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Risk-Reward With Alliance Data Systems

- By Jonathan Poland

Alliance Data Systems (ADS) is at the tail end of a restructuring that is expected to leave the company to operate as a more efficient private-label credit card provider with solid long-term growth potential. In the meantime, market volatility is the friend of investors in its stock.

In April, Alliance Data Systems sold its Epsilon and Conversant business to Publicis Groupe in an all-cash deal valued at $4.4 billion with the transaction looking to close in the second half of 2019. The proceeds will go to pay down some of the $24 billion in corporate debt on Alliance's books, as well as repurchase stock. The deal will likely put the company's earnings above $22 per share in 2019.


Alliance Data bought Epsilon for $300 million in 2004 and Conversant for $2.3 billion, and stands to make a healthy profit as it slims down to focus on expanding its card services segment, which already includes 160 branded credit programs with over 40 million customers at stores like Wayfair, Pottery Barn, Walgreens and Ulta Beauty.

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There is plenty of growth available left for the company that has already seen its earnings move from $144 million in 2009 to north of $1 billion in the last 12 months. Investors should salivate over the 45% gross margin, only $194 million in capital expenditures on $2.5 billion in free cash flow, and a book value that has increased from $5.23 to $42.75 in the last decade.

Selling off assets at a profit to focus on the crown jewel of the operation is never a bad idea. Too many organizations spread thin instead of adding fire to the profit center. Competition is far more intense across marketing and data analytics, which makes the divestiture of Epsilon-Conversant a smart move.

That said, there are plenty of risks, namely whether or not its brand partners will be able to compete against online merchants like Amazon. In fact, last fall Alliance Data Systems introduced a plan that would help it remove underperforming portfolios from its Card Service segment, paving the way for commercial retailers. This move helps it limit the exposure to the number of cardholder defaults, which could cause an increase in the cost to fund receivables. The average credit card debt for Americans is between $5,000 and $10,000, but remains a necessary part of everyday life, and with only 27% of credit holders carrying a balance most of the time, the statistics play right into the hands of Alliance Data Systems and its partners.

Sometimes, a step back can create the opportunity for multiple steps or a leap forward, which is what Alliance seems to have done. The leap forward is coming, and now is the time to buy. From a numbers standpoint, if the company does earn $22 per share and is priced just halfway back to its five-year average, it could see $300 per share again.

Disclosure: I am not long or short Alliance Data Systems.

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This article first appeared on GuruFocus.