JG
Wentworth: It’s my $$$ and I need it now!
What a beautiful little business that is obfuscated by
GAAP accounting.
You have probably come across one of their catchy commercials
(If not see here, SFW: https://www.youtube.com/watch?v=ZbGw3A9Dg-Q)
and must have wondered what they do. Fairly simple actually – whenever a person
is a claimant to tort or accident claims from insurance companies, he/she had 2
ways of getting that cash. 1st way is to take the lump sum up-front
but footing the tax bill, the 2nd way is called “structured
settlement”, whereby he/she receives a fixed monthly stream of tax-exempt cash-flow for the
next 5-30+ years. The latter structure is likely more attractive given tax and
discounting, and thus we see around a $ 5-6 Bn total receivable balances (TRB)
being issued every year.
Unfortunately, when a need arises (mortgage, injury, debt
repayment, college, etc), there is no easy way to turn that annuity steam into
a lump-sum, and here is where JGW steps in: It will apply a discount rate (say
10.5%) on the streams the claimant want to exchange and he/she will get the
cash now – while entitling JGW to that specified period of cash flows. And both
parties go their merry ways. Straightforward, but why is it a good business?
3 things: Sourcing, process, and funding/pricing. JGW
built a marvelous moat.
Sourcing:
How does a company buy structured settlements when claimants don’t even know
the company exists? The $70 mm spent by JGW is 10x its competitors and makes it
the most widely known brand in the industry.
Process: To
purchase the structured settlement, JGW and the claimant actually have to
appear in front of the judge with all the evidences on hand and ask for “permission”
so to speak. The process takes 8+ weeks and is a rather tedious and painful
process (more so if it fails).
Funding/Pricing:
And to JGW’s special sauce. Since it has the largest scale, it can actually
access the institutional funding market via securitization @ 4.5-5% (in high
demand given 10+ yr WAL and very low default rate). This low base allows them
to offer a 10.5%-11% discount rate to claimants, much lower than 18%+ that
peers are offering.
All-in, it’s really a chicken-and-egg problem. Since JGW
has the lowest funding base, it has a tremendous advantage winning
clients. And given its widest reach and a quick process, it can get the most
receivables amount under its belt than anyone else – thus fueling the
securitization platform, which in-turn allows it to access the lowest cost of
capital. Its competitors either don’t have the marketing reach, can’t win the deal if they have
it due to pricing or process, or don’t have enough scale to tap the institutional market. Larger players
won’t enter due to the market’s small size, further entrenching JGW as the only
dominant player.
And the cash-flow profile is very attractive. It is very
similar to a brokerage model: The whole process of sourcing all structured
settlements to placing the ABS bonds typically take 4.5 months, and JGW
essentially gets 20% of the total receivable balances that securitize when the process
is done. Add to that interest income, fees, and subtract from it various
expenses, what we are looking at is an adjusted net income almost analogous to
free-cash-flow.
In my down-side case, even with a weaker TRB profile,
higher interest rate environment, and lower spread, JGW can still do $1 in
adjusted EPS, effectively placing the downside @ $7-8 / share. All while
preserving the $2.00 in earning power optionality, and rapid deleveraging w/
solid business model for years to come. JLL’s ownership, while
tax-disadvantaged for common stock holders, does spell alignment of interest.
W/ the $15 mm share repurchase in the back-pocket amidst investigation and
unlock scare, it’s a good time to pick up some shares should one believe in the
long-term earning power and upside optionality to M&A + fees.
Risk
·
The rise of alternate financing sources
online (i.e. Lending Club) seems to be a secular negative for the company.
Given that most of the sales on structured settlements is “need-based”, should
an alternate, cheaper source of financing emerge that charges less than 11% and
takes less than 8 weeks, no one in the right mind will settle the cash-flow
stream and JGW will be in some deep trouble. Of course, one can argue that
JGW’s clients are lower income individuals with poor credit, a group that may
still receive exorbitant interest rates; but actually having a potential financing
source vs. none can make a difference for a lot of people.
·
The rise of interest rates is bad for them on
multiple fronts: not only do they have to underwrite the bonds at a higher
discount rate, should JGW attempt to maintain the current 5-6% spread, the
discount rate they pay to claimants will need to be higher and the final
payment amount lower, which could lead to decrease of conversion (i.e. to do
the same URB volume, JGW will have to source more clients who are also less
willing to part with the settlement streams). It will be a true test to whether
the “need-based” claim is real.
Market
Folly Q1 Letter: detailed overviews of some hedge funds’
portfolios as well as 2 detailed pitches going over ASPS and AHT…Source: http://www.hedgefundwisdom.com/wp-content/uploads/2014/05/HFW-Q1-2014.pdf
A
multiplayer game environment: An interview w/ Yanis
Varofakis, Valve’s in-house economist (and in-case you don’t know Valve, it’s
only the most prominent, and private, gaming company in the world): “elaborate
statistics is what you use when you don't know everything… But in a video game
world, all the data are there… That's something of an opportunity, a chance to
experiment with a macroeconomy. We can experiment in economics with individuals.”…Source:
http://reason.com/archives/2014/05/07/a-multiplayer-game-environment/2
The
upside is not reflected in King Digital: LSigurd’s blog is one that
I frequent – for his outstanding performance and often to-the-point (and for the
most part accurate) calls. This time around he fancies KING. He assumes (1) 7x
FCF is cheap enough, (2) Candy Crush is long-tailed, (3) marketing means
something, (4) future games may be latching on, and (5) international
incremental revenue. [Note: no amount of marketing can salvage a bad movie, and
to say that Candy Crush is a “franchise” is quite an insult to many great games
created. FCF might bail the investment out, sure, but what happens when
redeployment of capital has absolutely no certainty of success / return
what-so-ever? The video game industry is viciously tough and even the most talented
fail with ample backing – while success often comes with more than a strike of
luck (even more than movies). Be my guest if one is willing to to pay ½ of EA,
1/3 of ATVI or Nintendo, 2.5x of TTWO, or ~value of Valve for this company]…Source:
http://reminiscencesofastockblogger.com/2014/05/26/the-upside-is-not-reflected-in-king-digital/
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