I wrote yesterday that Credit Corp Group Limited (ASX: CCP) had entered a trading halt following the publication of an anonymous report by 'Checkmate Research'. Following the company's response, and its return to trade today, the Credit Corp share price has fallen 12% to $16.64.
I was sent a copy of the 37-page report yesterday evening by Motley Fool analyst Ed Vesely. Please note that most of the allegations contained in the report have been rejected by Credit Corp as incorrect and most of the report is just opinion.
However, in its report, Checkmate argues that:
- Credit Corp's main business is a payday lender that is avoiding classification as a payday lender via its use of a legal loophole
- Avoiding classification as a payday lender allegedly brings regulatory or funding benefits to Credit Corp
- Credit Corp's bank Westpac Banking Corp (ASX: WBC) has cut funding to other payday lenders like Cash Converters International Ltd (ASX: CCV) and Money3 Corporation Limited (ASX: MNY)
- Checkmate says that Westpac should stop doing business with Credit Corp, in the same way that it has with other payday lenders
- Checkmate accuses Credit Corp of alleged 'earnings management' due to its too smooth gross profit margins, given that changes in the business have not resulted in a significant change in margins over the past few years
- Checkmate says that Credit Corp is worth $10 a share instead of its last traded price of $18.84
There is too much to cover in any one article – 37 pages worth – so I will try to summarise the main points.
Payday lending?
Checkmate states that Credit Corp uses a loophole in the Small Account Credit Contract (SACC) legislation that makes it legally not an SACC lender ('payday lender'). Checkmate also states that Credit Corp is effectively obeying the 'letter' while avoiding the 'spirit' of the law. Checkmate quotes a large number of media and other articles & sources (including one by me) that describe Credit Corp as a payday lender even though it does not meet the criteria for one.
If Credit Corp does not technically meet the criteria for a payday lender, then I must apologise for describing it as one. I may have been in error when I used that phrase. However, Checkmate's point is well made in that Credit Corp is still lending in a very similar segment of the market, and is widely seen as a 'payday lender' even though it is technically not one.
Credit Corp forcefully denied this allegation in its response and stated that it is categorically not a payday lender.
Earnings management?
Elsewhere, Checkmate's allegations of 'earnings management' may have some teeth, as Credit Corp's gross margins do appear to be much smoother than they have been historically. However Checkmate itself acknowledges that "the exact mechanics of earnings management at CCP is not clear" which makes it difficult for the shareholder to determine what is actually happening. Credit Corp responded that Checkmate's analysis is incorrect. Credit Corp stated that several US peers use a similar amortisation approach to Credit Corp, plus that Credit Corp's provisioning for losses has become less volatile in recent years as the company has further developed its lending criteria.
Credit Corp also categorically denied Checkmate's allegations about switching assets between segments and capitalising transaction fees. These are fairly technical matters which I won't go into, but if Credit Corp has truly not done these things, then that is good news for shareholders. However, these are complex matters and even for the best analysts it is hard to categorically prove a matter either way from the outside. In some circumstances it can take several years for allegations of this type to be proved or disproved.
Valuation?
Lastly, while Checkmate has raised some interesting points above, I think the Checkmate valuation of Credit Corp at ~$10 a share may be incorrect. The discounted cash flow (DCF) valuation posted in the Checkmate report appears to assume that Credit Corp won't make any more loans or buy any new debt ledgers for collection.
That is an aggressive assumption to make, especially as the reasoning behind it is not clearly articulated. The absence of a terminal value in the DCF would result in Checkmate's valuation of Credit Corp being much lower than otherwise.
Checkmate also uses a 'blended' price to earnings (P/E) and price to book (P/B) ratio approach for valuation which assumes that, if Credit Corp had a similar multiple to peers, it would be worth less. That is true, but it also overlooks the degree to which Credit Corp has been dominating its industry over the past few years.
If Credit Corp is a higher quality company, it should be fair to value it higher than its competitors.
As a result of these things, I'm not convinced that Checkmate's valuation is accurate, bearing in mind that many business valuations can have large margins for error due to inherently uncertain assumptions.
One possibility is that the value of Credit Corp's business (not its share price) will change as a result of the Checkmate report, especially if Credit Corp decides to change its accounting. More conservative accounting could result in lower reported profits or higher reported losses, for example.
That is a possibility, however I think that Credit Corp's response was overall quite strong. Importantly, Credit Corp responded to the nitty-gritty of Checkmate's allegations. Blue Sky Alternative Investments Ltd (ASX: BLA) did not do this in response to its own short report several months ago.
Right or wrong, I believe that Checkmate makes a valid point about public perception of Credit Corp as a payday lender, however, and this may bring further regulatory attention for the company. It is also true that after this report, every eye will be on Credit Corp as it releases its annual report over the next couple of months. Still, for now I think the Checkmate report is not as large a concern as it might first have appeared.
