Financial Mail - Investors Monthly
Finbond buys into four US pay-day lenders
Finbond has soared 391% in the past three years, thanks to its strategy of microlending and mutual banking. But its biggest gamble so far has been buying into four US pay-day lenders. Can it work? asks Giulietta Talevi
You’ve probably seen the adverts, on the Internet at least, of pay-day lenders who’re willing to tide you over until the next pay cheque comes along: “Need cash now? We’re ready to lend a hand.”
In America, more than 19-million households count a pay-day loan “among their choice of short-term credit products”, says one association dedicated to the business of short-term loans.
Clearly it’s a business model SA’s only mutual bank, Finbond, found too tempting to resist. This month, it announced it had bought four pay-day lenders in the US and Canada in a deal worth more than R500m. It might not seem like much, but Finbond is worth only R2.1bn, so it’s a risky gamble equal to 25% of its market value.
One small-cap fund manager, who asked not to be named, says: “if the American assets they are buying are so great, why have no Americans bought them?”
It’s clearly a big gamble for a company that some retail investors believe may be the next Capitec. In recent years, those investors have been handsomely rewarded. Finbond’s share price has rocketed from around 12c/share in 2012 to R4.05 by the end of last year, outperforming the JSE all share many times over. It’s a thumping vindication of CEO Willie Van Aardt’s strategy of microlending to the 40% of South Africans ignored or frozen out of the formal banking system, as well as having a mutual bank that, at last count, held R921m worth of deposits from people attracted to the high rates it pays.
And yet, in recent weeks, the ardour has cooled, with the stock having shed more than 10% this year to trade at around R3.60.
This suggests that the market is not entirely sold on the pay-day lending plan.
What Finbond is buying in the US is a flashy technicolour collection of lenders, with names like Cash in a Flash and American Cash Advance.
They aren’t small businesses either: American Cash Advance owns 41 branches in Louisiana and Mississippi, Cash in a Flash has eight branches in Indiana, while the lender Cashback LLC owns 37 branches in Southern California, with plans to open another five. The Canadian lender is Ontario-based Cash Shop, which owns six branches.
Surprisingly for a company that has done so well in recent years, the company appears particularly defensive over this deal. Finbond CEO Willie Van Aardt says all the deals were done at earnings-enhancing prices, “as is glaringly obvious” from its Sens document. But it’s not as simple as Van Aardt suggests.
For example, he says Finbond’s C$6.5m purchase of Cash Shop puts the business on a multiple of 6.5 times earnings.
However, if you use the net after-tax profit of C$194,209 for the year to December, this puts the purchase price at 33 times its earnings. Finbond supplies no other earnings figures in its acquisition announcement.
Asked to clarify this, Van Aardt told Investors Monthly that the multiple paid will be closer to 6.5, because the pay-day lender has provided a warranty that the profits will be at least C$1m.
“That unaudited C$194,209 [of the previous year] includes “abnormally high fees” paid to previous shareholders the year before that will not be repeated in the current year, and I’m looking at the warranted profit of C$1m,” Van Aardt says.
Thanks to the steep rise in Finbond’s shares in recent times, its own shares trade on a p:e ratio
It’s clearly a big gamble for a company that some retail investors believe may be the next Capitec
of 35 times earnings. So it would make sense for Van Aardt’s company to use its equity, through a R525m rights offer, to stake its claim on American soil.
It’s a transformative deal. If shareholders give it the green light, Finbond expects up to 50% of earnings to be in dollars within the first year. Within five years, it expects its dollar profits to grow to between 70% and 80% of its overall earnings.
Of course, it’s easy to see why South African firms are falling over themselves to expand into so-called hard currency regions, given the increasingly frail rand, which shows little obvious sign of recovering its poise.
But the US is a hard teacher: Old Mutual and Discovery both floundered before reigniting their US careers with vastly scaled-back approaches, while financial services group Sage ran aground in spectacular fashion.
Van Aardt suggests Finbond doesn’t intend to make similar mistakes. “It’s worth remembering that the US partners and senior management that we get as part of the acquisitions have extensive practical knowledge of the market with a proven track record of success,” he says.
Finbond has apparently been scouting around for ways to diversify its risk and increase its revenue. The pay-day lending model in the US provides “earnings-enhancing growth opportunities”.
Van Aardt says the US foray will be ring-fenced from its South African operations. It’s a risky business, however. Pay-day lenders have been squeezed by regulators in the UK, with Wonga.com coming under fierce attack for what many believed to be predatory lending tactics.
Van Aardt says that the profitability of branches in North America is “significantly superior to that in SA”.
He expects the 91 branches that Finbond is buying to generate earnings similar to those it makes through its 342 SA branches in the short term.
Once the acquisitions are in the bag, Finbond will be lending US$130m/year through its microcredit division. But not everyone is as bullish. One analyst, who previously covered Finbond, says: “The idea of pay-day loan businesses in America making bottom-line profits of $1m scares the living daylights out of me — these are clearly not businesses of scale.
“I hope they understand the risks and have done all the research into the regulatory intricacies in the US.”
But the regulation, says Van Aardt, is “significantly more favourable” to that in SA, with pay-day lending regulated on a state-by-state basis.
According to the Pew Charitable Trust, 12-million Americans resort to pay-day loans every year. In 2013, the typical cost of taking out a pay-day loan was $55, and a typical pay-day loan customer would end up taking out loans over five months of the year, paying $525 in fees.
Van Aardt appears unfazed by regulatory rumblings. “We had discussions with state legislatures as well as federal legislatures and are comfortable with the current and potential future regulations.”
In SA, Finbond has had its share of clashes with the regulators — notably the National Credit Regulator.
Having secured its mutual bank licence in 2012, Finbond has gone from making a headline loss of 1.3c/share at its 2012 year-end to headline earnings of 8.6c/share for the year ended February 2015. Its total assets, at last count, were R1.2bn.
Cleverly, the business marries long-term fixed depositors seeking a higher yield, with short-term borrowers. Typically, Finbond’s entire loan portfolio turns 3.5 times a year, with an average loan size of R1,472 and an average tenure of 3.5 months.
In a 2014 note on the company, Anchor Capital wrote: “The key to Finbond’s explosive growth potential [off an admittedly small base] is the massive spread earned between their funding source and their loans written.”
Given that the company has also secured a banking licence, this gives it extra room to grow.
Institutions have largely stayed away until now. While it moved to the JSE’s main board in March 2014, only the Eskom Provident Fund had a stake in it, and that a paltry 0.01%.
But in February last year, Protea Asset Management, on behalf of Midbrook Lane and the Riskowitz Value Fund, snapped up 10.26% of its shares. They join Van Aardt’s Kings Reign Investments, which owns 33.7% of the company and Serge Belamant’s JSE-listed payment services group Net1, which holds 25.9% of the firm.
Protea and Midbrook are the brainchildren of Sean Riskowitz, who swooped on listed insurance outfit Conduit Capital last year, prompting a management shake-up and the departure of former CEO Jason Druian.
Midbrook Lane is now underwriting Finbond’s R525m rights offer, which will be used to fund the North American blitz.
Riskowitz has no worries about the US pay-day lending foray. “I believe you can deduce that we are very positive about the transaction and the prospects of Finbond’s North American expansion,” he says.
For its part, Net1 will stump up R136m to follow its rights, while Van Aardt has committed R75m.
Net1, better known to readers for the fallout over a social security payments tender, has been a passive investor in Finbond since 2009, when it sold some of its branches to Finbond in exchange for shares.
Herman Kotze, Net1’s finance director, says: “There are limited business links between the two firms. We have provided Finbond with arms-length shareholder loans over the years and we provide our EasyPay bill payment service, along with pre-paid airtime and electricity products, at Finbond branches.”
But Kotze says that Net1 “has certain technological offerings that may be applicable to Finbond’s US operations and [that it looks] forward to exploring these opportunities with Finbond’s management”.
Those already invested are predictably talking in gung-ho terms. But for people on the outside, it’s a gamble worth more contemplation.
Anchor Capital’s research note perhaps sums up the equation best: “If Finbond can replicate [Capitec’s] success, shareholders could be handsomely rewarded — but given the execution risks, we believe this is a stock for risk-seeking investors only.”