Credit Acceptance Corporation - University of Oregon Investment

UNIVERSITY OF OREGON
INVESTMENT GROUP
November 17, 2010
Financials
Credit Acceptance Corporation
RECOMMENDATION: HOLD
Stock Data
Price (52 weeks)
Symbol/Exchange
Beta
Shares Outstanding
Average daily volume
(3 month average)
Current market cap
Current Price
Dividend
Dividend Yield
Valuation (per share)
DCF Analysis
Comparables Analysis
Current Price
Target Price
$33.21 - $63.45
CACC/Nasdaq
0.744
30,540,000
28,589
$1.643 Billion
59.57
NA
NA
$88.70
$48.62
$59.57 (as of 11/12/10)
$68.66
Summary Financials
Revenue
Net Income
Operating Cash Flow
2009A
$380,663,000
$146,045,000
$183,584,000
BUSINESS OVERVIEW
Credit Acceptance Corporation (CACC) was founded in 1972 by Don Foss. Don Foss’s experience in the used car
industry began after graduating high school when he would repair old, beat up cars and sell them for a profit. In 1967,
he opened his first used car lot in Detroit, MI. He soon grew his used car business into multiple lots around the
Detroit and Ann Arbor region of Michigan. His competitive advantage and success stemmed from his unique
Covering Analyst: Nick Poggi
Email: [email protected]
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational.
Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be.
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financing strategy that focused on finding ways to finance anyone regardless of credit history. He was also known for
his outlandish commercials and marketing schemes that gained a lot of attention from customers. Don always found a
way to finance his customers and became very successful at taking customers with poor credit and turning a profit.
Don’s true skills clearly lied in financing, and went on to found Credit Acceptance Corporation in 1972 in Southfield,
Michigan. CACC specializes in providing credit to consumers with poor credit ratings, for the purchase of used cars.
The company grew quickly as it developed long lasting relationships with used car dealers around the nation. In 1992,
CACC celebrated its Initial Public Offering through the Nasdaq followed by a second offering in 1995. Through its
innovative business model and strong relationships with customers, Credit Acceptance has become one the largest
subprime auto lenders in the United States.
Business Model
Credit Acceptance’s core business begins with its direct consumers, or what it calls “dealer-partners.” These dealerpartners are the thousands of used car dealers around the United States that enroll in CACC’s program to allow them
to finance consumers with lower credit ratings. CACC’s revenues are derived from two main programs: the portfolio
program and the purchase program.
Portfolio Program
The portfolio program represents a majority of CACC’s revenues, and is the key to allowing dealer-partners to sell
cars to consumers with poor credit scores. To enroll, dealer-partners fist apply with CACC and can choose to pay an
upfront fee of $9,850 or pay an upfront fee of $1,950 with an additional provision to pay CACC 50% of its first
consumer loan pool. Essentially, CACC acts as a middleman to allow consumers with low credit to receive financing
for a car. When a dealer-partner sells a car under CACC’s program, CACC pays the dealer-partner an advance of the
money owed on the purchase in return for the right to service the consumer’s loan and receive interest payments and
a portion of the principal.
The scenario above represents a basic portfolio program with CACC. CACC requires dealer-partners to group
consumer loans into groups of 100 loans. In addition to servicing the consumer loans, CACC charges the dealerpartner a servicing fee equal to 20% of the pool total. Throughout the duration of this process, CACC pays back
dealer-partners a percentage of the loan they service. The portfolio program benefits all parties, as the consumer is
able to buy a quality car that they would not be able to buy previously due to poor credit. The dealer-partner is able to
make sales to consumers who generally would not be eligible for financing. CACC shares the risk with dealer-partners
and is able to return a profit by servicing these transactions.
Purchase Program
Credit Acceptance began its purchase program in March 2005, where it will purchase a group of loans outright from
dealer-partners. CACC will only pay dealer-partners a single payment for the whole group of loans rather than paying
the dealer-partners back a percent as the loan reaches fruition.
As of September 30, 2010, the purchase program represented 90.5% of combined revenue vs. only 9.5% from the
purchase program.
Dealer-Partner Relationships
In addition to the obvious benefits of creating additional business for dealer-partners, CACC focuses on maintaining
long, mutually beneficial relationships with them. Not only will CACC help service their loans, but will also aid in
marketing, business development and strategy with the dealer itself. CACC wants all dealer-partners in their program
to succeed, as it will result in success for CACC. Credit Acceptance is known also for holding large conferences with
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dealer-partners to discuss strategy and to help them drive for success. As the relationship with specific dealer-partners
grows, they receive additional benefits such as larger advance payments and higher dealer payback.
The relationship with dealer-partners also helps build CACC into the market, so they can get a closer look at the
market they are servicing. Through its partnerships and loans, CACC can more accurately forecast for the future and
improve service to dealer-partners. The number of active dealer-partners enrolled with CACC has increased from
1,766 in 2005 to 3,168 in 2009.
Revenue Sources
Within the specific programs themselves, revenue is broken down into three categories: finance charges, license
fees/premiums earned and other income. Finance charges are comprised of servicing fees charged to dealer-partners,
finance charges from consumer loans, fess from third party products and monthly program fees charged to dealerpartners in the portfolio program. This represented about 86.6% of CACC’s business in 2009 and is clearly their
largest source of revenue. Secondly, CACC earns revenue through the premiums earned on the reinsurance of vehicle
service contracts, which consisted of roughly 8.8% of revenue in 2009, but has grown significantly in relation to
finance charges from 2008 to 2009. Finally, other income includes mainly dealer support products and services that
made up about 4.6% of CACC’s business in 2009. CACC does not face material seasonality. CACC did do business
internationally in Canada and the United Kingdom in the past, but ended its operations in both of these countries, as
it believed it could achieve a higher return in the United States.
Sub-Prime Auto Loans (Auto-Backed Securities)
The second aspect of CACC’s business model involves its application of auto-backed securities in the auto loaning
industry. CACC was a pioneer in packaging loans together, of similar value and payments, to establish a new asset
with lower risk than a single loan that pays an annuity out. CACC can either sell these securities or maintain them inhouse depending on market conditions and potential profitability. This strategy allows CACC to limit its risk by selling
off portions of loans, and also become a middleman to see a piece of every loan that they service. In addition, this
frees up capital allowing them to find the highest return for their dollar.
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Auto-backed securities operate very similarly to bonds. Investors receive streams of payments from the pools of
consumer loans. Investors are given the option to invest in varying degrees of risk called tranches that determine the
return they will receive. The higher the risk of default, the high the return the investor will receive. In addition, a risk
of pre-payment by the consumer exists as well. If the consumer decides to pay off its loan early, investors will be hurt,
as they will lose the future streams of payment.
Following the recent economic downturn, the idea of sub-prime mortgage pools has received a very negative
connotation. This is undoubtedly justified, as it was a leading cause of the recession, however auto-backed securities
behave much differently. Auto loan pools feature fixed interest rates rather than floating rates making them safer. In
addition, the risk of default is lower, as each loan for a car is smaller than that for a house. However, the risk of prepayment is higher with these smaller loans. Credit Acceptance has been very successful in passing through costs
between dealer-partners and sub-prime investors, which has allowed them to grow their business with decreased risk
and increased capital.
Average Consumer Loan Data;
Size of Pool: 100 to 500 auto loans
Average size of Consumer Loan accepted: $12,689
Percentage growth in average size of Consumer Loan: (12.6%)
Average initial term: 38 months
BUSINESS AND GROWTH STRATEGIES
Credit Acceptance primarily grows its business through natural, organic growth that comes with the increase in the
demand of cars. Especially following the recent recession, many consumers were left with poor credit ratings, but still
in need of a car. In addition, CACC has been able to grow extensively through economies of scale, which has led to
decreased expenses and the ability to accept more and more dealer-partners. Credit Acceptance is additionally the
market leader for servicing auto loans for consumers with poor credit ratings, which often naturally makes them the
first choice for potential dealer-partners. In addition to passive growth, CACC actively recruits new dealer-partners to
enroll in their various financing programs.
Growth Strategy
In CACC’s most recent earnings call, CEO Brett Roberts acknowledged that future growth of CACC is unlikely to
come from increasing return on capital, as it has recently reached historic highs in a very favorable competitive
environment. As of late 2009, competition has begun returning and will make it much more difficult for CACC to
maintain such a high return on capital. CACC therefore hopes to increase the size of its business rather than its return
in order to maintain growth. They have made pricing changes in the early stages of 2010, which has reduced the
return on the business, but should increase the number of new enrollments from dealer-partners. They hope to
balance their pricing strategy to maximize volume and profitability while maintaining low default risk from consumers.
Each new relationship with dealer-partners greatly benefits CACC, and with this strategy, they should be able to
continue their growth and improve their top line numbers. CACC also has no plans in the recent future to expand
internationally.
MANAGEMENT AND EMPLOYEE RELATIONS
Chairman of the Board: Donald Foss, is the founder of CACC, and its largest shareholder with nearly 4.8 million
shares. Although he is now 66, and not as actively involved with the operational side of the business, he still holds a
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vital role to the success of CACC. He has grown the company from scratch into the auto loan powerhouse it is today.
As CACC’s largest shareholder, he will continue to have a substantial impact on the company in the future.
Chief Executive Officer: Brett Roberts has worked with CACC since 1991 and was named CEO in 2002. He has
continued Don’s legacy in leading growth for the company and has further established its dominance in the auto
credit services industry. Brett holds roughly 314,000 shares of CACC stock.
Credit Acceptance only has 911 full time employees, and holds a strong tradition of incentive sharing with its
employees to align values of success within the company.
RECENT NEWS
November 4, 2010: Credit Acceptance announces completion of $100.5 million asset-backed financing to help pay
for past indebtedness.
September 10, 2010: Credit Acceptance announces extension of $75.0 million revolving warehouse facility, and will
decrease its floating rate on the debt from LIBOR plus 3.75% to LIBOR plus 3.00%.
March 25, 2010: CEO Brett Roberts sells $4.1 million worth of CACC shares.
INDUSTRY
Credit Acceptance’s industry is difficult to define, as it is by far the largest nontraditional used car subprime lender in
the United States. However, CACC faces fierce competition from a number of different directions. CACC’s
competition varies from individual car dealers to large banks and automobile manufacturers who offer credit to
consumers. As the economy recovers, CACC will see heightened competition from traditional lenders such as banks
and credit unions as well as from new direct competitors. Many of its larger indirect competitors have much greater
financial resources as well as long standing relationships with dealerships that could hurt CACC’s future success.
Despite this highly competitive environment, CACC has been able to successfully establish itself as a mainstay in the
auto-lending industry. By offering credit to consumers who would normally be rejected by traditional lending and
repackaging auto loans to investors, CACC’s business model has allowed it to see sustained success. In terms of direct
markets, CACC most closely competes in the subprime auto-lending industry, but is also very concerned with the
used car dealership industry.
Sub-prime Auto Lending
The subprime auto lending industry consists of lenders who provide credit to consumers who do not qualify for
traditional lending sources such as banks and credit unions. These entities are held by certain standards that come
from FICO scores and LTV Ratios. Many consumers do not meet the standards and therefore cannot borrow from
these traditional lenders. Consumers still need a way to borrow, however, and will turn to subprime lenders for access
to credit. According to recent credit reports, consumers without a FICO score above 700 and an LTV of 80% or
below are most likely to be ineligible for traditional lending. This creates the opportunity for a market in subprime
lending, and has fueled its growth for years.
The market for subprime lending will continue to increase, as consumers look for nontraditional sources of lending.
Competition is also heating up in the subprime lending market, as consumers begin to show trust once again in its
benefits. In addition, subprime lenders are seeing increased competition from automakers as they have increased their
efforts to provide their own financing to consumers in-house.
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Used Car Dealerships
The auto industry was hit extremely hard by the recent down turn in the economy. Consumers as a whole are holding
on to their cars longer, and no longer buying new cars as often. This, in tandem with a decrease in disposable income
has led to stagnant growth in the industry as a whole.
The used car industry, however, continues to grow as more and more consumers try to cut down on wasteful
spending. Currently, used car sales represent 34% of all cars sold in the US each year. This number is expected to
continue to rise as consumers attempt to minimize auto depreciation and elect to buy used cars vs. new cars. Used car
dealerships have also found ways to survive despite the recession. While 36% of new car dealers were forced to close
down in 2009, only 2.5% of used car dealers had to close down. As consumers become more and more conscientious
about wasteful spending and the economy continues to improve, the used car market will undoubtedly continue to
grow. This increase in demand for used cars will continue to propel Credit Acceptance’s success and future growth.
S.W.O.T. ANALYSIS
Strengths

Strong relationship with dealer-partners

Experienced Management Team

Aligned management incentives

Innovative Business Model
Weaknesses

Significant long-term debt

Inability to forecast amount and timing of future collections

An aging majority shareholder and founder, Don Foss
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Opportunities

Traditional lenders such as banks and credit unions tightening credit standards, which will in turn grow the
subprime lending market

Used car industry is expected to outpace new car sales with a growth rate of 5%

Improving economy
Threats

Adverse financing regulations with auto pools

Increased competition from auto makers and other subprime lenders

Limited access to future financing
COMPARABLES ANALYSIS
Quoted company bios taken from Yahoo! Finance profiles:
Nicholas Financial (NICK) – “Nicholas Financial, Inc., through its subsidiaries, operates as a specialized consumer
finance company. The company engages in acquiring and servicing contracts
for purchases of new and used automobiles and light trucks. It also makes
direct loans and sells consumer-finance related products. In addition, the
company engages in developing, marketing, supporting, and updating industryspecific computer application software for small businesses located primarily in
the Southeast United States. It operates 54 branch locations in the Southeast
and the Mid-Western states. The company was founded in 1986 and is
headquartered in Clearwater, Florida.“ Nicholas Financial has a very similar
business structure as Credit Acceptance and services loans similarly to CACC.
NICK is substantially smaller with a market cap of only about $122.5 million, but has a similar P/E as CACC and
most closely resembles their business. NICK is weighted 30% in the analysis because of its similarities to CACC.
White River Capital (RVR) - “White River Capital, Inc., a financial services holding company, through its
subsidiaries, engages in specialized indirect auto finance businesses. The
company, through Coastal Credit LLC, engages in acquiring and
servicing the sub prime auto receivables from franchised and
independent automobile dealers that have entered into contracts with
purchasers of used and new cars, and light trucks. It provides financing
programs to customers of automobile dealers, who meet Coastal Credit’s credit standards, but who may not meet
the credit standards of banks and credit unions; and acquires contracts from dealers for vehicle purchases made by
borrowers who have limited or impaired credit histories or who are purchasing older model and higher mileage
automobiles. The company, through Union Acceptance Company LLC, holds and oversees its portfolio of non-prime
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auto receivables. White River Capital, Inc. was founded in 2004 and is headquartered in Rancho Santa Fe, California.”
White River Capital engages in subprime lending extremely similar to Credit Acceptance, albeit on a much smaller
scale. With roughly a market cap of only $73 million, White River Capital is significantly smaller than CACC, but was
given a weighting of 25% to reflect its similar business structure.
World Acceptance Corporation (WRLD) - “World Acceptance Corporation engages in small-loan consumer
finance business. It offers short-term small loans, medium-term larger loans, related
credit insurance, and ancillary products and services, as well as loans standardized
by amount and maturity. The company also offers income tax return preparation
services and access to refund anticipation loans. In addition, it markets and sells
credit life, credit accident and health, credit property, and unemployment insurance
products; markets automobile club memberships to its borrowers; and reinsures
credit insurance. Further, the company, through its subsidiary, ParaData Financial
Systems, provides data processing systems; and markets computer software and
related services to financial services companies. It serves individuals with limited
access to consumer credit from banks, savings and loans, other consumer finance
businesses, and credit card lenders. As of March 31, 2009, the company has 944 offices in South Carolina, Georgia,
Texas, Oklahoma, Louisiana, Tennessee, Illinois, Missouri, New Mexico, Kentucky, Alabama, and Mexico. World
Acceptance Corporation was founded in 1962 and is headquartered in Greenville, South Carolina.” With a market cap
of $674 million, World Corp is more comparable in size to Credit Acceptance than the previous two comparables.
Although World Corp does not provide subprime lending in the auto industry; it competes in the same overarching
credit industry and has seen very similar growth to CACC. World Corp was given a rating of 25%.
EZCORP Inc. (EZPW) - “EZCORP, Inc., together with its subsidiaries, lends or provides credit services to
individuals to meet their short-term cash needs. It offers pawn loans,
which are non recourse loans collateralized by tangible personal
property, including jewelry, consumer electronics, tools, sporting goods,
and musical instruments. The company also provides signature loans
consisting of payday loans, installment loans, auto title loans, or feebased credit services to customers seeking loans. In addition, EZCORP provides credit services, including advice and
assistance to customers in obtaining loans from unaffiliated lenders. As of September 30, 2009, it operated a total of
910 locations consisting of 369 the U.S. pawnshops, 62 pawnshops in Mexico, 477 the U.S. short-term loan stores,
and 2 short-term loan stores in Canada. The company was founded in 1989 and is headquartered in Austin, Texas.”
EZCORP is the most similar in size to Credit Acceptance with a market cap of about $1.2 billion. Like Credit
Acceptance, EZCORP lends to consumers with poor credit ratings and services high-risk loans and has seen similar
growth. However, with a very little debt to equity ratio and a dissimilar business model involving short-term cash
lending, EZCORP was only given a weighting of 20%.
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DISCOUNTED CASH FLOW ANALYSIS
Revenues
To project out revenues into the future, I first split the total revenue into its three different sources: finance charges,
license fees/premiums earned and other revenue. Using historical data and future projections by the company, I was
able to forecast revenues into the future. Past revenue growth was very high in 2008 and 2009, at 30.12% and 21.94%
respectively despite the economic downturn. In 2010, CACC is on pace to grow total revenue by roughly 16%. As
CACC continues to mature into the future, revenue growth will decrease each year to a terminal value 4.48% in 2019.
The used car industry itself is expected to see continued growth of 5%. Credit Acceptance will continue to outpace
this growth, as it has historically, but will soon fall roughly in line with it due to increased competition and a more
mature business.
Percent of Revenue
Historically, finance charges revenue has accounted for roughly 92% of total revenue, but in 2009 and 2010 so far,
this number has decreased to roughly 87% due to growth in license fees/premiums earned. This ratio will remain
roughly the same into the future. Until 2009, license fees/premiums earned did not account for a substantial portion
of revenue, but now has become roughly 9% of CACC’s revenue source. License fees/premiums earned revenue
growth has been extremely irregular in the past, but will stabilize into the future as CACC becomes more consistent in
this area of business. Other revenue will remain stable at roughly 4-5.5% of total revenue into the future.
Operating Expenses
Operating Expenses in 2009 and so far in 2010 were historically low for Credit Acceptance at 31.32% and 32.57%
respectively as a percent of revenue. Much of this can be attributed to a decrease in salaries and wages as a percent of
revenue, as CACC attempted to weather the recession and decrease expenses. Additionally, CACC was able to
decrease their provision for credit losses, as they tightened their credit standards offered to dealer-partners. As the
economy improves, CACC will once again increase its salaries and wages paid to its employees as a percentage of
revenue. Additionally, as CACC continues to move towards maturity in tandem with an increase in competition, they
will boost their sales and marketing expenses to maintain an advantage in the industry. CACC has also been successful
in decreasing general and administrative costs, and this will remain fairly constant into the future. Provision for credit
losses will increase to a terminal value of 5%, and provisions for claims will remain constant at 5%. As a whole,
operating expenses will increase from their current historically low numbers to reach a terminal value of 44% of
revenues, which is more consistent with past figures prior to 2009.
Depreciation and Amortization
Depreciation and amortization have remained relatively constant as a percent of revenue in the past, but have
increased to 2.66% so far in 2010. I believe this number will decrease to a more historically consistent number of
1.50% of revenue and remain there into perpetuity.
Net Working Capital
Credit Acceptance has greatly increased their net working capital as a percent of revenue from 99.10% in 2008 to
122.11% in 2009 and to an expected percent of 142.47% in 2010. This change can be attributed to the decrease in
current liabilities in 2009 and 2010. Historically, CACC has relied on short-term debt to satisfy its capital needs, but
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has begun taking on long term debt, thus leading to a decrease in the need for current liabilities. Current assets on the
other hand have continued to grow, as loans receivable represent the largest portion of current assets. As CACC
continues to do business, loans receivable will continue to grow leading to a consistent increase in current assets.
Current assets will continue to grow into the future but at a slowing rate as revenues decrease into the future. Current
liabilities have decreased mostly because of a decrease in secured financing. Move forward, current liabilities will grow
as CACC secures additional financing, and then decrease once again as the need for financing decreases with slower
growth. As a whole, net working capital will increase to its highest level in 2012 at 149.41% of revenue, but then
decrease to a terminal value of 133.34%.
Capital Expenditures
Capital Expenditures have never represented a large percentage of revenues for CACC, and will continue to represent
1-2% of revenues into the future.
Beta
I first performed a 5-year monthly regression of CACC’s returns against the S&P 500’s returns and received a beta of
0.518 with a standard error of 0.3266. I do not believe that this is an accurate portrayal of CACC’s risk. CACC’s
business is inherently risky with subprime lending, and with the exception of White River Capital, all other
comparables have a much higher beta. To more accurately calculate beta, I ran a 3-year weekly regression, and arrived
with a beta of 0.744 and a standard error of 0.1566. This is much more accurate, as I believe it reflects the business
risk much more effectively with a smaller standard error.
Cost of Debt
Cost of debt equals 7%, as was explained by Senior Vice President and Treasurer, Doug Busk, in Credit Acceptance’s
most recent earnings call.
RECOMMENDATION
HOLD for all portfolios – I recommend a HOLD for all portfolios, as Credit Acceptance still has value and an
upside potential. Credit Acceptance Corporation has continued to grow every year and will continue to do so into the
future through its innovative subprime auto lending to consumers with poor credit. CACC was able to successfully
weather the recession, and will see continued growth as traditional lending sources tighten their credit and the auto
industry continues to rebound. Despite increasing competition and regulation, CACC has the experience and
management that will allow it to thrive as a nontraditional lender into the future. With a current price undervaluation
of 15.26%, I recommend a HOLD for all portfolios.
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APPENDIX 1 – COMPARABLES ANALYSIS
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APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
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APPENDIX 3 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
APPENDIX 4 – BETA SENSITIVITY ANALYSIS
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APPENDIX 5 – REVENUE PROJECTIONS
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APPENDIX 6 – SOURCES
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Ibisworld
Yahoo! Finance
Google Finance
SEC.rov
Wikipedia
Credit Acceptance Corporation
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