Alliance Data Systems (ADS) Beats Expectations Soundly

Remember we own Alliance Data Systems (ADS) for a non financial, non commodity (i.e. non correlated to the most controversial areas of the market), heavy buyback stock. [Aug 29: Starting New Position: Alliance Data Systems] While these criteria have not protected the stock completely, it's done better than a lot of things of late on a relative basis as it's "only" down about 20% from recent peak. With the stock up nearly 6% in early trading, off of a solid earnings report, I am going to take off most of this position, and reduce it from a 1.3% stake to 0.1% stake since gains last about 10 minutes nowadays. As per our thesis, as share count is reduced, the earnings per share will of course increase even if revenue or indeed net income is flattish. Full report here.

• Marketing and transaction services company Alliance Data Systems Corp. said Wednesday its third-quarter earnings more than doubled on a spike in revenue from its loyalty services division. (that's misleading since there was a large 1x hit in 2007 of $40M)
  
• Net income in the third quarter increased 137 percent to $69.3 million, or 91 cents per share, from $29.2 million, or 76 cents per share, in the year-ago period. Adjusted for one-time costs, cash earnings came in at $85 million, or $1.22 per share. On average, analysts surveyed by Thomson Reuters expected third-quarter profit of $1.16 per share.
• Quarterly revenue edged up 4 percent to $511.2 million from $492 million in the previous year. The company attributed the increase in revenue to growth in its loyalty services, which includes programs such as air miles. Loyalty services revenue increased 25 percent to $187.7 million during the third quarter. The segment's revenue was boosted by the strong performance of its Canadian Air Miles Reward Program.
• Revenue from the company's Epsilon marketing services rose 6 percent during the quarter to $130.8 million, while the revenue of its private label credit unit shrunk 12 percent to $182.4 percent due mainly to the loss of the Lane Bryant portfolio.
• The company is also raising its full-year cash earnings to $4.40 per share from $4.35 per share. Analysts are forecasting $4.37 per share.

The main reason we own the company here...

• ...the Company spent approximately $420 million on share repurchases during the quarter pursuant to previously announced share repurchase programs. Year to date, the Company has repurchased 14.3 million, or 18 percent, of its outstanding shares for $870 million out of the aggregate $1.8 billion authorization.

This company was a busted deal candidate and I believe is fixing itself up for another potential buyout; but without credit markets that's going to take a while. In the meantime its trading at just over 10x 2008 earnings which I guess is now considered expensive.

You do have to love this step they took earlier this month; they call it "liquidity insurance" - it will cost them a bit now but they cannot be accused of not having liquidity which in this market is a death knell.

• As a result of the actions the Company has recently taken to significantly expand its excess liquidity capacity, or "liquidity insurance," primarily with the recently announced new funding facilities of $1.4 billion, the Company will incur incremental costs of approximately $8.0 million from these facilities. These incremental costs are the result of the current dislocation of LIBOR rates and tight credit markets.

2009 Guidance

The Company is expected to benefit from:

• Loyalty Services' organic revenue and adjusted EBITDA growth of 18 and 20 percent, respectively;
• Epsilon Marketing Services' organic revenue and adjusted EBITDA growth of 8 and 13 percent, respectively;
• Private Label Services' revenue and adjusted EBITDA growth in the mid-single digit range;
• Private Label Credit portfolio growth in the low double-digits. Fourth quarter exit rate of mid-single digits plus 10 new programs ramping up;
• Minimal Capital Expenditures;
• Strong Free Cash Flow generation;
• Robust excess liquidity; and
• Accretion from the share repurchase programs.

The Company is expected to be negatively impacted by:

• Canadian dollar currently running at 10 cents below 2008's average rate, which should impact revenue and adjusted EBITDA by $80.0 million and $20.0 million, respectively;
• Funding costs and "liquidity insurance" increasing due to the credit crunch, which is the reverse of typical behavior during a recession ($25 million negative impact to revenue and adjusted EBITDA); and
• Assumption of deep recession which will drive loss rates up in a steady and moderate fashion similar to 2008. 100bps = $44 million negative impact to revenue and adjusted EBITDA.

The Company expects cash earnings per share growth of 17 -18 percent, equating to cash earnings per share of $5.15 - $5.20.

Alliance Data will continue to utilize its free cash flow generation and low leverage to execute its $1.8 billion share repurchase programs in 2009. Accretion from the share repurchase programs is expected to mitigate a significant portion of the challenges in 2009.

Long Alliance Data Systems in fund; no personal position