Description

Upbound Group | UPBD (f/k/a RCII | Rent-A-Center)

Summary:
Significant ink has been spilled, further corroborated by read-throughs and channel checks, indicating consumers on the low-income end of the spectrum are still feeling the pressures of cost inflation and other economic factors without experiencing the wage growth of years prior. While other consumers resort to credit card debt (which continuously hits record highs >$1T), lower income consumers will instead pass on the home improvement, furniture, electronic and other discretionary purchases credit quality continues to suffer. 

Considering that reality, here is something that’s likely not a sustainable proposition in this environment:

1. Providing credit and holding existing loans (yes, they’re effectively loans not “leases”) on home improvement products etc, or worse yet, having a business with a large footprint of fixed costs requiring strong sales to sustain margins. Looking across the peer landscape, everyone is seeing revenue declines since the hyped days of COVID, albeit UPBD has had a flattish 1Q-2Q off an easy comp from 2023

2. A management team that is very incentivized to push off writing off bad debt and continue to accrue in a worsening environment. It's important to note that as a matter of accounting on rentals, the company doesn’t disclose a the bad debt as an expense, instead buckets it as a contra-revenue/keeps it undisclosed…”Our trade and notes receivables consist of amounts due from our lease-to-own customers for lease renewal payments and past due uncollected lease payments, adjusted for the probability of collection based on our assessment of historical collection rates and length of time the receivable is past due” 

3. Oh, and Letitia James (AG of NY) and the CFPB have their eyes set on your business model

Quick Background:

NYSE : UPBD
54.7m s/o * ~$33.50 = $1.8b mcap
+ $1.2bn of net debt = $3b EV

Segments:

1. ~1,780 Rent-A-Center stores (“LTO”) | ~$1.8b of revenues and a MDD EBITDA margin | Flat to shrinking 

2. 30K retail locations serviced by ACIMA (“VLTO”) | Acquired in Feb 2021| $2.2b revenues and a LDD EBITDA margin | 24% rev CAGR over the past 5 years but slowing to HSD/LDD rates

3. ~420 franchised locations that acquires product from UPBD. De-minimis (<$5m), but shrinking,EBITDA

4. ~130 Mexican locations. De-minimis effect on financials

5. Corporate ~400 bps of margin or $160m

EBITDA nets to ~$470m (~11% margins), Interest expense will be ~$100m, CapEx is another ~$75m, which leaves us with ~$300m of FCF before working capital, or an ~15% FCF yield

What is Lease-to-Own (“LTO”)?

Selling or leasing large-ticket items to subprime consumers and allowing customers to pay for the item through weekly, bi-weekly, or monthly payments. Customers are typically offered early purchase options at discounted rates and no long-term obligation. LTO is similar in nature to buy-now-pay-later (“BNPL”), though BNPL is more focused on prime consumers, and is attempting to penetrate the daily spend categories, whereas LTO focuses on one-time large ticket purchases. To cover the higher operating expenses associated with rental purchase transactions and product turnover, rental purchase agreements require higher aggregate payments than those generally charged under other types of purchase plans, such as installment purchase or credit plans. All in, this accumulates to 30-40% more per item than if purchased outright. For instance, if R sells $1mm of merchandise, they will typically generate $1.35mm of revenues. Typically 40% of all rental agreements culminate with ownership.

What is virtual lease-to-own (“VLTO”), and does this have anything to do with e-commerce? 

When a third-party retailer partners with an established LTO operator to provide its customers with credit. This allows the retailer to expand its customer base without having to offer financing from its own balance sheet. This can be done through a staffed kiosk in the partner’s location or entirely virtual. It is important to note this is not exclusive to e-commerce. Both LTO and VLTO occur in-store and online, with RCII’s LTO e-commerce penetration at 25% and VLTO at 15% with significant runway ahead. The only difference lies in the economics; LTO operators are the beneficiary of the retail markup in addition to the equivalent of “interest income”, whereas in VLTO the third-party retailer is the beneficiary of the retail markup, and the VLTO operator benefits from the rental payments above the purchase price paid to the retailer.

Who are some of the direct peers?

PRG, AAN (PRG was the “VLTO” of AAN and spun off). See abcd1234’s write up from 2022 and some of the messages on that thread which I found very insightful considering we have 2 more years of knowledge.
Other consumer credit companies could also be considered, but are not pure-play peers as they serve a different end-market and use case.

The industry set trades ~1-2x of EBITDA less than UPBD, likely driven by the growth of ACIMA and better EBITDA margins at UPBD v. its peers as UPBD can spread corporate costs over a larger revenue base where LTO and VLTO are combined.

Is management good at capital allocation?

Management acquired ACIMA in Feb 2021 for $1.6b (mix of stock and debt) during a particularly unique time when the entire industry was over earning as an effect of stimulus (revenue increases as more purchases are made and less bad debt, slightly offset by less interest and fees, with EBITDA margins increasing more drastically). While they used those proceeds to buyback ~8% of stock o/s, they clearly assumed the good times (as did the market) would continue long-term and were incorrect. See Exhibit below.

Where does the business go from here?

Considering the RCII segment will continue shrinking and ACIMA’s growth rates are slowing (2024 is working off an easy comp, but effectively ACIMA’s growth is slowing), and contra-revenues will eventually need to increase to account for worsening credit quality, we foresee multiple quarters of disappointing results and declining margins towards pre-COVID levels. What seems like the normalized multiple will quickly transform into a multiple that is significantly higher than the market will be willing to pay.

Catalyst

Overaggressive management assumptions coming to the surface