- A high-growth business previously masked by a stagnant, legacy business is now independent and publicly traded.
- Virtual lease-to-own is closer to being a fintech than traditional lease-to-own retailers.
- Growth potential is completely free at 12.5x forward earnings.
- Management is prioritizing share repurchases over dividends.
"This article was amended on 4/27/2021 to reflect new clarifying remarks."
Prog Holdings (NYSE: PRG) is the leading virtual lease-to-own provider in the U.S with large national retail partners such as Best Buy, Lowe’s, Big Lots, and Signet Jewelers. The company has strong returns on capital, significant growth opportunities, minimal debt, and a share repurchase authorization equivalent to 10% of the current market cap. This high growth business was previously masked by a stagnant, legacy business in an unpopular industry, but the two businesses have now separated. At $44 per share, the market is offering this company for an EV/EBIT multiple of 10.5x on 2020 results and a forward PE multiple of 12x. Other businesses with similar growth prospects justifiably trade for at least 20x forward earnings, which implies a minimum share price of $72 and at least 65% upside.
Industry and Background
The lease-to-own (LTO) industry, also known as rent-to-own, enters into lease transactions with credit challenged customers for household products. Customers’ options range from buying out the lease within 90 days at the retail price + the origination fee or extending the lease for 12-18 months, in which case the total cost of ownership averages 2x the retail price. Both ends of possible outcomes result in attractive returns on the initial capital spent to purchase the merchandise relative to the risk of nonpayment and duration.
This is potentially a significant market, as roughly 35% of the U.S. population has a subprime credit score and a study by the Federal Reserve in 2019 found 37% of Americans would struggle to immediately cover a $400 emergency expense. While a business centered around subprime customers may put off investors at first glance, the LTO industry actually emerged unscathed from the financial crisis of 2008. Tightening credit drives customers to lease transactions and losses on existing leases are limited because the lessor resells the merchandise picked up from nonpaying customers. Historically, the industry has been dominated by Rent-A-Center and Aaron’s controlling roughly 2/3s of the market, with the remaining 1/3 being fragmented across smaller players.
In 2014, Aaron’s entered the virtual lease-to-own (VLTO) space with the acquisition of Progressive Leasing. Progressive enables retail partners to run their own LTO program by purchasing merchandise from the retail partner and entering into a lease transaction with approved customers at the point of sale. Progressive only generated $550 million in revenue for 2014, compared to $2 billion in sales for Aaron’s existing business at the time. In the following 5 years, Progressive’s revenue quadrupled while Aaron’s stagnated, resulting in Progressive becoming the bigger business. Progressive’s ROIC steadily climbed as the business scaled, and its pretax ROIC reached 40% for 2020. The key to Progressive’s business model is their proprietary decisioning engine, which automates customer approval and personalizes pricing using alternative data such as bank account details and customer history. Offering these capabilities to retail partners is a far superior business model than that of traditional LTO retailers as VLTO providers don’t need to maintain stores or distribution chains and largely pass off advertising costs to the retail partners.
In 2020, Aaron’s and Progressive Leasing separated into two independent, publicly traded businesses through a slightly unusual spin off. The original parent company retained Progressive Leasing, was renamed to Prog Holdings, and began trading under the new ticker PRG. The newly formed spinoff gained The Aaron’s Company name and the original ticker, AAN. The former CFO for Aaron’s, who had been with the company for 25 years and led the acquisition of Progressive in 2014, now leads Prog Holdings as the CEO with a long-term incentive award worth over 4x his base salary. The only major disadvantage of the separation is the loss of synergy from re-leasing returned Progressive merchandise through Aaron’s brick and mortar stores. Progressive now partners with multiple third-party vendors to sell returned merchandise. Benefits to Progressive from the separation include:
- Eliminating the obligation to maintain brick and mortar stores or re-invest in the business with lower ROIC.
- Getting more bang for the buck in repurchasing Progressive's shares alone rather than shares of the combined business because Progressive's mispricing is greater.
- Eliminating potential conflict of interest from providing VLTO services to a retail partner that might compete with Aaron's once it has LTO capabilities.
- Building a brand separate from Aaron's.
While the separation should’ve been a catalyst for the market to reward Progressive’s superior business model and growth potential with a much higher multiple, the stock has instead declined over 20% since it officially began trading as an independent company on December 1st, 2020. Considering management quickly eliminated the dividend to prioritize returning excess capital through a $300 million share repurchase authorization, they likely believe the company to be undervalued as well.
Management still believes the potential market for VTLO is under penetrated, estimating that the current VTLO industry is reaching $7 billion in sales out of a $30-40 billion TAM. I’m inclined to agree, as Progressive likely contributes less than 1% in revenue to their biggest retail partners. Progressive disclosed in their 2020 10-K that more than 30% of revenue was derived from their top three POS partners and 72% from the top 10. If 20% of Progressive’s revenue came from Best Buy alone, that would imply Progressive added $500 million to Best Buy’s revenue as their exclusive VLTO partner. This is equivalent to roughly 1.1% of Best Buy’s $43.6 billion in sales for 2020. Considering the size of the subprime credit population that Best Buy was previously unable to sell to, it seems reasonably plausible for LTO sales to contribute to 5% of Best Buy’s revenue, or $2.2 billion at full penetration. Realizing the full potential of the Best Buy partnership alone could nearly double Progressive’s total revenue. Progressive’s partnership with Best Buy (and Lowe’s, which is likely similarly under penetrated) began in 2019 and is still in the process of becoming fully integrated within the business. Management expects to become fully transactional in their larger retail partners’ e-commerce platforms in 2021. Proper e-commerce integration, which Progressive had lacked in 2020, is an important distribution channel which may unlock the next stage of growth. Progressive previously derived most of their revenue from in-store sales, which relied on customers already knowing about the LTO option, noticing placards in-store, or sales associates suggesting the option to customers. E-commerce integration should help spread awareness of the leasing option to online shoppers.
By this point, the skeptical investor is probably wondering why Rent-A-Center’s and Aaron’s (original brick and mortar operations) stagnated for the past several years if the TAM for consumer lease transactions remains largely untapped. I believe the reason may be best understood with a short story of a hypothetical town. Consider a bank that only offers consumer loans at 25% interest, the loans can only be used to shop at 1/10 businesses in town, and the loans must either be paid off within 90 days or extended to 12 months. There will be people who are satisfied with those conditions, but it would be a very particular segment of the population. Then, a new bank in town begins offering consumer loans with interest rates that range from 15-25%, can be used at 3/10 businesses in town, and has options to terminate the loan each month. The new bank still targets a subsegment of the town’s population but has significantly expanded its TAM relative to the first bank. Lease transactions are not the same as consumer loans, but this narrative of newer entrants expanding the TAM would explain why Progressive Leasing and their biggest VLTO competitor, Acima, both grew rapidly while their legacy competitors flatlined.
Prog Holdings also contains another subsidiary named Vive Financial, which is a provider of second-look financing targeting customers that are below prime but with a better credit profile than the typical LTO customer. Vive is naturally a complementary business to Progressive. Progressive might be able to utilize its experience assessing subprime consumers to expand into the fringe area between subprime and prime, which may also serve as a way to retain relationships with customers that graduate from LTO transactions as their financial position improves. Vive currently contributes only 2% of revenue and its operating losses reduce total operating profit by around 3%. The potential synergies are interesting but it’s too early to reasonably estimate its impact on the company’s value.
The LTO industry is an easy punching bag for the media and politicians but regulatory risk is limited. While the voices of disgruntled customers online are the loudest, Progressive actually has a net promoter score of 62. Most of their customers appreciate the service for improving their quality of life when no-one else was willing to extend credit. Banning the industry outright will be difficult as LTO or payday loans are the primary options to purchase a big-ticket item for consumers with subprime credit and low cash savings. Unlike payday loans, an LTO transaction doesn’t put the customer at risk of entering a vicious cycle of debt and there will always be situations where leasing makes sense. Progressive will likely be able to adapt to more nuanced changes in regulation, if any do occur, since the average duration of its lease portfolio is only 6-7 months, and the business is asset-light outside of working capital requirements. Progressive is already transitioning away from being a LTO retail story to being a fintech with the ability to assess the credit profile of subprime customers without relying on credit scores.
Competitors have been active and growing, with Rent-A-Center acquiring Acima and Katapult going public through a SPAC. However, Progressive Leasing still remains the best potential partner to national retailers. As the largest VLTO provider, Progressive has the greatest competitive advantage in data accumulation for their decisioning engines, a large repeating customer base, and a strong reputation in proper receivables management. Given the LTO industry’s unpleasant history in harassing customers for payments, Progressive’s exclusive relationships with Best Buy, Lowe’s, and others sends a particularly important signal to other prospective national retailers that are concerned about protecting their brand image. Barriers to entry are reasonable, since new entrants would need to spend years losing money while collecting data, training their models, and developing the compliance infrastructure. Successful entry isn’t impossible, but it’s also not appetizing considering the large lead held by competitors.
- Share repurchases
- Time passing for the post separation selling to fade and financials to populate databases
- Progress on increasing penetration at large retail partners
- New exclusive partnerships
Although Prog Holdings was not technically the SpinCo, the stock has experienced an unjustified sell-off. Aaron’s now trades at an EV/EBIT multiple of 9.5x, and the small difference from Progressive’s EV/EBIT multiple of 10.5x suggests the market has yet to realize these two companies have drastically different growth prospects and business models. Investors now have the opportunity to acquire ownership in a market leader with significant growth potential near a no-growth multiple.
This article was written by
Analyst’s Disclosure: I am/we are long PRG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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