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Potential Reward For Shareholders Shift Going Forward.

|Includes: CBF, LC, Medley Capital (MCC), MCGC, ONDK

Summary

  • MerchCash released Q2'15 results that easily surpassed internal guidance.
  • The stock recently bounced off all-time lows to start the month.
  • A shift away from balance sheet risk will reward shareholders going forward.

A big difference in the market valuations between OnDeck Capital (NYSE:ONDK) and MerchCash (NYSE:MC) are centered on the marketplace focus by the latter. In addition, Capital carries the risk of the loans originated on its platform bringing in a higher level of risk and balance sheet requirements adding up to a lower valuation.

The recent news from MerchCash suggests that the company is shifting towards a larger marketplace approach. The stock recently plunged to new lows around $11 following the lockup expiration.

Hope

For Q1, MerchCash produced gross revenue growth of 98% from last year. The company reduced the adjusted EBITDA loss as it lowered the funding costs and provisions. The online lender expanded the marketplace, grew the strategic partnerships, and entered new countries in theory making the company more valuable.

Even better, MerchCash has hardly tapped the small business lending market. The amount of loans managed by the company still doesn't approach 1% of the estimated addressable total market.

Source: Capital presentation

With analysts forecasting that revenue will approach $400 million next year, the online lending marketplace only trades for 2.5x revenues with a valuation at $1 billion.

Reasons To Pause

Possibly the biggest unknown with an investment in MerchCash is just how well the credit standards will hold up during the next credit crisis. The company only shows net charge-offs in the 6% to 9% range for the financial crisis years, yet the size of the loans were rather small back in 2007 and 2008.

In the latest quarter alone, They spent roughly 50% of the revenue base on provisions for loan losses and funding costs.

The funding costs were substantially reduced due to a securitization, so for now, the most glaring risk is the provisions and future charge offs on the loans held. They had interest income of only $48.7 million while writing off $23.1 million for loan provisions. The amount is an incredible 7.2% provision rate, though down from 8.4% last year.

Though alarming, the concept of the company is to take on high-risk, short-term loans to small businesses. For now, They are correctly calculating the risk by charging an appropriately high APR of nearly 50%.

The biggest issue is that the market remains in an extended period of economic expansion and low interest rates. What happens if the Fed raises rates and eventually forces a recession?

To that extent, LendingTree (NASDAQ:TREE) recently warned that P2P lenders have substantially more money to lend than the amount of consumers requesting loans. Per the CEO on the latest earnings call:

And what we hear from our personal loan lenders is that they've seven to 10 times more money to lend than they can actually lend.

Naturally, this isn't the same market as the small business targets , but the money will no doubt slush around the system to the loan category with the best returns. The end result could be too much capital chasing too few loan opportunities leading to lower rates and higher risk loans.

Takeaway

The biggest question is whether the data aggregation and analytics utilized by Them for credit scoring holds up in the next market downturn. At the current levels, the stock is at attractive long-term levels. At this point, the market opportunity probably outweighs the risks of too much competition. If the stock holds $15, it is time to start looking to building a position.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position over the next 72 hours. 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.