CASH AMERICA INTERNATIONAL INC CHICAGO, March 6, 2015 /PRNewswire/ -- In response to inquiries from Cash America International, Inc. ("the Company" or "Cash America") shareholders and various market participants, SAF Capital Management LLC today released its letter delivered to Cash America's Board of Directors on January 27(th), 2015.
-- Believes the restructured Cash America, with its leading market
position, steady free cash flows, underleveraged capital structure and
de-risked operating model is drastically undervalued on a cash-flow,
asset value, replacement value or private ownership basis.
-- Based on discussions with various market participants, believes there
are multiple parties interested in acquiring Cash America in a
"take-private" transaction, however, maintains its view that the
Company can generate higher returns for shareholders via an aggressive
public recapitalization.
-- Appreciates the constructive dialogue and subsequent adjustments made to
Cash America's stated capital allocation policy, however, believes--
based on analysis of Cash America equity and debt trading activity-- the
Company is not sufficiently taking advantage of the current fleeting
opportunity to create shareholder value via open market share
repurchases.
-- Holds a significant ownership stake in Cash America, while hedging
remaining regulatory and industry-specific exposure via direct and
derivative positions in industry peers.
The full text of the letter follows:
Cash America International, Inc.
Attn: Board of Directors
1600 West 7(th) Street
Fort Worth, Texas 76012
c/o Jack R. Daugherty
c/o Daniel R. Feehan
c/o Daniel E. Berce
c/o James H. Graves
c/o Buddy "B.D." Hunter
c/o Timothy J. McKibben
c/o Alfred M. Micallef
January 27, 2015
Dear Board Members,
As a long-time shareholder of Cash America International, Inc. ("the Company" or "Cash America" or "CSH"), SAF Capital Management LLC ("We" or "SAF") has maintained a constructive dialogue with Company leadership over the past two years. In the spirit of that dialogue, the purpose of this letter is to summarize recent communications with Company leadership, and serve as a discussion piece for the Company's Board of Directors (the "Board") and long-term Cash America shareholders.
Based on our discussions with various market participants, we believe there are multiple parties that would be interested in acquiring Cash America and/or its Enova International Inc. subsidiary ("Enova") in a "take-private" transaction. Although we believe the Company's equity trades at a modest discount based strictly on normalized earnings, we feel the Company is drastically undervalued on a cash-flow, asset value, replacement value or private ownership basis. The following characteristics make Cash America a uniquely attractive target for private ownership and suggest the Company is deeply undervalued:
1.) The Company's 20% ownership stake in Enova must be liquidated by November 13, 2016, and this monetization will provide tremendous pre-tax cash flows to the company. We believe this timeline is misunderstood by most market participants, who assume the Company will hold its Enova stake for five-years post-divestiture.
The relatively near-term liquidation of the Company's 20% Enova stake should generate significant pre-tax capital gains that can be distributed to shareholders. Having spoken with both buy-side and sell-side analysts covering the Company as well as many of its largest shareholders, we believe the market has largely missed the fact that the Company must liquidate its 20% stake in Enova within the next 22 months. Many market participants are valuing the Company assuming the Enova stake will be monetized at the end of a five-year period, as this is traditionally the timeframe guidance provided by the Internal Revenue Service in such transactions. However, in this instance, Cash America received a private letter ruling that directed the Company to liquidate its Enova stake within 24-months post-transaction in order to protect the tax-free nature of the Enova divestiture. Dan Feehan, the Company's Chief Executive Officer, briefly mentioned this timeframe in a recent Company conference call, but, we believe nearly all market participants missed this critical piece of information. (One analyst stated to SAF that Mr. Feehan likely "misspoke," and the timing was "certainly five years out.") Using the current market price of the Enova stake as a pre-tax liquidation value, in combination with management's 2015 EBITDA guidance as a run-rate, the Company could generate upwards of $400MM in pre-tax capital gains and EBITDA over the next 24 months, which represents over 65% of the Company's current market capitalization. We believe these assumptions may be conservative, particularly because we feel that although Enova's stock price may experience significant volatility in the months around the Consumer Financial Protection Bureau's ("CFPB") expected upcoming regulatory announcement regarding short-term-single-payment ("STSP") lending, its value will likely increase over the 20-month time period after the market digests the new regulatory framework and Enova's pilot operational initiatives begin to gain traction.
2.) The newly restructured Cash America has a leading market position--the largest pawn operator in the United States (by pawn loan volume)--and produces cash flows with enviable robustness and stability. Potential acquirers see the opportunity to purchase a Company with these favorable characteristics at a suppressed multiple, due to the market's lingering misconceptions regarding the Company's exposure to regulatory and other risk factors.
The retail pawn business "pure play" model is attractive due to its inherent insusceptibility to technological obsolescence and "consumer fad" risk, and the Company's strategic reorganization--which SAF advocated for--has categorically addressed the primary risk factors previously faced by the company:
Restructuring creates de-risked Operating Company
-------------------------------------------------
Pre-restructuring Risk Factor Post-restructuring status
----------------------------- -------------------------
Regulatory Exposure Dramatically reduced by the spin-off
of Enova subsidiary. Further
mitigated via the de-emphasizing of
STSP lending at CSH retail
locations. Cash America discontinued
STSP lending at 188 retail locations
since Sept. 2013, announced plans to
discontinue STSP at 160+ additional
locations by end of Q1 2015). STSP
<10% of Revenues in 2015.
------------------- -------------------------------------
Currency risk/Foreign Government Complications Shutdown of Mexico operations results
in 100% domestic footprint, no
foreign currency risk, simplified
US-only government oversight.
---------------------------------------------- -------------------------------------
Exposure to Gold Prices Shift in retail strategy to emphasize
'over-the-counter' sales versus
scrap channel disposition and
increased emphasis on non-jewelry
retail sales reduces impact of gold
price fluctuations.
----------------------- -------------------------------------
Despite these changes, Cash America currently trades at a valuation multiple in-line with companies bearing relatively large levels of exposure to the aforementioned risks, and Cash America's stock price often swings wildly in reaction to news headlines regarding upcoming regulatory developments from the CFPB. The reality is that Cash America is forecasted to generate less than 10% of its 2015 revenue from the type of STSP lending activity that is expected to be subject to potential upcoming regulation. To our knowledge, the CFPB has signaled no intention to regulate pawn lending, likely due to the nature of the pawn lending model, which avoids many of the worrisome characteristics of STSP loans. This non-recourse secured lending model--with its simplicity, lack of collection activities and avoidance of customer "debt cycle" concerns--has been subject to no material changes in federal regulation in over 30 years.
Cash flows generated via retail pawn operations should trade at a market premium, as they are generally more stable and robust than the cash generated by other alternative lending businesses, and compare favorably in terms of demand stability relative to most consumer-facing industries. Cash America's closest competitor, First Cash Financial Services Inc. ("First Cash" or "FCFS"), enjoys a market multiple of nearly 12 times TEV/EBITDA, versus Cash America's 6.2 times TEV/EBITDA(1). Although some of this valuation gap can be explained by FCFS' stronger growth rates and operational efficiency, we believe this near 100% valuation premium is largely due to market misconceptions regarding Cash America's regulatory risk as well as frustration among institutional investors with Cash America's shareholder-unfriendly capital allocation policies.
(1) To better compare the market value
of the two company's retail
operations, in this calculation, Cash
America's 20% stake in Enova is
treated as a cash equivalent, valued
at the 1/15/2015 closing price of
Enova stock. Notwithstanding the fact
that this assumption excludes likely
tax liabilities that would be expected
to be incurred at the time of the
Enova stock sale transaction, we feel
this value calculation will prove to
be conservative, as the Enova stock
will likely appreciate over the next
22 months. Without this adjustment,
Cash America's EV/EBITDA multiple is
7.2.
3.) After years of capital-intensive expansion, there is room for significant profit margin expansion throughout Cash America's operating model.
A strategic buyer should be able to acquire Cash America and quickly remove both corporate and store-level costs, thus driving rapid profit margin expansion. Under present management, initiatives are currently underway to reduce corporate-level costs and to shift storefront employee costs towards an increasingly variable, performance-based compensation system. As the company transitions out of its rapid growth-via-acquisition phase, we feel it is appropriate for operating efficiency to be a primary Company focus. Our view that further significant costs can be removed from Cash America's retail locations is supported by examining the Company's competitors. For example, First Cash Financial Services, Inc. has averaged SG&A costs of 36% of revenues (versus Cash America's 46%), while maintaining superior store-level performance as measured by gross margins on merchandise sales (FCFS 39% vs Cash America's 28%) and nearly all efficiency ratios. (Management has provided guidance that the recent slowdown in inventory turnover ratios is an intentional component of a strategy to improve the retail shopping experience. It is likely too soon to gauge if this will lead to improved overall profitability). First Cash's, as well as fellow competitor EZCORP, Inc.'s, operating metrics maintain their edge, even after adjusting for geographical and inventory mix. We believe these examples validate the thesis that meaningful decreases to store-level expense can be achieved without compromising retail performance. We are concerned that the current unnecessary costs in the system hide the true cash flow potential of the Company, and may allow an opportunistic buyer to purchase the Company at a discount to its true value.
4.) By even the most conservative analysis, Cash America maintains a significantly underleveraged capital structure.
The Company has ample room to safely increase its leverage without bumping into the current covenant restrictions on its outstanding bonds, and these covenants themselves are too restrictive given the newly restructured "pawn pure play" nature of the business. We feel the current capital structure is inappropriate given CSH's operational cash flow, with long-term debt levels presently more than $100MM below the EBITDA/Long-term Debt ratios described as "comfortable" by the Company's Chief Financial Officer in 2013. Although a private buyer would likely swap-out any outstanding debt contracts, we believe there are many iterative steps that the Company could take to accomplish the same results via a public recapitalization - even while remaining in compliance with the temporary covenants recently added to the Company's Credit Agreement.
Were Cash America to entertain a go-private bid and/or initiate a formal sales process at this juncture, we believe the aforementioned regulatory confusion, coupled with potential tax complications (if said process were to commence within 6-months of the Enova divestiture), would result in bids that do not reflect the true value of Cash America. In our view, Cash America can achieve a sustainably higher market valuation by instead concentrating efforts towards tightening existing operations and returning excess capital to shareholders.
We feel that if the Board takes the analysis contained in this letter into consideration, and executes against these items in a timely manner, the Company will generate share price appreciation far greater than the standard, "market price + control premium" acquisition offers that the company would likely receive in its current condition and regulatory circumstances.
Consistent with our previous communications with the Board, we feel Cash America is in urgent need of a broad-based, analytics-driven, capital allocation methodology. As a minimum threshold to receiving approval, this disciplined approach would require that the projected risk-adjusted returns, for all material capital expenditures, significantly exceed the relative return available through Company share repurchases. Having studied the Company's capital deployment history, we can only conclude that many investment decisions were made in isolation, in a "silo," with only the expected absolute returns of each individual investment taken into consideration, rather than a relative analysis comparing each expenditure's projected returns against the returns available by simply repurchasing Cash America shares from the open market. If implemented at present, the application of this allocation methodology would lead to an immediate cessation of external store acquisitions, a discontinuance of debt extinguishment and the commencement of a valuation-based share buyback program as detailed below.
-- The Company should cease external store acquisitions and instead focus
on increasing per share ownership of its own severely mispriced assets:
Although we appreciate the potential benefit of a "land grab" acquisition strategy, by virtually any metric, the Company's overall growth-via-store-acquisition tactic has been ineffective in generating shareholder returns. In the last decade(2), the Company has spent roughly $650,000,000 of shareholder capital--an amount that exceeds the current market capitalization of the company--to purchase existing retail stores from its competitors, paying an average price of $1.72 MM per store (and a significantly higher $2.3MM per location for domestic pawn shops). The end result of these massive capital expenditures is a market capitalization that is nearly 20% lower than it was in December of 2004--a full decade ago. If we strip away the current market value of the Company's 20% Enova stake, we see that the current standalone retail business' enterprise value is over 30% lower than it was in 2004. Simply put, spending $650 MM in shareholder capital on external store acquisitions has yielded dramatically negative returns for shareholders and its continuance cannot be justified.
(2) This time period represents
a particularly good point-of-
reference for comparison, as
the operations of the Company
in 2004 were domestically
focused and the Company had
not yet acquired its online
lending division, thus
providing for a reasonable
apples-to-apples comparison
to today's business
operations. However, the same
calculations applied against
any timeframe since the
Company's inception yield
similar results, after
adjusting for Enova's economic
impact.
The data contained in the following table highlights the current valuation disconnect between the market price of Cash America equity and the replacement value of its assets. Cash America receives less market value per pawn location than any of its competitors. For example, First Cash Financial Services Inc.--the only other publicly-traded "pawn store pure play"--has a Total Enterprise Value ("TEV") of $1.73MM per location, whereas Cash America's TEV currently trades between $760K-$915K per location, depending on how one values Cash America's Enova stake. Some CSH locations that the Company classifies as "pawn stores" function primarily as consumer lending operations and therefore deserve lower valuations; however, even if we adjust the Company-issued store count data to assign zero value to pawn locations in which consumer lending is a primary revenue driver, and also assign zero value to the company's 85 Cash Checking locations, we see that at most CSH is receiving between $1.0MM - $1.1MM in TEV per "pure pawn" location, which is roughly 50% less the average acquisition price paid for such locations, and 40% less than the market value attributed to First Cash Financial's pawn stores. We believe this data demonstrates the irrationality of continuing external store acquisitions at a time when the Company's currently-owned stores can be purchased at a steep discount pro rata via Company stock repurchases:
External Store Acquisitions Yield Negative Returns
11/30/2004 1/15/2015 Change
---------- --------- ------
Domestic Pawn
Locations 441 863 +96%
------------- --- --- ---
Cash Checking
Locations 253 85 -66%
------------- --- --- ---
Total Locations 694 948
--------------- --- ---
CSH Market Cap $758,829,600 $615,909,870 -19%
-------------- ------------ ------------ ---
Shareholder Capital
spent on external
acquisitions:
11/30/04-1/15/15 N/A $647,485,000
------------------- --- ------------
Avg. Price Paid per
Domestic Pawn
Lending Store
acquisition since
11/30/04: N/A $2,300,000
------------------- --- ----------
CSH Market Cap per
Domestic Pawn
Location $1,720,702 $713,685 -59%
------------------ ---------- -------- ---
TEV per Domestic Pawn
Location -(Net
Enova)* $2,188,108 $760,155 -65%
--------------------- ---------- -------- ---
TEV per Domestic Pawn
Location $2,188,108 $914,568 -58%
--------------------- ---------- -------- ---
TEV per "Pure Pawn"
Location - all other
Locations valued at
Zero - (Net Enova)* N/A 1,052,992
-------------------- --- ---------
*For this illustrative calculation,
Cash America's 20% stake in Enova is
treated as a cash equivalent, valued
at the 1/15/2015 closing price of
Enova stock. Notwithstanding the fact
that this assumption excludes tax
liabilities that would be expected to
be incurred at the time of the Enova
stock sale transaction, we feel this
value calculation will prove to be
conservative, as Enova stock will
likely appreciate over the next 22
months.
The primary motivations cited by Company leadership for incremental store acquisitions are: strategic positioning, which should translate into an ability to grow profit margins relative to industry competitors; and the pursuit of economies of scale, which should lead to increased profit margins on an absolute basis through cost reductions. In this instance, we note in the table below that additional storefronts have not benefited the economics of Cash America's business model in relative or absolute terms, with profit margins having decreased since the inception of this acquisition strategy in 2004, while competitors have increased their profit margins over the same time period.
EBITDA as % of
Revenues
---------------
TTM 9/30/2004 TTM 9/30/2014 Change
------------- ------------- ------
Cash America
International,
Inc. 16.3% 10.0%* -6.3%
-------------- ---- ----- ----
EZCORP, Inc. 9.6% 14.3% 4.7%
------------ --- ---- ---
First Cash
Financial
Services Inc. 20.5% 20.6% 0.1%
------------- ---- ---- ---
*Utilizing management's adjusted EBITDA, without further adjustments. CSH's unadjusted
EBITDA was reported as 9.0% for this time period.
We are not generally opposed to a roll-up strategy, and we do not believe Cash America drastically overpaid for these locations. However, external store acquisitions must be coupled with or followed-by an aggressive drive towards operational efficiency and a willingness to continually adjust the Company's capital structure. Otherwise, growth-through-acquisition--even when it appears to be accretive to earnings--will only reduce shareholder value, as it has for Cash America over the last decade.
-- The Company's current discounted market valuation, coupled with its
underleveraged balance sheet, presents a tremendous opportunity to
create value through recapitalization.
Per data in the 'External Store Acquisitions Yield Negative Returns' table above, the Company can currently repurchase the future earnings streams of its own pawn shops pro rata for $700K-$1MM per location-- these are the same domestic pawn stores for which the company paid an average of $2.3MM, and the value of these stores should have increased as their operations were standardized and integrated into the Cash America system. We believe the Company's balance sheet should be recapitalized to achieve a leverage level more appropriate for a steady, cash flow positive operating business such as CSH. Further, we believe all excess capital produced from operations should be deployed towards share repurchases, so long as CSH shares are available at a price that provides an attractive risk-adjusted return relative to the Company's alternative investments and cost of capital.
In a series of transactions that cannot be explained mathematically, the Company, which we believe is already underleveraged, has been deploying shareholder capital to prematurely retire outstanding debt--debt with a coupon far below the Company's EBITDA/enterprise value yield. On a recent earnings call, when asked to justify these expenditures, the Company's CFO responded that, "we had already repurchased a lot of shares." This type of subjective reasoning is insufficient, and this verbal exchange has been cited repeatedly among frustrated shareholders as being indicative of a pervasive capital allocation problem within Cash America.
-- We feel it is critical that the Board seek to hire an operations-focused
CEO with a demonstrated history of driving retail and/or pawn profit
margin expansion, and that the Company announce its mandate to return
shareholder capital prior to hiring the new CEO.
We were disappointed to hear of Dan Feehan's retirement, as we were looking forward to having his considerable skillset focused internally on driving domestic retail operations. Prior to this point, it seemed there were three discrete businesses to be managed within the Cash America umbrella: (1) Domestic Retail, (2) Mexican Retail and (3) Online lending. Cash America didn't appear to have the rank-and-file operational roster to support these disparate activities and, as a result, leadership's energy was diluted across these businesses. The incoming CEO will inherit a much simpler organization, and we feel that his/her executive mandate should emphasize margin expansion within existing operations. As we have discussed with management, we are in favor of the Company pursuing growth only when it increases long-term per-share intrinsic value. Our analysis reveals that when we consider (1) Cash America's market equity valuation levels, (2) Current market prices quoted for external pawn location acquisitions, and (3) Cash America's operational cost structure, it is not possible to allocate capital to growth through acquisition without destroying per-share value. Given these facts, we believe it is clear that management should hire a CEO with an understanding that he/she should be focusing entirely on returning capital to shareholders and driving operational margin expansion, until such time that one of the three aforementioned variables changes materially.
The current Company valuation makes it imperative that much thought be given to the sequence of the Company's corporate actions in 2015. In the case of Cash America, a recapitalization and stock repurchase/special dividend program would primarily serve as a mechanism for returning value to shareholders that has already been created through Company activities. It is fitting that current shareholders who financed these activities and executives who worked to create this value would be enriched via the recapitalization. What is not acceptable, in our view, is for a newly hired CEO to receive an equity grant with CSH stock trading at current discounted levels - and to receive an instant payoff by harvesting the value created prior to his/her arrival (or promotion, should the candidate be an internal hire). In our view, granting an equity award to a new CEO, at these valuations, would be an unjustifiable wealth transfer from current shareholders to the newly appointed executive, and would be irresponsible for the Board to approve. Therefore, we believe it is critical that Company leadership articulate its intentions to return capital to shareholders--so that the market can price-in these capital returns--prior to issuing initial equity compensation to the incoming CEO. Some might argue that such actions may make it difficult to attract CEO candidates; We feel that this sequence may indeed reduce the size, but would likely increase the quality, of the candidate pool. A pre-established mandate would aid in the selection of appropriate candidates, as it will filter out executives who do not wish to be compensated based on their ability to optimize operations, make equity "sweat" and otherwise incrementally improve the per-share value of the Company.
-- The Board should form a Strategic Committee charged with maximizing
shareholder value.
After a lengthy diligence process, SAF initially invested in Cash America having gauged it to be a solid company with strong leadership, and we still hold this view. The current opportunity is to translate the past decade's worth of progress against traditional corporate benchmarks (i.e. significant growth in revenues, new store openings, innovative product offerings, etc.) into shareholder returns. Given that generating superior long-term shareholder returns is the primary purpose of any corporation, this objective certainly warrants the absolute focus of a sub-group of directors. Further, we think it is worth discussing whether the Board may benefit from the incremental addition or substitution of a subset of directors who can specifically make the generation of shareholder returns a priority.
I look forward to hearing from you regarding our proposals.
Sincerely,
Mark McGowan
Managing Member
SAF Capital Management LLC
Contacts:
Investor Relations: (312) 753-3200
inquiries@safcapital.com
www.SAFcapital.com
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SOURCE SAF Capital Management LLC
