GEORGE TOWN, Cayman Islands, May 9, 2018 /PRNewswire/ -- Quarz Capital Management, Ltd. (QCM), an investment manager, today issued a letter urging LendingClub to take immediate and decisive steps to address the severe undervaluation of its share price and unlock a potential attractive total return of >70% for shareholders.
QCM views LC's targeted Adjusted EBITDA to Revenue margin of ~11.9% in 2018E which is believed to be lower than it's close peers and what the firm has already achieved in 2-3Q17 and 2015 as unconvincing and unambitious. With its scale and operating advantages of a projected ~23% growth in loan originations, LC's board and management should upgrade profitability targets to levels that commensurate with industry peers and increase focus as well as expediate on a cost optimization strategy to increase LC's profitability.
QCM also proposes that LendingClub revamps its top executive compensation structure by placing more emphasis on firm profitability, earnings growth and shareholder return. A Peer Group referenced to determine top executive compensation structure can be tech and financial firms of similar size, financial metrics and profitability.
To increase shareholder return on LC's substantial cash holdings, QCM recommends the firm to allocate more capital than currently planned through direct or co-investment of high quality and short duration loans and new products on LendingClub's own platform. An attractive recurring interest income of ~$20million p.a. can be generated on $500million of capital allocated with staggered maturity implemented to further enhance LC's liquidity position. This allocation can improve platform investors' confidence in LC's technologically driven credit model while also ensuring that the firm retains ~$100million of cash to execute on strategic initiatives such as mergers and acquisitions.
QCM believes that its recommendations can provide a clear pathway to deliver a significant potential return for shareholders. The investment manager has delivered the following letter to LendingClub's management team, board of directors and other stakeholders.
QUARZ CAPITAL MANAGEMENT, LTD. ISSUES OPEN LETTER TO
THE MANAGEMENT AND BOARD OF LENDINGCLUB CORPORATION
ALL RECIPIENTS ARE ADVISED TO READ
"IMPORTANT DISCLOSURE INFORMATION"
AT THE END OF THE ATTACHED LETTER
Quarz Capital Management, Ltd.
Clifton House 75 Fort Street
George Town I KY1-1108 I Grand Cayman
Cayman Islands
Singapore - May 9, 2018
US ONLINE MARKETPLACE LENDING BEHEMOTH TRADING AT 'STARTUP' VALUATION
- POTENTIAL TOTAL RETURN IN EXCESS OF 70% OVER THE NEXT 3 YEARS -
Dear Mr Sanborn, Mr Allocca and Members of the Board,
Quarz Capital together with its affiliates have built up a sizeable position in Lending Club Corporation (the "Company", "Firm"," "LC US", "LendingClub" or "LC"). We together are among the top shareholders of the firm.
LendingClub is the largest online lending marketplace platform in the US with an estimated ~50% market share1. The firm is projected to generate more than $700million of revenue on ~$11billion of loan originations in 2018E. LC's substantial loan origination volume of more than $35billion since 2006 and its proprietary credit data increase the effectiveness of credit and risk models and enable the largest institutional investors to undertake the rigorous due diligence required to allocate capital on its platform.
We strongly believe that online marketplace lending is a winner takes all industry due to the distinct advantages of network and scale effects. LC's leading market share and strong revenue generation enable the firm to outspend competitors to reach out to the broadest group of borrowers and deepen its technological advantage. The firm can leverage on its platform and substantial client base to introduce complimentary products such as Auto and other secure lending products to further drive growth. We believe that LC is well placed to capture more than 5-10% share in its estimated addressable market of more than $400billion2 in the US credit card consolidation lending industry alone. This can potentially triple LC's revenue to more than $1.8billion in the next 5 years.
Despite the obvious competitive advantage and structural growth potential, LC's share price has collapsed by more than 65% and 85% over the past 2 and 3 years. With the firm's substantial net cash balance of approximately $650million3 amounting to ~55% of its current market capitalization, LC is trading at a distressed 2018E EV/Revenue of ~0.76x times with short interest increasing to 7% of the total float. In comparison, Funding Circle - UK's largest online lending marketplace will potentially be IPO-ed at a valuation of $2billion or more than 11x EV/ 2018E Revenue. Significantly smaller listed US peers such as OnDeck as well as non-prime focused and higher risk - Elevate Credit are also trading at a substantial premium of EV/2018E Forecasted Net Revenue of 1.33x and 1.00x4. We think it is critical that LC's Board and management confront and resolve the reasons resulting in the firm's drastic undervaluation.
We firmly believe that the severe loss of investors' confidence in LendingClub relates to the firm's continuing lack of profitability despite its strong revenue generation and growth potential (besides legacy events/issues). This has also resulted in investors' underestimating the viability of the online marketplace lending model despite peers proving the model's sustainability and growth potential. The main purpose of our letter is therefore to propose 3 in our view, necessary and readily available steps for the Board and management to commit to without delay to restore shareholders' confidence and unlock a potential $1billion of shareholder value, yielding more than 70% increase in LendingClub's share price over the next 3 years.
Recommendation 1. Emphasize on cost control to increase profitability
Despite returning to loan origination growth since a turbulent 2Q16 and generating strong net revenue of $575million in 2017, LC's core business continues to remain unprofitable, losing $140million (ex one-offs) from 3Q16 to 4Q17. We view LC's targeted Adjusted EBITDA to Revenue margin of ~11.9% for 2018E and its goal of achieving slight profitability only in 2H2018 as unconvincing and unambitious. Closest peers such as Prosper and Sofi already achieved Adjusted EBITDA margins of 16% and 42% on revenue of $86million and $280million in 2-3Q17 respectively (loan origination of $1.5billion and $6.6billion).
LC's Adjusted EBITDA margin on a loan origination and net revenue of $4.9billion and $311million in 2H17 respectively already trended above 12%. Prior to management changes in 1H16, Adjusted EBITDA margin was materially higher at 16% in 2015, and provided clear evidence of the firm benefitting from economics of scale even at loan origination volumes 25% lower than anticipated levels in 2018E. Expenditures on both General & Admin as well as Engineering & Development as a percentage of revenue were both significantly lower than current levels. LC's Board and management seem to be unable to translate their strong advocacy of the superiority of the capital light, technically driven and scalable online marketplace lending model over the traditional balance sheet heavy banking model into cashflow.
With the scale and operating leverage advantages of a projected ~23% increase in loan origination volume in 2018E, LC's targeted margin and profit levels are clearly lower than peers, historical levels and what we believe the firm could achieve with stronger focus on cost control. We therefore call on board and management to review and upgrade profitability targets to levels that commensurate with industry peers and expediate on a cost optimization strategy which can increase LC's profitability.
Recommendation 2. Improve alignment of compensation system for top management
While LendingClub's profitability targets were below par, the firm's key management was still paid more than $24million in 2017 despite losses (ex one-offs) of $70million. Comparatively, key executives of the 30th-50th ranked US banks5 (by assets) were compensated an average and median of ~$15.3million and $12.3million in 2017 despite overseeing median loan book sizes of ~$24billion (more than double that of LC) and generating substantially higher median revenue and profit of ~$1.5billion and ~$400million respectively. LC's total stock compensation for 2017 totaled $70million, similar in size to its substantial GAAP Core Net Income loss. 2017's stock compensation was interestingly higher than in 2015 when the firm generated higher Adjusted EBITDA of $70million ($45million in 2017) but paid "only" $51million in stock compensation.
Peer group companies which LC's board itself referenced to determine the key executives' compensation in 2017 were also substantially larger (average market cap of $4.0billion vs $2.2billion for LC) and achieved significantly higher profitability (Median and Average profitability of $46.1million and -$9.8million). Importantly, share prices of this peer group appreciated notably by an average of 50% in 2017 while LC's share dropped by 17%. Notwithstanding the considerable incomparability in size, growth in profitability and performance of the share price, LC's key executives were compensated at the upper quartile of this peer group.
We are supportive of LC's current board and management and recognize that the value opportunity described in the letter can be attributed to them successfully navigating the firm back to growth following a turbulent 1H2016. While a minor proportion of 2017 compensation can be attributed to relocation benefits for 2 new executives, we strongly urge the board to revamp the compensation structure to one which references a peer group of tech and financial firms of similar size, financial metrics and profitability as well as to layout clear and transparent criteria for the award of bonuses. It is critical that key managers as important stakeholders align their compensation to demonstrate their shared interest with shareholders and other employees in the success of the firm.
Recommendation 3. Increase shareholder return on sizeable cash holdings
We are surprised by LC's decision to retain a largely "underutilized" substantial cash hoard of more than $600million generating minimal returns since its 2014 IPO despite the firm operating an industry leading lending platform. While Management has committed to allocate $300million to Investor Programs over the midterm, we deem the decision to keep more than $300million of cash as liquidity reserve as excessively conservative and inefficient. This is in view of the attractive opportunities of direct or co-investing in high quality and short duration loans and new products on LendingClub's platform. A potential recurring interest income of $20million p.a. could be generated on $500million of capital allocation to the platform. Staggered maturity can be implemented to further enhance LC's liquidity position. We believe that this allocation can further improve the confidence that investors have in LC's technologically driven credit model. LendingClub can continue to retain ~$100million of cash to execute on strategic initiatives such as mergers and acquisitions.
The sharp undervaluation which LC's share price trades at periodically due to adverse investor's sentiment can additionally provide a tremendous opportunity for the firm to initiate a shareholder accretive buyback programme. This is especially true when more than half of the LC's share price is backed by cash and does not reflect the intrinsic value and growth potential of its core business. A comprehensive share buyback programme can provide a clear indication of board and management's strong confidence in the continued execution of their strategy and the future cashflow generation capability of the firm.
Conclusion
With the implementation of the proposed strategies and the oversight necessary to ensure its execution, we firmly believe that LendingClub on conservative assumptions can generate a GAAP Net Income of over $60million and achieve a share price of $4.8+ by 2020E. Our model assumes that LendingClub continues to significantly invest more than $400million and $240million on Sales & Marketing as well as Engineering & Product Development to further enhance and build the firm's leading position in both market share and technology. To the extent that LendingClub is to take a more aggressive approach to reducing cost, closing margin gaps vs. peers and utilizing the cash on the balance sheet, there exists substantial potential upside to our price targets for the company.
We request and look forward to a collaborative and positive dialogue with Lending Club's Board and management. Our intention is for the company to move forward expeditiously on the proposals outlined such that improved profitability can be seen as soon as in 2H18.
We firmly believe that after the conclusion of most "legacy issues", LendingClub is at a pivotal point. Navigating successfully will require an increased focus on operational excellence and shareholder value creation. We strongly believe that the recommendations outlined in the letter can provide an optimal path for LendingClub to continue its market leadership. As long-term oriented shareholder, we look forward to working with LC's management team and share our thoughts on the significant opportunity at LendingClub.
Sincerely yours,
Jan F. Moermann
Chief Investment Officer, Quarz Capital Management, Ltd.
Havard Chi, CFA
Head of Research, Quarz Capital Asia (Singapore)
| 1 Credit Suisse and Foundation Capital. Excludes non-marketplace platforms such as Sofi |
About Quarz Capital Management
Quarz Capital Management, Ltd. is a value oriented and research driven investment management firm that seeks to earn above average, long-term returns by identifying value investments across the globe.
www.quarzcapital.com
Important Disclosure Information
SPECIAL NOTE REGARDING THIS LETTER
THIS LETTER CONTAINS OUR CURRENT VIEWS ON THE VALUE OF LENDINGCLUB CORPORATION'S SECURITIES AND ACTION THAT LENDINGCLUB CORPORATION'S BOARD MAY TAKE TO ENHANCE THE VALUE OF ITS SECURITIES. OUR VIEWS ARE BASED ON OUR ANALYSIS OF PUBLICLY AVAILABLE INFORMATION AND ASSUMPTIONS WE BELIEVE TO BE REASONABLE. THERE CAN BE NO ASSURANCE THAT THE INFORMATION WE CONSIDERED IS ACCURATE OR COMPLETE, NOR CAN THERE BE ANY ASSURANCE THAT OUR ASSUMPTIONS ARE CORRECT. LENDINGCLUB CORPORATION ACTUAL PERFORMANCE AND RESULTS MAY DIFFER MATERIALLY FROM OUR ASSUMPTIONS AND ANALYSIS. WE HAVE NOT SOUGHT, NOR HAVE WE RECEIVED, PERMISSION FROM ANY THIRD-PARTY TO INCLUDE THEIR INFORMATION IN THIS LETTER. ANY SUCH INFORMATION SHOULD NOT BE VIEWED AS INDICATING THE SUPPORT OF SUCH THIRD PARTY FOR THE VIEWS EXPRESSED HEREIN. WE DO NOT RECOMMEND OR ADVISE, NOR DO WE INTEND TO RECOMMEND OR ADVISE, ANY PERSON TO PURCHASE OR SELL SECURITIES AND NO ONE SHOULD RELY ON THIS LETTER OR ANY ASPECT OF THIS LETTER TO PURCHASE OR SELL SECURITIES OR CONSIDER PURCHASING OR SELLING SECURITIES. ALTHOUGH WE STATE IN THIS LETTER WHAT WE BELIEVE SHOULD BE THE VALUE OF LENDINGCLUB CORPORATION'S SECURITIES, THIS LETTER DOES NOT PURPORT TO BE, NOR SHOULD IT BE READ, AS AN EXPRESSION OF ANY OPINION OR PREDICTION AS TO THE PRICE AT WHICH LENDINGCLUB CORPORATION's SECURITIES MAY TRADE AT ANY TIME. AS NOTED, THIS LETTER EXPRESSES OUR CURRENT VIEWS ON LENDINGCLUB CORPORATION. IT ALSO DISCLOSES OUR CURRENT HOLDINGS OF LENDINGCLUB CORPORATION SECURITIES. OUR VIEWS AND OUR HOLDINGS COULD CHANGE AT ANY TIME. WE MAY SELL ANY OR ALL OF OUR HOLDINGS OR INCREASE OUR HOLDINGS BY PURCHASING ADDITIONAL SECURITIES. WE MAY TAKE ANY OF THESE OR OTHER ACTIONS REGARDING LENDINGCLUB CORPORATION WITHOUT UPDATING THIS LETTER OR PROVIDING ANY NOTICE WHATSOEVER OF ANY SUCH CHANGES. INVESTORS SHOULD MAKE THEIR OWN DECISIONS REGARDING LENDINGCLUB CORPORATION AND ITS PROSPECTS WITHOUT RELYING ON, OR EVEN CONSIDERING, ANY OF THE INFORMATION CONTAINED IN THIS LETTER.
As of the publication date of this report, Quarz Capital Management Ltd. and its affiliates (collectively "Quarz"), others that contributed research to this report and others that we have shared our research with (collectively, the "Authors") have long positions in and own options on the stock of the company covered herein (LENDINGCLUB CORPORATION) and stand to realize gains in the event that the price of the stock increases. Following publication of the report, the Authors may transact in the securities of the company covered herein. All content in this report represent the opinions of Quarz. The Authors have obtained all information herein from sources they believe to be accurate and reliable. However, such information is presented "as is", without warranty of any kind – whether express or implied. The Authors make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and the Authors do not undertake to update or supplement this report or any information contained herein.
This document is for informational purposes only and it is not intended as an official confirmation of any transaction. All market prices, data and other information are not warranted as to completeness or accuracy and are subject to change without notice. The information included in this document is based upon selected public market data and reflects prevailing conditions and the Authors' views as of this date, all of which are accordingly subject to change. The Authors' opinions and estimates constitute a best efforts judgment and should be regarded as indicative, preliminary and for illustrative purposes only.
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This report's estimated fundamental value only represents a best effort estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor.
This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of the Authors. Also, this document does not in any way constitute an offer or solicitation of an offer to buy or sell any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction. To the best of the Authors' abilities and beliefs, all information contained herein is accurate and reliable. The Authors reserve the rights for their affiliates, officers, and employees to hold cash or derivative positions in any company discussed in this document at any time. As of the original publication date of this document, investors should assume that the Authors are long shares of LendingClub and have positions in financial derivatives that reference this security and stand to potentially realize gains in the event that the market valuation of the company's common equity is higher than prior to the original publication date. These affiliates, officers, and individuals shall have no obligation to inform any investor about their historical, current, and future trading activities. In addition, the Authors may benefit from any change in the valuation of any other companies, securities, or commodities discussed in this document. Analysts who prepared this report are compensated based upon (among other factors) the overall profitability of the Authors' operations and their affiliates. The compensation structure for the Authors' analysts is generally a derivative of their effectiveness in generating and communicating new investment ideas and the performance of recommended strategies for the Authors. This could represent a potential conflict of interest in the statements and opinions in the Authors' documents.
The information contained in this document may include, or incorporate by reference, forward- looking statements, which would include any statements that are not statements of historical fact. Any or all of the Authors' forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors, most of which are beyond the Authors' control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this letter are forward-looking statements including, but not limited to, statements that are predications of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Forward-looking statements are not guarantees of future performance or activities and are subject to many risks and uncertainties. Due to such risks and uncertainties, actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Forward-looking statements can be identified by the use of the future tense or other forward-looking words such as "view," "believe," "convinced," "expect," "anticipate," "intend," "plan," "estimate," "should," "may," "will," "objective," "project," "forecast," "management believes," "continue," "strategy," "promising," "potential," "position" or the negative of those terms or other variations of them or by comparable terminology.
Important factors that could cause actual results to differ materially from the expectations set forth in this letter include, among other things, the factors identified in the risk sections in LENDINGCLUB CORPORATION Annual Report for the year ended December 31st, 2017 and prospectus. Such forward-looking statements should therefore be constructed in light of such factors, and Quarz Capital Management is under no obligation, and expressly disclaims any intention or obligation, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
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