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Sachin Gupta

ADS AT A GLANCE

P/E ► 18.5 AVG EV/EBITDA ► 9.62 AVG ROA ► 6.2% AVG ROE ► 41.6% AVG Debt to Equity ► 20.1 HIGH Current Ratio ► 1.30 AVG Interest Coverage Ratio ► 3.07 AVG

 

 

 

 

 

 

This article refers to the company. For American Depository Share (ADS), a unit representing foreign ownership of a company, see American Depositary Share

Alliance Data Systems (NYSE: ADS) is a credit card company that offers light label credit cards to companies that can then distribute their own branded credit cards. For example, retailers such as Victoria's Secret, and J. Crew use ADS's credit cards.^[1]

ADS administers customer loyalty programs for companies such as BMO Bank of Montreal, Citibank, and Hilton.^[2] Alliance Data is also the provider of the AIR MILES credit card program in Canada which 70% of Canadian households use. Using various information they gather about customer transactions, Alliance Data works with clients to built customer loyalty programs and attract new customers.^[3]This is a service Alliance Data has built through the acquisitions of Epsilon and Abacus, two leading providers of marketing data, over the last two years. ^[4]

Because Alliance Data provides private label credit cards, it ends up holding the balances of its clients customers. These balances are securitized and sold to the public markets. The average customer is a middle to upper class females between the ages of 35 and 49 and has a balance of $360.^[5]

ADS depends on a small number of large clients for a substantial portion of its revenue. The top 10 clients accounted for 40.7% of revenues in 2007 with one client, the BMO Bank of Montreal, representing 10.2% of total revenues.^[6] Furthermore, Alliance Data is exposed to currency and interest rate risk. Between 2006 and 2007, the increased value of the Canadian dollar increased revenue by 66.9 million USD.^[7] If the value of the Canadian dollar relative to the USD were to diminish, revenues would as well since ADS does not currently hedge against currency value fluctuations.^[8] Between 2004 and 2007, rising interest rates increased costs by $63 million per year.^[9]

In May 2007, the Blackstone group announced that it would be purchasing Alliance Data for $81.75 per share. ^[10] However, the deal did not go through after credit markets tightened in late 2007 and in early 2008 Alliance officially announced that the merger had failed. ^[11]

Business Description

Alliance Data Systems provides customer loyalty programs, database marketing services, marketing consulting, and private label credit cards. It monitors client transactions and uses captured data to help clients acquire new customers and maintain existing customers in more effective ways than traditional mass marketing programs. ^[12] Companies use Alliance Data's services because most of these programs are difficult, time-consuming, and expensive to maintain in-house.

Transaction and Credit clients include brands such as Hilton, Victoria's Secret, Canada Safeway, Shell Canada, Amex Bank of Canada, J.Crew, and Expedia. Marketing Services clients include BMO Bank of Montreal, Citibank, Bank Of America, and Amex Bank of Canada. These clients as well as nearly 800 others encompass a wide variety of markets including financial services, retail, grocery and convenience stories, technology, hospitality, travel, and pharmaceuticals. ^[13]

Business Segments

ADS Segment Operating Margins ^[14]

• Marketing Services (47% 2007 revenue, 32.3% income) gathers customer information to help clients design effective marketing programs.^[15] Alliance Data has the largest loyalty program in Canada, AIR MILES, with over 120 sponsor companies and reaching nearly 70% of Canadian households. ^[16] Sponsor companies pay Alliance Data on a per mile issued basis which covers all marketing, customer service, and rewards redemption costs. In the United States, Alliance provides targeted e-mail marketing programs that help acquire new customers through its Epsilon business. In February 2007, Alliance acquired Abacus, a customer acquisition company that owns data from 1,500 catalogers, retailers, online merchants, and business to business marketers. ^[17]

• Credit Services (35.2% of 2007 revenue, 85.4% of income) provides account creation, funding, and risk management services for the 85 private label retail card programs Alliance Data provides its clients.^[18] In 2007, this segment managed $3.9 billion in receivables from 23 million active accounts.^[19] The average account has a $360 balance and is held by middle to upper income individuals. ^[20] Typically, a cardholder is a 35 to 49 year old married female who uses the card as method of payment at a particular store.^[21] Most customers are considered prime borrowers and ADS does not target sub-prime borrowers.^[22] The current and future receivables from this division are packaged and sold as securities in the public markets. However, ADS retains an ownership interest in these receivables.^[23] In 2007, ADS's two largest clients in this segment, Intimate Brands and Redcats accounted for nearly 18.9% and 14% respectively of the receivables. ^[24]

• Transaction Services (32.8% of 2007 revenue, -12.0% of income) processes transactions for private label credit cards issued by the Credit Services division.^[25] This division handles customer support and bill payment and collects purchasing behavior information on clients' customers. Transaction Services also handles transactions at many gas stations and the 7-11 chain. ^[26]

^[27]

Financial Information

In May 2007, Blackstone Group (BX) announced a plan to acquire Alliance Data for $6.76 billion or $81.75 per share. However, in early 2008, it became evident that Blackstone and Alliance Data Systems would not be going through with the deal and on April 21, 2008, Alliance Data Systems announced the deal would not be going through with the merger.^[29]

Revenues and Operating Income

Over the last few years, Alliance Data's revenues have steadily grown. In 2007, total revenue was $2.291 billion ^[30], a 14.6% increase over 2006 revenue^[31]. 2006 revenue was 28.7% greater than the revenue in 2005. ^[32] The primary drivers of growth between 2006 and 2007 were a 28% revenue increase in the Marketing services division with the acquisition of Abacus and a 10.5% increase in securitization income and finance charges from the Credit Services division.^[33] Growth between 2005 and 2006 came from a 40.6% increase in the Marketing Services division from the acquisition of Epsilon and growth in AIRMILES, a 30.3% increase in Credit Services from expanded securitization income, and a 10.9% increase in Transaction Services from new clients.^[34]

During these same periods, operating expenses have grown at a steady pace as well. In 2007, operating expense was $1.648 billion, an 11.1% increase over 2006. ^[35] This was primarily due to expenses associated with the acquisition of Abacus in the Marketing Services division and increased staffing costs due to more customers in the Credit and Transaction services divisions. In 2006, operating expenses increased 23.4% to $1.483 billion.^[36] The increase in expenses during this period were due to 36.3% increase in the Marketing Services from the acquisition of Epsilon and increased costs from the AIR MILES program. In 2006, Credit Services had a 21.1% increase in expenses due to increased marketing costs and Transaction services had a 9.6% increase in operating expense.^[37]

^[38]

Operating Income for 2007 decreased $3.0 million to $344.3 million for 2007.^[39] This decrease was caused by a loss on the sale of the Mail Services division and the revenue and operating expense factors discussed earlier. 2006 was marked by a $110.7 million or 46.8% increase in operating income from 2005.^[40] This increase was due to increased revenues.^[41]

Geographic data

Over the last few years, around 70% of Alliance Data's revenue has come from the United States. ^[42] However, the increasing value of the Canadian dollar has increased revenue and the percentage of revenues from Canada. This has also led to a modest increase in the profit from Canada.

ADS Revenue by Geographic Location^[43]

Trends/Forces

Loss of a single client in 2007 cut quarterly revenues by 7% in Credit Services division

Lane Bryant, one of ADS' largest clients decided to take its credit services in-house in November 2007. Lane Bryant composes nearly 7% of revenues in the Credit Services division. ^[45] This loss is tied to larger issue regarding ADS' client list. The 10 largest clients composed 40.7% of 2007 revenues.

ADS depends on a small number of large clients for a substantial portion of its revenue. The top 10 clients accounted for 40.7% of revenues in 2007 with one client, the BMO Bank of Montreal, representing 10.2% of total revenues. A loss of revenue from a large client will adversely affect revenue. ^[46]

Major client exposure breakdown by division:

1. Marketing Services: the 10 largest clients represented nearly 48.9% of revenue in 2007. BMO Bank of Montreal provided about 21.5% of this division's revenue and the contract with them expires in 2009. ^[47]
2. "Credit Services": the 10 largest clients represent 84.5% of this divisions revenue. Intimate Brands represented 20.9% and the Redcats represented 12.4% of revenue. The contract with Intimate Brands expires in 2012 and the contract with Redcats expires in 2016.^[48]
3. "Transaction Services": the 10 largest clients represent 45.8% of 2007 revenue.^[49]

Rising interest rates increased costs by $63 million per year between 2004 and 2007

Increasing interest rates decrease the value of many of the securitized credit card portfolio's ADS services and sells. Increased rates increase the costs associated with borrowing money and the costs of lending it to consumers. To combat rising interest rates, ADS actively hedges interest rate risk using derivates products such as interest rate swaps and treasury locks. Still, interest rates have their effects and a 1.0% increase in interest rates would result in a decrease of $10 million of pretax debt related income. ^[50]

As Interest Rates rose from their 2004 lows to their current 2007-2008 highs, the amount ADS has paid in interest has increased dramatically. These changes are detailed in the table below:

Between 2006 and 2007, the increased value of the Canadian dollar increased revenue by 66.9 million USD

Nearly 29% of 2007 revenues came from Canada where transactions are executed in Canadian dollars.^[52] As a result, financial results will be affected by the fluctuation in the USD to Canadian dollar exchange rate. Currently, ADS does not hedge against any currency fluctuations and the high value of the Canadian dollar has been beneficial in recent periods. A decline in the value of the Canadian dollar would have a negative impact on financial results.^[53]

In 2006, the increased value of the Canadian dollar brought an addition $31.2 million of revenue but also raised expenses by $25.1 million for a total profit of $6.1 million. ^[54] In 2007, the heightened value of the Canadian currency brought an additional $35.7 million of revenue but another $28.2 million in expenses resulting in a profit of $7.5 million. ^[55]

Competition

Marketing Services

• Convergys (CVG) provides clients with customer data and works to optimize revenues and business processes. They offer similar services to ADS' Marketing Services division.
• Acxiom (ACXM) provides analytical data on consumers and helps clients project customers future purchasing patterns. These services are in competition with many provided by ADS' Marketing Services division.

Credit Services

• American Express Company (AXP), Mastercard (MA), Visa (V) provide popular credit cards that can be specially branded by companies by banks. These programs compete will ADS' private label credit card programs.

Transaction Services

• Total System Services (TSS) is a payment processing company and is one of the largest credit processors. It directly competes with ADS' Transaction Services for clients in the United States and Canada.
• Global Payments (GPN) is a global payment processor that processes for clients in the US, Canada, Latin America, the UK, Europe, and Asia. It is partnered with HSBC in Asia which gives it access to 10 asian markets. GPN is a direct competitor to the services ADS provides.

References

1. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
2. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
3. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
4. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
5. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 7
6. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 14-15
7. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 16
8. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 16
9. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 20
10. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 2
11. ↑ http://www.cnbc.com/id/24211814/ Alliance Data Terminates Sale to Blackstone
12. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
13. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 3
14. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
15. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 5
16. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
17. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
18. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
19. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
20. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
21. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
22. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
23. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 6
24. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 7
25. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 11
26. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Business" Page 7
27. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
28. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
29. ↑ http://www.cnbc.com/id/24211814/ Alliance Data Terminates Sale to Blackstone
30. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
31. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 41
32. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 44
33. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
34. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 45
35. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
36. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 45
37. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 45
38. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40-45
39. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 40
40. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 45
41. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Management Discussion and Analysis of Financial Data" Page 45
42. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Notes to Consolidated Financial Statements" Page F-46
43. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Notes to Consolidated Financial Statements" Page F-46
44. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Notes to Consolidated Financial Statements" Page F-46
45. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Selected Financial Statements" Page 33
46. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 14-15
47. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 14-15
48. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 15
49. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 15
50. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 20
51. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Selected Financial Data" Page 30
52. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 16
53. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Risk Factors" Page 16
54. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Selected Financial Results" Page 45
55. ↑ Alliance Data Systems (ADS) Form 10-K FY 2007, "Selected Financial Results" Page 41