Paypal Portfolio Acquisition
On November 16th, Synchrony announced the acquisition of a nearly $6bn Paypal credit portfolio, and a $1bn interest in separately held receivables. Additionally, Synchrony will become the exclusive co-branded credit card for Paypal for the next decade. I believe this begs the question of what Paypal credit actually is. This service, available to select customers, offers interest free loans for 6 months on purchases above $99. Part of the value proposition to Paypal is that it increases purchases by about twofold.
It is important to note that Paypal credit portfolio also seems less healthy than Synchrony’s credit card portfolio, with 11% of the Paypal portfolio with FICO scores (a measure of creditworthiness) below 600, below the subprime threshold, compared to Synchrony’s 7%. While the inorganic growth to the portfolio, in SYF’s area of expertise, is certainly a positive catalyst at first glance, I believe that given the price paid for the acquisition, the success of the acquisition depends on the health of the portfolio, or in other words, can be measured by the success of the charge off rates. Given the trends towards rising rates and flat charge-offs in the past year, the effect of this is still uncertain. However, Synchrony is now in control of the underwriting, and as a result, may choose to tailor the portfolio away from the lower FICO end of the market. I will note that I like to exposure to e-commerce that Synchrony was originally lacking.
Running a comps on (SYF), using Alliance Data Systems (ADS), American Express (AXP), Capital One Financial (COF), and Discover Financial (DFS) as the comparable companies yields a 30% upside, on a net income and tangible book value basis. Please note that ADS has a negative TBV due to the high goodwill on its balance sheet, and as a result was excluded from the P/TBV calculations.
However, I argue that the picture is not so rosy and simple. Applying a more comprehensive comparables valuation in a P/B regression (a regression of P/E vs. ROE) yields approximately an 11% upside. Breaking this down, I believe we see SYF’s P/E as far more fairly valued when accounting for its relative return on equity, as much of the comps upside was eaten into.
Excess Equity Valuation
As far as a method of internal valuation is concerned, it makes little sense to run a cash flow based valuation on a FIG company such as Synchrony, and as a result, I have elected to use the ‘Excess Equity Model’. Please refer to Prof. Damodaran’s paper for a thorough explanation, but the crux of the model is that it values company equity by adding up its current book value of equity, discounted ‘excess equities’ (growth in book equity over its theoretical cost of equity) and its terminal equity value. The model is simplistic in that it proxies book value of equity for market value of equity, due to marked to market accounting practices. My base case five year model, which projects a straight line decrease in ROE to a terminal 13% yields an upside of 17.89%, given that I calculate a cost of equity of 9.11%. I recognize that a 13% ROE is more bearish than current analyst estimates.
 FICO statistics taken from respective 2016 10-K’s
Disclosure: I am/we are long SYF.
Additional disclosure: A stock that I successfully pitched for a fund over a year ago.