Presentation from the 2010 CFSA Conference made by Decosimo's Mike Costello on post crisis financing options for businesses in the payday advance industry.
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Post Crisis Financing Options for the Payday Industry
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Post-Crisis Financing Options
Mike Costello, CPA•ABV•CFF, ASA, CFE
Principal, Joseph Decosimo and Company, PLLC
Managing Principal, Decosimo Corporate Finance, LLC
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About Decosimo
• Accounting firm with nearly 150 CPAs
• Member of CFSA
• Headquartered in Chattanooga, TN
• Offices in Cincinnati, OH; Atlanta and Dalton, GA;
Grand Cayman, USVI; Memphis, Nashville, and
Knoxville, TN
• Expertise in multiple industries
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About DAS
• A practice of Decosimo CPA firm
• Provides business valuation, litigation support, and
transaction advisory services
• More than 35 years of transaction experience
• Industry expertise includes payday lending and others
• Professionals hold ASA, CBA, and/or ABV credentials
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About DCF, LLC
• Investment bank, member FINRA, SIPC
• Provides sell-side and buy-side advisory, sources debt and
equity financing, and performs fairness opinions
• Formalization of corporate finance activities Decosimo
firm has performed for more than 35 years
• Have completed hundreds of transactions during our
history and more than $15 billion in total transaction
value in the past several years
• Have raised capital for several payday industry leaders
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Presentation Topics
1. Basics of value and financing in the payday industry
2. How the financial meltdown affected financing
3. How you can increase your chances of getting
financing
4. Different financing options available and financing
case studies
5. Head to tee-off on #1, the airport, and/or the bar
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Value and Financing Basics
• Value affects your ability to finance
• Why are banks unwilling to lend in general?
1. Values have decreased
2. Overall reduction in willingness to accept risk
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Increasing Value
Senior Debt Sub Debt Equity
• If percentage of value various
25% sources are willing to lend is
50% fixed…
25% • Can only obtain more
financing by increasing value
25%
• Increasing value can also make
50%
a less risky investment and
increase the percentage sources
25% are willing to lend
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What Has Happened to Value?
Value is affected by:
1. The money you make (earnings and growth)
2. The risk you take (the riskiness of your industry and
company)
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Earnings and Growth
• Earnings were down significantly during late 2008, but
recovered during the latter half of 2009
• Public companies show similar earnings measures:
Payday Industry Public Company Earnings
Operating Revenue Gross Profit EBITDA Net Income
140%
% Change in LTM Figures Since 9/04
120%
100%
80%
60%
40%
20%
0%
-20%
-40%
-60%
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
LTM Ending
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Economic Factors
• Economists expect unemployment to remain high through 2012
– Less people qualify for payday products, those that do have a higher chance
of default
Unemployment Rate
Historical Philly Survey WSJ FOMC Range FOMC Central Tendency
11%
10%
Unemployment Rate
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010* 2011* 2012* Long
Run*
Year
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Economic Factors
• Economists expect economic recovery to be slow
– Real GDP growth expected to be moderate through 2012; FOMC lowered
long-run expectation
Real Gross Domestic Product Growth
Historical Philly Survey WSJ Survey FOMC Range FOMC Central Tendency
6%
5%
4%
3%
% Change
2%
1%
0%
-1%
-2%
-3%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010* 2011* 2012* Long
Run*
Year
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Risk
• The industry has suffered extensively from real and perceived
increases in risk, mostly regulatory
• There has been some recovery due to decreased regulatory pressure
Payday Loan Industry Capitalization Rates as Implied by MVIC/EBITDA
Mean Median
20%
Cap Rate (1 / MVIC to EBITDA)
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Nov-05
Nov-06
Nov-07
Nov-08
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
May-05
May-06
May-07
May-08
May-09
Jan-06
Jan-07
Jan-08
Jan-09
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Quarter
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Capital
• Many companies have attempted to “clean up” their balance sheets
• Public companies have significantly increased stock repurchases,
appear to be increasing debt repurchasing
Public Company Financing Cash Flows
Issuance of Debt Issuance of Stock Repayment of Debt Repurchase of Stock
700%
600%
% Change Since 9/04
500%
400%
300%
200%
100%
0%
-100%
Trailing Twelve Months Ended
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Affect on Value
• Values are down = Less room for financing
Payday Lending Portfolio Performance
Payday Portfolio ^DJI ^GSPC ^IXIC
20%
10%
0%
-10%
% Change
-20%
-30%
-40%
-50%
-60%
Jun-07
Jun-08
Jun-09
Dec-06
Dec-07
Dec-08
Dec-09
Feb-07
Feb-08
Feb-09
Oct-07
Oct-08
Oct-09
Aug-07
Aug-08
Aug-09
Apr-07
Apr-08
Month Apr-09
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Frozen Credit Markets
• Flight to quality – ultra-sensitive to risk
• Banks are unwilling to lend, or
• Banks will lend a smaller portion of value
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Frozen Payday Credit
• The industry is perceived as risky:
– Regulatory risk
– “Reputational” risk
• Banks exiting industry
• The “prettiest” companies can still get financing
• Smaller lenders left no option
• Negotiation processes now driven by credit officers
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Frozen Payday Credit
• Industry attractiveness appears to be improving:
– Earnings and growth getting stronger
– Regulatory risk is reducing
• Credit markets are in the process of thawing
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Obtaining Financing
• Earnings and Growth:
– Consistent profitability
– Strong, expandable growth model
– Maintain a strong base of mature stores
• Reduce Risk:
– Diversify your regulatory risk by operating in multiple states
– Track record of minimal bad debt expenses
– Have polished, well-documented compliance and operations
procedures in place
– Maintain a pristine balance sheet – do what you can to de-lever
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Where Can You Find Financing?
• Debt:
– Mezzanine debt
– Private placement
• Equity:
– Private equity group
– Private placement
– Recapitalization
– Strategic sale
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Traditional Debt
• Senior lenders have exited the payday credit market
• Only a few desire to provide credit for the best payday
companies
• A few expressed interest in funding money service
business
• Expect strict covenants, short terms, and higher rates
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Traditional Debt
• Medium term notes and long-term debt:
– Banks no longer want to commit longer than a few years
• Only the “prettiest”
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Traditional Debt – Case Study
Large private company with minimal use of debt
• Successfully renegotiated credit facilities with rest of bank
group and new bank
• Still favorable terms with slightly higher rate, but didn’t get
as much as would have liked, shorter term than usual (2
year)
• Banks wanted changes
• Successfully amended in December 2009 after strong year,
increased credit limit, extended term
• Also obtained seasonal credit in the beginning of 2010
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Debt Alternative – Mezzanine
• Advantages:
– Typically have higher risk profiles
– Can fill 0.5× to 2× EBITDA gap
– Growing market of providers – many options
– Less sensitive to “reputational risk”
• Disadvantages:
– Typically much higher interest rates – 15% up to 20%+
– Sometimes want an “equity kicker” or conversion option
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Debt Alternative – Private Placement
• Advantages:
– Can have very high risk tolerance
– Can access investors that aren’t concerned with
“reputational risk”
– Can have better control over the terms
– Can fill large value gaps
• Disadvantages:
– Tough to access
– Requires a lot of leg work
– Typically only available to larger companies
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Debt Private Placement – Case Study
Dollar Financial recently raised $600 million through a
private debt placement
• Intended to raise $350 million to help pay off this debt
• Offering was oversubscribed:
– Raised $600 million, paid down term notes, other debt, and
financed acquisition of Dealers’ Financial Services
• 10.375% interest rate, fairly favorable terms, 6 year
term
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Another Debt Private Placement
Private company, significant amount of debt, large credit
facility due 2011
• Negotiations were unsuccessful with banks
• Pursued private equity capital
• Successfully raised debt financing through private
placement
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Traditional Equity Financing
• Advantages:
– Don’t have to deal with banks, terms, etc.
– Don’t have to pay interest
• Disadvantages:
– You take the risk
– You may not have the money
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Private Equity Financing
• Advantages:
– PEGs have compiled funds from institutional investors and
wealthy individuals with diversified portfolios – and high risk
tolerance for their private equity investment
– Transfer some of the equity risk to the PEG, can get some cash
out of the business
• Disadvantages:
– Typically will only invest controlling interest amounts
– Dilution of ownership
– Sell their interests in 4-7 years to another PEG, current owners, a
competitor, or the public (an IPO)
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PEGs and Payday Lending
• During the crisis, PEGs have been fairly hands off
• PEGs have not invested a significant portion of raised capital due to the financial
crisis
• They will be pressured to “put money to work” very quickly in the next few years
Private Equity “Overhang”
Source: Pitchbook Data, Inc.
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Equity Private Placements
• Advantages:
– Can have very high risk tolerance
– Can access investors that aren’t concerned with
“reputational risk”
– Can sell any percentage of the company
• Disadvantages:
– Tough to access
– Requires a lot of leg work
– Typically only available to larger companies
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Recapitalizations
• Advantages:
– Current owners typically compensated for a large portion of
ownership
– Sponsor brings in debt financing from their relationships
• Disadvantages:
– Usually give up control of the company
– Often depends heavily upon obtaining senior bank
financing
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Strategic Sales
• Advantages:
– Typically get full liquidity for interests
– Sometimes able to get attractive values
• Disadvantages:
– Most likely don’t continue with the business
– Most strategic buyers won’t pay attractive values
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Conclusion
• It is a rough financing market, but seems to be
improving
• Do what you can to increase your value and reduce
your risk
• Consider creative, less-traditional methods of
financing
• Seek advice from professionals
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“WHEN WE NEEDED A BUSINESS VALUATION, WE LOOKED TO DECOSIMO
BECAUSE OF THEIR ALTERNATIVE FINANCE INDUSTRY KNOWLEDGE AND
ADVANCED VALUATION CREDENTIALS.”
- ROGER DEAN, CFO
“DECOSIMO IS THE ACCOUNTING FIRM FOR THE ALTERNATIVE FINANCE
INDUSTRY.”
- LYNN DEVAULT, PRESIDENT
“WE CHOSE THE DECOSIMO CPA FIRM BECAUSE THEIR CPAs AND
ADVISORS HAVE THE MOST EXPERIENCE SERVING OUR INDUSTRY.”
-BEN PARAMORE, CFO