Description

Meta Financial has been written up on VIC several times in the past.  Those write-ups provide a nice overview on the business and this write-up seeks to give an update on recent transformational changes and explain why now is a good time to start buying the business again.

Meta Financial before was a combination of (1) a high quality prepaid card services provider and (2) a simple community bank.  Since late 2015 - 2016, however, Meta Financial made several strategic acquisitions (EPS, SCS, Refund Advantage) and formed several partnerships in the tax space that has transformed itself into a leading national provider of tax Refund Transfer and Refund Advance Loan Products.

Today, Meta Financial has strong market leading positions in both their prepaid and tax segments, and both businesses have attractive dynamics to deliver strong EPS growth.  The Company is currently trading at 11.2x Price / 2018EPS and a 2018 PEG of 0.4x.  This is very cheap given the growth dynamics today of the prepaid card franchise and the potential of the tax business.  Traditional bank investors who anchor solely off book value have missed this opportunity over the last few years.  Meta Financial today is one of the most attractive and highest quality community banks in the nation, yet trades at one of the lowest multiples in a banking sector that hovers around 15-20x.  This is a great buy on an absolute and relative basis to the sector, and the stock’s P/E multiple will re-rate when the Company delivers on double digit 25-30% EPS growth in 2018.

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Let me spend some time providing an update on the bank's prepaid card division first (and explaining why this business is better positioned today than in the past) and then discuss the tax business:

Meta Payments System (MPS) - MPS is the nation's leading prepaid debit card bank.  This is a high growth business with a strong moat.  It is very difficult for other community banks to replicate: MPS has spent ~$50mm in R&D, has 44+ patents outstanding (and more to come), significant investments in capital, compliance, and infrastructure investments, a large team of ~150 employees working in compliance, and another ~150 employees in IT.  This is not small feat for community banks to replicate.  Compared to the large banks, the Durbin Amendment has created a structural advantage for smaller banking franchises to capture more market share of the prepaid card industry.  The rule effectively caps debit card interchange fees for large banks above $10bn, which creates a structural advantage for sub $10bn banks such as CASH, TBBK, GDOT, BOFI.  In addition, MPS has long term contracts with its program managers (e.g. NTSP, HAWK, GCA) that guarantee a minimum amount of funding activity over a life of 5-7 years, so it is quite difficult for new entrants to gain share.

Very few sub $10bn banks today have the infrastructure to compete in the prepaid card space.  Of the few players that do, many of them are structurally disadvantaged relative to Meta Financial.  Given these dynamics, I believe MPS's strong growth should either continue or even accelerate.  My findings on each competitor below:

• The Bancorp (TBBK) - TBBK is currently under a consent order from the FDIC and Federal Reserve, and is unable to sign new program managers.  This consent order is going to take a long time for TBBK to get out of - probably 20 months at the earliest (recently announced BSA, then TBBK will need to show 12 months of sustainable performance, followed by a 3-month exam, and then 5 months to get lifted).  TBBK has significant capital and credit issues.  Moreover, they recently reduced their workforce by ~20% so it is highly questionable whether 20 months is even possible to get out of the consent order – think about this – regulators will be less inclined to stick their neck out to defend this bank.
  
  
• Green Dot (GDOT) - GDOT is facing activist pressure and it is questionable whether this franchise will even have a bank in the future.  Harvest has been pushing to either get the Steve Streit fired, sell off the bank, or sell the Company, so it is questionable whether they will have a bank left or revert to being a pure program manager
  
  
• Bank of Internet (BOFI) - They are at $8bn of assets vs. $4bn of assets for CASH, so one must question the long-term viability of their prepaid business plan, as BOFI grows and surpasses $10bn of assets in the future.  Moreover, BOFI is 1/10 the size of Meta in the prepaid card space.  They are just starting to get into the space whereas CASH has been focused with entrenched long-term relationships in the sector.  It would take a lot of effort, time and money for BOFI to replicate CASH's position.  
  
  
• Republic Bancorp, KY (RBCAA) - They want to grow faster in prepaid, but are struggling.  Building relationships and getting into the door is their biggest challenge.
  
  
• Sunrise – small/subscale; large Program Managers hesitate to work with them
  
  
• River City - simple operation (e.g. 3 guys in a room); large Program Managers hesitate to work with them

Vertical consolidation fears are overblown

With GDOT's recent acquisition of UniRush, there have been concerns lately regarding possible VERTICAL Program Manager consolidation.  I believe these fears are overblown.  Most program managers generally do not want to become a bank given the capital, regulations, and restrictions involved.  GDOT bought a bank and this was disastrous for them.  GDOT’s acquisition of UniRush is different and misinterpreted by the market to imply a vertical consolidation fear for Meta Financial.  This is not indicative of the industry because GDOT started out as a program manager, and they still maintain the program manager mentality when they think about growth.  

Tax Services Division

The Tax Services Division is a new and exciting growth story for Meta Financial.  The tax services division offers interest free Refund Advance Loans (RALs) and Refund Transfer products.  Meta Financial built up this division through several acquisitions (Refund Advantage, EPS, SCS) and partnerships (H&R Block, Jackson Hewitt, Liberty) that have transformed it into a dominant player in this high growth space.  

Refund Advance Loans

WE BELIEVE INVESTORS ARE CONFUSING REFUND ADVANCE LOANS (RALs) WITH AN OLD PRODUCT - REFUND ANTICIPATION LOANS (same “RAL” acronym) THAT GOT SHUT DOWN IN 2012.  Regulators and consumer advocacy groups hated the old Refund Anticipation Loans b/c these products charged high fees to the consumer.  On the contrary, the new product, “Refund Advance Loans”, are free to the consumer.  They are zero interest loans that do not cost anything, fees are paid by the tax preparer (who treat this as an effective marketing fee), and the funds can be placed into a prepaid card whereby the merchants get charged fees upon usage of the card.  

ESSENTIALLY, GIVEN THE CFPB and REGULATORY BACKLASH OVER THE LAST FEW YEARS, THESE PRODUCTS HAVE BEEN REDESIGNED TO SHIFT FEES & LIABILITY AWAY FROM THE CONSUMER.  

The new Refund Advance Loan product has also been previewed and piloted with the regulators, and it seems they are fine with this product.  The CFPB had no complaints.  The refund advance loan product with HRB has been previewed with the regulators and they received a non-objection from OCC.  The products offered by H&R Block have also been vetted by the IRS and CFPB and there have been no objections. 

I believe this product has significant growth potential over time because it is positioned well with many constituents:

·        Consumer: It is free and serves an important need especially among unbanked / underbanked populations

·        Regulators: Regulators have signed off on the product; the product shifts fees from consumers to businesses.  It also helps consumer given the IRS is delaying payments.

·        Tax Preparation Companies: The product has shown success in the early stages for tax preparers to acquire customers (e.g. H&R Block was able to slow down attrition from the launch of the product this year, and Jackson Hewitt and Liberty plan to use this product more aggressively next year).   

We are in the early stages of this product launch and the size of this market has the potential to be big.  Two years ago, Refund Advance Loans were non-existent.  H&R Block did not offer these products, and now it is becoming more widespread and the potential for growth is high.  Prior to Refund Anticipation Loans being shut down around 2012, this was a $5-6bn business spread among all the players.  

There are really truly 3 players that understand this product: Meta, RBCAA, SCS, and to a lesser extent BOFI.  You can break down the product into 2 components: (1) underwriting and admin, and (2) holding credit.  The acquisition of SCS in late 2016 was particularly important for CASH to bring together the (1) underwriting and admin and (2) holding credit function into one platform.  SCS has one of the best underwriting models for consumer tax lending but they are not a bank and previously partnered with a sister bank to hold receivables.  On the contrary Meta Financial is good at (i) moving money, (ii) compliance, (iii) has a prepaid debt program, and (iv) lowers execution risk. 

Refund Transfers

Meta is also well positioned on the refund transfer side.  The RT product is typically used by an individual who needs tax services (generally looking for help with the Earned Income Tax Credit[1]) but cannot pay out of pocket.  The RT product enables the preparer to direct the refund first to the processor’s bank where bank and processing fees, and tax preparer’s fees, are extracted; then the remainder of the refund is delivered to the filer via ACH, check, or prepaid card. 

Meta has advantages unique to their organization to capture additional share.  They are (i) a leading prepaid card bank, (ii) top 3 provider on refund transfer, (iii) leading provider on refund advance loans.  Going forward, management believes there is an opportunity to cross-sell and bundle these options, charging less overall, but capturing additional market share.

Note: HRB, Jackson Hewitt, Liberty have their own proprietary software.  The largest player catering to independents is TPG (GDOT) with half the total share of US refund transfers.  The 2nd and 3rd largest are Fort Knox/Refund Advantage and EPS, respectively

Meta Financial is well positioned with both the major and independent tax preparers:

·        Majors

o   H&R Block: Meta does both underwriting and admin, and holds a majority of the loans

o   Jackson Hewitt: SCS was already doing the underwriting and admin.  CASH’s acquisition of JTX did not close until December so there was not opportunity to hold credit in 2017.  However, this opportunity will be available in 2018

o   Liberty: Currently does business with RBCAA and River City, but CASH will receive a portion next year

o   Intuit: No announcement on refund advance loan product yet

·        Independents

o   TPG (GDOT) – #1 independent player and they currently use SCS.  In my discussions with Meta management, they are highly confident they can capture the funding/credit portion of the business too

o   Refund Advantage (#2 market player) – owned by CASH

o   EPS (#3 market player) – owned by CASH; EPS currently has funding with another bank which has not yet been moved over post deal; there is an opportunity here to move the funding over.

SCS is the underwriting product for TPG (GDOT) and Jackson Hewitt, and CASH owns Refund Advantage and EPS and has the partnership with H&R Block, and will also capture additional business with Liberty next year in 2018, so effectively this franchise is touching 80-85% market share! 

Competitors are weak in the space:

·        RBCAA – These guys are well experienced in the tax space but have poor relationships with the regulators.  Previously tried to buy H&R Block’s bank and the deal was blocked by the regulators.  They still have regulatory baggage

·        BOFI – They got into this space by learning from CASH.  They bought HRB’s bank and are part of the HRB partnership with Meta Financial, but Meta Financial is really the lead arranger of the deal 

·        River City – small/subscale operation

Meta is in a great position to capture the growth of the refund advance and refund transfer markets.  They have the infrastructure, underwriting capabilities, market share, and partnerships to capture a significant portion of this market.  Given the growth of the market, they will not be able to hold all of the loans, even if they wanted to so there should be plenty of opportunity. 

Outlook

The street is forecasting 2018EPS at $8.25/share.  I believe Meta Financial should be able to surpass this number.  Meta Financial generated core diluted EPS of $4.71/share in 2016, of which I estimate that core prepaid business was about ~$3.70/share.  Assuming the base prepaid debit business compounds at 15-20% takes you to ~$5.10 diluted EPS in 2018 for the prepaid business standalone.  In addition, my rough math suggests the tax business can contribute $3.33/share from the tax business (see below), so let’s assume a range of $3.25-3.50/share.  Based on this analysis, my estimate for core diluted 2018 EPS is $8.35-8.60, vs. street at $8.25/share.

I would also highlight there are two opportunities I have not factored into my analysis above which provides additional upside. 

• Product / Revenue Synergies – One opportunity I think the street may be missing is opportunities on the back end, where consumers can put their refund transfer / advance onto a Meta prepaid card, which drives additional income.  I would highlight that all refund transfers currently are being moved to the bank, and there is an opportunity to shift these funds onto a prepaid debit card to the benefit of Meta on the back-end.
  
  
• Synergies / Integration - All three tax companies have been operating independently; CASH has not integrated these franchises.  There are 3 sets of legal reviews, 3 sets of staff (compliance, call center, etc.).  

In summary, Meta Financial is a leading player in two interesting growth industries: prepaid debit cards and tax services (RALs + RT).  The Company has structural advantages in both segments because the competition is weak.  Ultimately, I think the street is too conservative in their 2018 forecast and core diluted EPS should come in much higher.  In the event I am wrong, and EPS comes in at street, the stock should still re-rate upwards from an 11.2x P/2018 EPS to at least 15x P/E upon delivering double digit 25-30% EPS growth in 2018.

Catalyst

Intuit partnership (if INTU decides to enter the RAL space)

Reporting better results next tax season

Communicating the back-end upside story of putting refund advances and refund transfer onto Meta prepaid debit cards

Operating leverage driven by cost take-out of duplicative functions within tax businesses