Advance America Advances Internet Strategy

Last month, I wrote about why I thought Advance America (AEA) was a compelling buy at $2.56 per share.  Shortly thereafter, the stock dropped down as low as $1.76, making it an even more compelling buy in my eyes.

The company reported earnings last week and it’s important to parse through the report to see how things are shaping up (see conference call transcript).  Revenues for all stores opened prior to 7/1/07 and still open on 9/30/08 decreased 4.0% while revenue in Ohio alone was down 4.2%.  A few months ago, pandering Republicans led by House Speaker John Husted and Chris Widener got a rate cap approved. Later today we’ll know whether or not a referendum to overturn that law went through or not. 

There are two takeaways from the Ohio situation:

The first is that Ohio revenue was down because customers literally weren’t sure if payday loans were still available after the law passed.  My firm funds several independent stores in Ohio.  We’ve been told that customers are calling stores asking if the loans are still available, and that store traffic has been down because of this mistaken belief that the loans were discontinued.

If the referendum is voted down (meaning the law is overturned), the confusion will be gone and I expect AEA’s revenue to improve in Ohio.  If the law remains in place, I expect AEA and all other lenders to lend under other statutes.  I do not expect any public chain to close their doors.  Not for a second.  Ohio is too lucrative to let go. 

Now, to earnings.  Personally, I’ve never thought that net income is the important number to look at for PDL companies.  Net income is often subject to many one-time charges, and the companies can jigger a bit with the “Provision for Doubtful Accounts” on the expense side.  (I’ve always backed out that number when examining the bottom line).  In AEA’s case, they also repurchased 21% of their outstanding shares, which also affects the bottom line number. 

In addition, net income was impacted by a host of write-downs related to store closings and to lobbying efforts in Ohio and Arizona.  The lobbying expenses are problematic because they aren’t tax-deductible and directly impact the bottom line.  AEA will see some expenses related to these efforts every year, although I don’t expect other years to be as costly as 2008 has been.

In addition, AEA’s business was slightly harmed by the stimulus checks from earlier this year. Another round of checks might come given the state of the economy, but this will also be a temporary setback.

Those are the reasons that net earnings don’t matter too much to me. What I really want to see is stable revenue and cash flow, and AEA has plenty of both.

The exciting thing about Advance America is the strategy announced in their earnings report – one I expected them to initiate in the near future, though admittedly not quite so soon.  Internet payday loans have exploded in popularity over the past few years.  Although difficult to gauge, most estimates put internet lenders as having about 15% market share.   Advance America is dipping their toe into this space.

They’ve made a marketing and servicing deal with CashNetUSA, a subsidiary of Cash America (CSH).  Advance America will drive customers to a special website where customers can get an internet loan funded by CashNet, which also bears the default risk.  Advance America picks up an undisclosed fee of net revenue.  As long as those fees exceed their marketing costs, that’s a no-risk source of revenue for them – and I believe it will be significant.

This move is critical for Advance America.  With the storefront market close to saturation, PDL companies that are not diversified into pawn shops will need to find other sources of growth.  Beyond the purchase of title loan companies, expanding onto the internet is the absolute right way to go.

But there are barriers to entry.  The internet borrower is very different from a storefront customer.  Default rates are much higher.  One must have strict controls on underwriting and a crackerjack collections department.   Depending on how lucrative this partnership is, Advance America may elect to just stay the course.  If it only provides minimal revenue, they’ll need to educate themselves further on the internet model  and either create one themselves, or buy someone out.

Advance America continues to trade for around book value, and even with the announced dividend cut, yields 9.3%.  Their revenue base is stable, they have fantastic cash flow, and they are properly positioning themselves for the future.  

For those worried about Obama’s desire to pass a federal rate cap of 36% on all loans, I would say that those concerns are overblown.  Rep. Barney Frank and Sen. Tim Johnson are both chairmen of their respective arm’s finance committees, and understand the benefits of payday loans.  There’s no way a federal cap will be instituted, particularly if Ohio voters send a message on Election Day to overturn that state’s rate cap.

Disclosure: Author holds a long position in AEA

Comments

[User 291282:]

I am confident that Ohio voters will see through the lies and deceptive advertisements of the payday lending industry and vote yes on Ohio issue 5! Voters realize that payday lending is usurious, predatory and designed to trap borrowers in debt! I cast my vote today to lower interest rates from 391% APR to 28% APR! Vote yes on issue 5!

www.yesonissue5.com

2008 Nov 04 09:14 AM

[Concerned U...:]

The article's comments are valid and honest. AEA and others offer a financial option, when used prudently - just like any other financial tool. Consumer demand is strong and will continue to grow as America adjusts to changing economic conditions and weans itself off of easy and irresponsible credit and asset valuations. The current situation is a combination of many things for decades here (with recent years spreading to other developed countries to some extent). To not understand and acknowledge this is naive or uninformed.

A payday loan can be a responsible tool when used correctly. Unlike an Overdraft charge - a common comparable, made without the choice of funding or use of funds, terms or any other related choices by the consumer, but by the bank / credit union. If an overdraft charge were to play by the same rules (disclosure, opt-in, APR, etc,...) there would be no discussion about the better choice. The banking lobby has eliminated that comparison information.

The cycle of debt argument is flimsy at best. A bad decision does not necessarily mean the product was bad, the application for the situation or unforseen/changing circumstances, or mismangement were probably the real reason. To extend that argument, no credit product is good and we should all eliminate car loans, credit cards and mortgages - as well as most modern food options and mass produced products.

2008 Nov 04 12:09 PM

[Inwestor:]

I don't think anyone should have the right to decide if another person can borrow money when they need it. A cap on interest rates would put every pd company out of business, due to the high default rates the industry would not survive.

A report by the New York Fed proved that states with pd companies had lower crimes rates and less poverty. The customers that use pd loans can not walk into a bank and ask for a loan, they have bad credit. The only other option is pawn loans. We all know a lot of the product that goes through pawn shops is stolen. So if you are voting against pd companies, maybe you should invest in steel bars for your home and your car. Because people are still going to need money and will find a way to get it. Outlawing pd companies does not solve anything it only creates more problems. So if you don't need pd loans, don't use them. Simple as that. But don't tell others that do need them that they can not have them.

I found a very responsible website: wirelend.com, they offer cash advance loans but also debt consolidation help for those who may be having debt problem. Check it out.

2008 Nov 04 12:49 PM

[YadYap:]

There is no question that the payday loan industry is moving toward the internet. Think about the generation 30 and younger. Virtually all of them are on the internet for shopping, social networking, research, etc. I think the internet portion of the payday loan industry will be as big as the store front portion in 10 years.

2008 Nov 04 01:56 PM

[PDemployee:]

What ever happened to free enterprise? No one is dragging these folks in. More likely they are being pushed in by the financial institutions and their growing fees: overdraft fees, overlimit fees, usage fees, non-usage fees. Then the banks tell 'em we gotta close your account because you're too much trouble for us. Look, we're just here to help short term. Sometimes that's all a person needs.

2008 Nov 20 10:06 PM

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