Description

SUMMARY

Rent-A-Center (“RCII”) is NOT the company you remember from 2015 (when last posted on VIC).  Following its acquisition of Acima in February 2021, RCII has completely transformed into a valuable FinTech platform.  To summarize our thesis, RCII is an industry leader with proven & incentivized management, high growth accelerated through its Acima acquisition, capacity to return significant capital to shareholders, and an attractive valuation.

AN INDUSTRY LEADER

“Industry leader” can mean many things.  In this case, RCII arguably covers all definitions as the leader in size, profitability, uniqueness, and innovation. 

As far as size, RCII is the largest and most profitable traditional lease-to-own (“LTO”) business.  Through its Rent-A-Center branded stores, RCII leases household goods (such as appliances, furniture, and electronics) to credit-constrained customers.  After making lease payments for 12-24 months (depending on the lease agreement) or by paying the early buyout price (within 6 months), LTO consumers can own the leased product.  To be clear, these are leases and NOT loans.  At any time, a customer can cancel his/her lease by returning the product.

Though often misunderstood, the LTO industry is quite attractive.  For starters, it is effectively a duopoly with RCII and Aaron’s (“AAN”) having 65%+ market share.  Both benefit from reputable brands and extensive store networks.  Weekly (for RCII) or monthly (for AAN) lease payments result in substantial recurring revenues and ultimately an average ROI of ~3x per product.  Lastly, the LTO industry is recession-resilient because low-credit consumers buy more in good economies and there are more low-credit consumers in bad economies.  Hence, RCII growth accelerated during COVID and revenue per store grew 6% during the GFC (2007-2009).  In recent years, RCII has revived growth by expanding its e-comm presence, which now represents ~25% of LTO revenue.

Following its purchase of Acima, RCII is also the second largest and most profitable virtual lease-to-own (“VLTO”) business.  Instead of leasing through its own stores, RCII leases products through the point-of-sale (“POS”) systems or website checkouts of partner retailers (such as Wayfair).  As an example, a lower-FICO consumer tries to buy at Wayfair but cannot access traditional credit.  So, Acima (now owned by RCII) will buy the couch and lease back to the consumer.  Like traditional LTO, the consumer will own that couch after making all lease payments or paying the early buyout price.  VLTO shares the same compelling traits of LTO, but has higher-growth due to significant white space and is capital-light due to operating in retailers’ stores or on their websites.

Unique to RCII, we believe it is the only company offering both traditional LTO and VLTO.  This results in a distinct competitive advantage.  When Acima customers return product, RCII can monetize the product through its Rent-A-Center stores (the traditional LTO channel).  In turn, this allows Acima to lease more aggressively.  Meanwhile, VLTO competitors must try to sell returned product at pennies on the dollar through eBay and liquidators.  VLTO competitors want to minimize product returns and therefore may be forced to be more conservative when leasing.

On top of scale and its unique omnichannel LTO/VLTO platform, RCII has taken the lead with innovation.  More specifically, the company exclusively partnered with MasterCard (“MA”) to issue the industry’s first LTO payments card.  Through this “Acima LeasePay” card, credit-constrained consumers can be pre-approved for up to $4k that can be used for qualified goods at any retailer that accepts MA.  This effectively expands Acima’s presence from its ~50k partner retailers to millions of merchants.  RCII also launched Acima Marketplace and Acima Browser Extension.  The Marketplace is a website where consumers can lease various products from e-comm retailers that are not partnered with Acima.  Similarly, the Browser Extension enables consumers to lease goods on the websites of retailers that do not have a pre-negotiated agreement with Acima.  In sum, these three innovations should allow credit-constrained consumers to access more retailers, retailers to sell more products, and RCII to accelerate its growth.  Importantly, the impacts of these innovations are NOT included in RCII’s FY23 targets discussed below so could be a source of meaningful incremental upside.

PROVEN & INCENTIVIZED MANAGEMENT

Mitch Fadel was recruited to rejoin RCII as a director and then named CEO in January 2018.  He had a successful 15-year career as President/COO of RCII.  But in 2015, Fadel left after the then-CFO was picked over him to be CEO.  That CEO (and former CFO) had “great ideas” but led to RCII’s profits collapsing.  Hence, a shareholder activist took control of RCII and brought back Fadel in 2017/2018.

In three short years as CEO, Fadel quadrupled RCII’s EBITDA and eliminated its debt burden.  How?  In short, he reversed the prior CEO’s terrible decisions.  Three key examples include: terminating money-losing projects (like a new POS system), rehiring experienced employees to replace part-time labor (since customer relationships are crucial in this industry), and extending the early buyout price from 90 to 180 days (giving consumers a reason to make lease payments for longer).  From Fadel’s appointment in January 2018 to reporting 3Q20 earnings/updating FY20 guide in October 2020, RCII’s share price tripled leading to a ~50% IRR.

Fortunately, CEO Fadel was not finished creating shareholder value.  RCII announced the planned purchase of Acima in December 2020 and closed the transaction in February 2021.  Due to the transformational acquisition of Acima coupled with continued strong results, RCII’s share price has ~doubled since October 2020. Yet, our estimated fair value implies more than another ~double from here.  Fadel certainly seems incentivized as he owns $50mm+ of shares compared to only a $1mm salary.

Furthermore, Fadel has surrounded himself with a talented team.  His CFO (Maureen Short) helped orchestrate RCII’s turnaround.  Post-CEO appointment, Fadel immediately brought back RCII’s former CMO (Ann Davids) to lead marketing.  Fadel then appointed Anthony Blasquez to lead RCII’s traditional LTO segment after two decades with the company.  At the same time last June, he recruited Jason Hogg to lead the VLTO segment.  Jason has founded successful FinTech businesses and led divisions of larger FinTech companies.  Jason also now has Acima’s founder (Aaron Allred) to both help lead the VLTO sales team and integrate Acima into RCII.

HIGH GROWTH ACCELERATED THROUGH THE ACIMA ACQUISITION

As mentioned, RCII tripled its EBITDA from 2017 to 2020 before acquiring Acima.  Meanwhile, Acima grew its EBITDA ~eightfold over that three-year timeframe.  Acima accomplished this impressive result by capitalizing on a growing VLTO market.  Most Americans want to shop in a traditional retail store/website (not a RCII store/website), but ~1/3^rd have below prime credit so need VLTO.  Furthermore, most retailers do not have a VLTO option.  Hence, the VLTO industry has < $15b of revenue today, but RCII believes this could reach ~$100b.  RCII acquired Acima to exploit VLTO’s untapped potential.

Pro forma for Acima, 50%+ of RCII’s profits are now derived from digital sources including RCII’s website and VLTO retail partners’ POS systems & websites.  This should mean higher growth and better margins going forward.  As evidence, 2Q21 EBITDA grew 40%+ y/y and RCII raised its FY21 guidance.  More importantly, RCII provided FY23 targets that imply profits ~double from pro forma FY20.  Note that RCII materially raised its FY21 guide after outlining its FY23 goals.  Plus, its FY23 targets does not include

Acima’s recent innovations/growth initiatives.  As described later, we think RCII’s FY23 guidance will prove conservative.

CAPACITY TO RETURN SIGNIFICANT CAPITAL TO SHAREHOLDERS

RCII has reported positive free cash flow (“FCF”) in 19 of the past 20 years.  Due its low capital intensity, Acima should further improve RCII’s FCF generation.  Because of substantial cash flow, RCII has already reduced its pro forma net leverage to 1.7x despite recently acquiring Acima.  RCII also has $500mm+ of liquidity. 

Given its pristine balance sheet, excess liquidity, substantial FCF, and low valuation (see below), RCII just announced a $250mm share buyback equating to 5%+ of its current market cap.  If the present conditions persist, we expect the company to re-up its buyback program once the $250mm is complete.  Current and future buybacks could create enormous shareholder value. 

See Restoration Hardware (“RH”) as a case study of the benefits of aggressive buybacks.  While its share price was depressed, RH repurchased ~half its shares and the stock grew twenty-fold over the next four years.  I’m not suggesting RCII will buy half its shares or generate a 20x return.  However, buybacks should certainly be accretive if RCII achieves its FY23 targets and its future looks anything like its past under CEO Fadel’s tenure.

ATTRACTIVE VALUATION

RCII recently reported 2Q21 run-rate FCF > $8/share.  For clarity, we define FCF as reported FCF (CF from Ops less CapEx) but remove net working capital changes.  This implies RCII trades for ~7.5x run-rate FCF, which seems far too low for a business guiding to ~doubling profits from PF20 to FY23.

Said differently, RCII trades for only ~7x run-rate EBITDA while Katapult (“KPLT”) trades for ~13x.  KPLT is a much smaller and barely profitable VLTO peer that recently came public through a SPAC.  Like many SPACs, KPLT initially promoted a very aggressive forecast and has since badly missed expectations while pulling guidance.  Of note, we think RCII might be taking share from KPLT at Wayfair, a customer that represents ~75% of KPLT’s Revenue.  Despite KPLT’s share price falling 80%+ from its 52-week high, the company still trades at huge premium to RCII.  In our view, RCII should be trading for the premium.

For further perspective, RCII trades for only ~1x 2Q21 run-rate Revenue while other “buy now, pay later” companies (“BNPLs”) trade for ~10-20x.  In fact, Square just announced its acquisition of Afterpay for > 30x run-rate Revenue.  We do not believe RCII should trade for 10-30x Revenue (though neither should the BNPLs), but we think the market is misunderstanding VLTO’s value relative to BNPLs as we outline later.

As mentioned above, we think RCII’s FY23 targets could prove conservative.  The company introduced a FY23 goal of $850mm+ EBITDA in February 2021.  Management admitted this goal did not include winning another national retailer as a VLTO partner despite a growing pipeline of potential prospects.  And since providing the FY23 target, RCII increased its FY21 EBITDA guide by ~15% or $85mm.  Plus, RCII launched the Acima LeasePay card, Marketplace, and Browser Extension after issuing the FY23 goal.  Each of these could be meaningful contributors to growth in the next 24 months.

Therefore, we forecast RCII to generate $900mm+ of FY23 EBITDA.  We also assume RCII will repurchase $500mm+ of shares through 2023.  Combined, this translates into ~$12/share of 2023 FCF for RCII.  Given its proven management, growth potential, and fortress balance sheet, we think RCII should trade for at least 12x FCF implying a 2023 fair value of $144/share or ~140% upside.

ADDRESSING POTENTIAL CONCERNS

How/why did RCII pay < 10x after-tax trailing FCF for Acima?

-          Our understanding is Acima’s controlling-founder (Aaron Allred) did not want to be the CEO of a public company, but recognized being pubic could accelerate Acima’s growth since most retailers are public and want to partner with public companies.

-          Progressive was distracted after being spun-off from Aaron’s, so RCII was the only logical buyer. 

-          By selling to RCII, Acima is now part of a public company and Allred can focus on leading the Acima’s sales team (not a public company). 

-          Plus, Allred cashed out ~75% of his investment while staying aligned by accepting ~25% of his payout through three-year restricted stock.

What is Acima’s competitive advantages?

-          Acima appears to have the best underwriting decision engine in the VLTO space.  Hence, Acima has the industry’s highest profit margins – i.e., Acima approves the optimal number of consumers while minimizing costly write-offs.  This decision engine is based on eight years of data and machine-learning.  Plus, now Acima has the industry leader (RCII) investing capital and resources to widen this moat.

-          Post-RCII’s acquisition, Acima can now place returned product at Rent-A-Center stores to be re-leased to store consumers.  We are not aware of any VLTO competitor with this ability. This allows Acima to lease even more aggressively while minimizing losses.  For example, Acima offers 18 to 24-month leases, while we think most peers offer only 12-month leases.

-          As part of RCII, Acima can now also place employees in-store to facilitate VLTO transactions in large retailers.  We do not believe any other VLTO offers this.

-          Our understanding is Acima is the only VLTO that accepts completely unbanked customers, which is critical to reach the low end of the subprime credit spectrum.

-          Acima has partnered with national retailers, such as Ashley’s HomeStore and Wayfair, which leads to great references/data points for other national retailers.  With each national retailer added as a VLTO partner, Acima’s resume becomes better.

-          RCII/Acima is one of only three public VLTOs, but one (KPLT) is far smaller and struggling. National retailers seem to prefer partnering with public VLTOs.

-          Acima has an exclusive partnership with MasterCard, which leads to further brand recognition, a seal of approval that could help attract national retailers, and access to millions of new merchants.

-          We believe Acima’s Marketplace and Browser Extension are also unique and not offered by competitors.

Are RCII profits inflated by government stimulus?

-          For starters, stimulus leads to consumers having more cash and less need for LTO/VLTO.

-          As outlined above, the VLTO industry has significant white space so we think that explains Acima and the VLTO industry’s growth.  Also, Acima’s EBITDA increased by more on a % and $s basis in 2019 (pre-stimulus) than 2020.  So, below we focus on the EBITDA for RCII’s US company-owned stores now known as the “Rent-A-Center Business” segment.

-          FY21 guide calls for $490mm at the midpoint, which implies ~80% or ~$220mm of growth compared to FY19 “Rent-A-Center Business” EBITDA.

-          I would first note this growth far exceeds the other large traditional LTO peer, AAN.  AAN had execution issues in FY18 and FY19, so we use FY17 as the pre-COVID starting point.  Based on the midpoint of its guide, AAN expects < 25% growth from FY17 to FY21 implying only a ~5% CAGR over four years.  This growth is far lower than RCII’s expected ~80% growth or ~35% CAGR, which implies RCII is benefiting from more than an industry tailwind.  

-          Plus, we do not think RCII is simply taking share from AAN.  RCII often serves a lower FICO customer than AAN, hence RCII customers generally make weekly payments (living paycheck to paycheck) while AAN’s customers make monthly payments.

-          We estimate these are the drivers of Rent-A-Center Business segment’s expected growth of ~$220mm from FY19 to FY21: 1) ~$70mm from e-commerce rising from 13% of store Revenue to ~25% at 25% estimated margin, 2) ~$20mm from lower write-offs due to more customers choosing auto-pay, 3) ~$70mm from lower fixed costs because CEO Fadel removed excess expenses from prior management, and 4) ~$60mm from higher growth & operating leverage due to new categories (such as tires), natural growth in the industry, & better execution.

-          Even if RCII’s store profits are inflated, this downside certainly seems priced in at RCII’s very low valuation multiple today.

-          Furthermore, our FY23 estimates assume Rent-A-Center Business EBITDA remains flat after FY21 despite plans to expand e-comm to ~50% of this segment’s Revenue and the likely addition of more product categories.

Will BNPLs take share from VLTO (Acima)?

-          Most BNPLs serve a very different customer.  They allow (often prime+) consumers to buy (often smaller ticket) items through ~four payments over several weeks.  VLTOs are typically leasing larger ticket items to subprime consumers through many small payments over 6-24 months.

-          BNPL arguably does not add incremental sales to the merchant as BNPL consumers typically have the cash to buy the product.  But, VLTOs are bringing an incremental sale because their consumers could not afford to buy the product otherwise.

-          Also, BNPLs charge retailers/merchants a fee (because that’s how BNPLs make $), while VLTOs typically buy products at the retail price (and then lease to consumers) without charging a fee.

-          RCII believes (and we agree) that BNPLs popularity has actually helped draw attention towards VLTOs as consumers seek financing alternatives.

-          As an aside, BNPLs have not proven they can generate a profit despite scale (Afterpay is ~$1b of Revenue) and maybe the best credit environment in history.  We think when the growth and credit bubbles pop, BNPLs write-offs could spike and valuations could compress.

-          To reiterate, we are not suggesting RCII should trade for > 10x Revenue but < 10x FCF seems far too low.

Catalyst

Continuing to beat consensus estimates & achieving/raising guidance, accretive buybacks, investor awareness of the transformed RCII.