. Progressive has been in this business for over 20 years and has reliably been able to maintain write-offs of only 6-8% for years. It has long-established algorithms and millions of data points for approving credit, and has developed a genuine expertise in extending credit to these customers.

o   While there is certainly regulatory risk, Progressive has navigated that risk and recently took its medicine with the FTC last year agreeing to pay $175M to resolve consumer complaints and has included and incorporated $15M annual additional compliance costs into its business model. There has been recent pressure to further regulate BNPL providers, and we believe that there could be additional pressure to further regulate LTO providers too. Again, we think Progressive is well-positioned to weather additional regulations, but it is a risk.

·       Departure of CEO Ryan Woodley. In connection with the spin-off, Ryan Woodley is leaving the company. It is not clear why he is leaving, but from the tone of the calls, the departure seems amicable. We think the management team in place is strong, but would have liked to see Ryan continue with Progressive.

·       Short-term pressure from continued low expectation setting by management.

Catalyst

• Spin-off
• Underselling by management
• Unveiling of robust FCF generation 
• Greenfield TAM 
• Conversion from POS to e-commerce