I bet you awoke this morning bemoaning your failure to purchase shares in Sears (NASDAQ:SHLD) back in 1993. In the early nineties, Sears was the dominant retailer with powerful subsidiaries in the insurance, lending and investment fields. Unfortunately, for some, Wal-Mart (NYSE:WMT) came along and ruined the party. Nonetheless, Sears proved an excellent investment over the last two decades.
"But, Chuck, Sears was a terrible investment!" You are right …if you did not take advantage of the company's many spin-offs over the years.
Since June 1, 1993, 100 shares of Sears has morphed, through spin-offs, into 50 shares of Sears, 21 shares of Sears Canada Inc. (OTCPK:SEARF), 78 shares of Discover Financial Services (NYSE:DFS), 156 shares of Morgan Stanley (NYSE:MS) and 184 shares of Allstate Corporation (NYSE:ALL).
With dividends reinvested, you would have enjoyed a 10.3% annualized return compared to the S&P annualized increase of just under nine percent over the same period.
Translated into dollars, an investor opting out of every Sears spin-off would hold 100 shares of the company worth $4,661. An investor taking advantage of the above listed spin-offs would hold shares in five companies totaling $22,210.36.
THE VALUE OF SPIN-OFFS
Horizon Kinetics, utilizing an actively managed spin-off investment strategy, outpaced the broader market by an average of 7% annually over a period of ten calendar years.
A Credit Suisse study, spanning seventeen years, determined spin-offs outperformed the S&P 500 by 13% during the year following their genesis.
Recent wildly successful spin-offs include Marriott International Inc. (NYSE:MAR), up 140% since its spin-off from the parent company, TripAdvisor Inc. (NASDAQ:TRIP) with a robust 66% increase in value since its inception and Phillips 66 (NYSE:PSX), rewarding shareholders with an 82% increase in share value since its separation from ConocoPhillips (NYSE:COP).
Of course, there are many spin-offs that have performed poorly after their market debut. Should an investor in General Electric (NYSE:GE) opt out of the upcoming spin-off, or will the new company, Synchrony Financial (NYSE:SYF) represent a golden opportunity?
A DISSECTION OF SYF
(For the sake of simplicity, the following content will generally refer to SYF as if it is currently an independent corporation.)
First and foremost, I have noted confusion among shareholders of GE stock. Some are obviously of the opinion that ownership of SYF will be forced upon investors in GE. The following is an excerpt from the prospectus outlining the pending split-off.
"GE has indicated that after this offering it currently is targeting to complete its exit from our business in 2015 through a split-off transaction, by making a tax-free distribution of all of its remaining shares of our stock to electing GE stockholders in exchange for shares of GE's common stock (the "Split-off")." (Emphasis added by the author.)
In other words, the shareholders of GE stock will be provided the option of owning SYF. GE is expected to release 20% of SYF shares through an initial IPO.
Upon its separation from GE, SYF will be the largest provider of private label credit cards in the United States. The new company will be large and diversified with 62 million active accounts and a client base that provides 329,000 retail locations across the United States and Canada. During 2013, SYF financed $93.9 billion of sales, and as of December 31, 2013, the company had $57.3 billion in loans receivable.
SYF will hold a high quality loans receivable portfolio. The company's active consumer accounts had an average FICO score of 714, and the total loans receivables held by SYF had a FICO score with a weighted average of 696.
Over the three years ending on December 31, 2013, SYF has grown its purchase volume and loan receivables at a CAGR of 9.8% and 8.2% respectively. For the years ended December 31, 2011, 2012 and 2013, the company's net earnings were $1.9 billion, $2.1 billion and $2.0 billion respectively. The company's ROA was 4.1%, 4.2% and 3.5% respectively.
SYF will operate through three segments:
Retail Card, Payment Solutions and CareCredit.
THE RETAIL CARD SEGMENT
The Retail Card segment (in the prospectus, the three segments are known as platforms) boasts programs with 24 national and regional retailers. The relationship with each Retail Card partner is generally a long term, exclusive agreement. The companies partnered with the Retail Card segment boast a total of 34,000 retail locations. The current list of Retail Card Partners is as follows:
Amazon, American Eagle, Belk, Brooks Brothers, Chevron, Dick's Sporting Goods, Dillard's, Ebates, Gap, J.C. Penney, Lord and Taylor, Meijer, Men's Wearhouse, Modell's, PayPal, Phillips 66, QVC, Sam's Club, ShopHQ, Stein Mart, T.J. Maxx (includes Marshall's and HomeGoods), Toys "R" Us (includes Babies "R" Us) and Wal-Mart.
With the exceptions of Ebates, Phillips 66, TJX and Toys "R" Us, the agreements between SYF and its Retail Partners have existed for a minimum of six years. Nine of the agreements are a decade or more in length.
J.C. Penney and Wal-Mart each accounted for 10% of the segment's revenues (Sam's Club revenues are not included in this calculation). The five largest partners in the Retail Card segment account for 47.9 % of the segment's revenues. The ten largest Retail Card partners accounted for 58.9% of the segment's revenues.
Since January 11, 2011, SYF added four new Retail Card partners to its client list. Those companies added $2.3 billion in receivables to SYF revenues.
Two of the Retail Card partners are to end their agreements with SYF by the end of 2014 (the names of the two corporations remain a mystery). PayPal is expected to extend the Retail Card agreement for an additional two years beyond 2014; however, it is anticipated PayPal will not renew the contract with SYF at the end of that period.
J.C. Penney, Wal-Mart, Belk and Brooks Brothers recently extended their agreements with SYF.
PAYMENT SOLUTIONS SEGMENT
As of December 31, 2013, SYF had 252 Payment Solutions programs with a total of 61,000 participating partners. Collectively clients of the Payments Solutions programs have 118,000 retail locations. Payment Solutions revenue by calendar year is as follows:
2011 $1.406 billion
2012 $1.446 billion
2013 $1.506 billion
The average length of the relationship between SYF and the 10 largest Payment Solutions programs is nine years. The ten largest clients are as follows:
Ashley HomeStores, Discount Tire, Haverty's Furniture, h.h. gregg, North American Home Furnishings Association, P.C. Richard & Son, Rooms TO Go, Select Comfort, Sleepy's and Yamaha Motor Corp. USA.
The Payment Solutions program is diversified across seven retail markets: home furnishings/flooring (39.3%), electronics/appliances (19.9%), home specialty (13.9%), other retail (7.9%), power (motorcycles, ATVs and lawn and garden) (8%), automotive (7.5%) and jewelry/luxury items (3.5%). No program within the Payment Solutions segment accounts for more than one percent of segment revenues.
In 2013, SYF added 12 new partners in its Payment Solutions network. Five retailers representing $100 million in loan receivables did not renew their agreements.
The majority of the partners in this segment are individual and small group healthcare providers. A small percentage of the clients are national and regional healthcare providers and manufacturers. As of December 31, 2013, SYF had agreements with 149,000 healthcare providers that collectively operated 177,000 locations. No CareCredit partner accounted for more than 0.4% of the segment's total revenues. CareCredit's revenues are diversified across five major specialties: dental (63.9%), veterinary (14.2%), cosmetic and dermatology (9.8%), vision (5.7%), audiology (2.8%) and other (3.6%).
CareCredit revenue by calendar year is as follows:
2011 $1.262 billion
2012 $1.366 billion
2013 $1.511 billion
In 2013, SYF added 17,000 partners to the CareCredit network.
Agreements between CareCredit partners and SYF are not exclusive and typically may be terminated with 15 days' notice.
OTHER IMPORTANT DEVELOPMENTS
In January of 2013, SYF acquired the deposit business of MetLife. This acquisition coupled with other initiatives resulted in an increase of deposits from $6.4 billion to $10.9 billion (as of December 31, 2013). The focus of SYF is to increase its deposit base thereby providing a stable and diversified source of low cost funding. This platform is highly scalable, allowing the company to expand without the overhead expenses of a brick and mortar branch network.
This allows SYF to benefit from the consumer shift from branch banking to direct banking. SYF is working to enhance its offerings in the field by offering enhanced loyalty programs and expanding mobile banking options.
The loss of two Retail Card partners in 2014 as well as the future loss by 2017 of PayPal should cause concern.
Investors should consider the possible effects of new payment technologies, such as Google Wallet, on the future operations of SYF; however, it is a rare corporation that faces no headwinds.
SYF will be limited in their ability to pay dividends or repurchase stock by the Federal Reserve Board.
The full effects of the Dodd-Frank Act are as yet unclear. It is known, however, that the Dodd-Frank Act and related regulations will work to restrict certain business practices, impose more stringent capital, liquidity and leverage ratio requirements, and likely impose additional costs on SYF and other financial institutions. The Dodd-Frank Act and related regulations could limit the fees SYF can charge for services and impact the value of the company's assets.
The Consumer Financial Protection Bureau (CFPB) is a new agency and as such the impact of the agency on financial institutions cannot be accurately gauged. Actions by the CFPB could result in SYF altering or ceasing to offer certain products and services.
A consent order that SYF entered into with the CFPB related to the CareCredit segment requires SYF to pay up to $34.1 million to qualifying customers. SYF states in the prospectus that the company expects additional costs and expenses in connection with actions required under the consent order.
Spin-offs as a group tend to provide gains exceeding those of the market. SYF appears to be a potentially robust company. SYF is diversified in many respects and has long-standing relationships with the majority of its partners. Recent developments within SYF indicate the company has good prospects for future growth.
While the eventual effects of Dodd-Frank and other regulatory agencies are uncertain, the competitive forces arrayed against SYF will be equally affected.
Although the pending loss of two Retail Card partners is a concern, the anchors for the Retail Card segment continue with SYF.
Due to my research regarding GE, I purchased shares on two occasions this month with an average cost of $25.83 per share. It is my hope to purchase additional shares in the near future. My intent is to become slightly overweight in this stock with the hopes of participating in the spin-off. The bulk of my GE stock will be held long-term, as I am bullish concerning the company's prospects.
Use this link for the prospectus outlining the spin-off of SYF from GE.
Disclosure: I am long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.