Shares of consumer financial services and credit provider Synchrony Financial (NYSE: SYF) have relinquished 12% of their value year to date, even as the broader market, as represented by the S&P 500 index, has gained nearly 10% so far this year. Synchrony's mild share-price losses in early 2018 accelerated this summer, when the company's otherwise healthy second-quarter 2018 earnings report was overshadowed by the revelation that major branded card partner Walmart (NYSE: WMT) had decided to allow its long-standing credit program agreement to expire in July of 2019.
Since then, Synchrony has partially allayed investor concerns: It announced a multiyear extension of its agreement to handle Lowe's Companies' commercial and consumer credit programs in mid-August. While shares have rebounded from a 25% loss in late July, their still-depressed levels indicate that investors retain doubt over the company's prospects. Is it warranted?
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Walmart's credit card receivables of roughly $10 billion represent nearly 13% of Synchrony's total portfolio. On Synchrony's earnings conference call on July 27, management observed that while discussions on the renewal began last year, the two companies never came to terms on an outcome which would be economically feasible for Synchrony.
Synchrony's management has outlined two potential scenarios regarding the program. The company will either sell the Walmart portfolio to a competing issuer, or convert qualifying accounts to a general-purpose credit card.
In the sale option, the company would undergo a valuation process for the portfolio, and complete a sale by the third quarter of 2019. The Walmart portfolio consumes about $1.5 billion of Synchrony's capital, so between this freeing up of cash, a projected gain on sale, and the releasing of reserves tied to the receivables, Synchrony expects to have roughly $2.5 billion of capital available through a sale transaction.
Synchrony has already indicated that it would use this amount either to repurchase its own shares or invest in higher-yielding opportunities. In addition, the company has identified $300 million to $350 million in ongoing cost savings from the portfolio exit. In this scenario, management estimates that it will be able to replace the earnings per share (EPS) impact of the current Walmart agreement.
In the conversion option, the company would begin converting qualifying cardholders to a general-purpose card as early as the first quarter of 2018, as it did when Toys R Us filed for bankruptcy last year. The return on the program would likely improve -- upon expiration of the Walmart agreement, Synchrony isn't subject to a retailer share agreement (RSA), and thus keeps all economic benefits to itself. Cardholders who don't convert to the general-purpose card can continue to use their cards at Walmart for three years, and Synchrony will collect royalties from Walmart during that period.
Mass conversion to a general-purpose card will diversity Synchrony's portfolio, and management is confident that it can incentivize customers to stay in the program over the long term. In the conversion scenario, management also estimates that it will replace the EPS impact of the Walmart agreement.
It should also be noted that in either the sale or conversion options, Synchrony predicts annual EPS accretion (that is, an addition to earnings) versus renewing the Walmart agreement under Walmart's terms.
Making whole on a potential loss isn't the issue
Reading between the lines of management's proposed tracks to address Walmart's exit, it's hard not to miss the presence of what must have been extremely onerous demands from Walmart's negotiators. This shouldn't surprise observers, as Walmart has for decades enjoyed a reputation for extracting the maximum possible out of its vendor relationships.
At any rate, shareholders should be encouraged that the company has a viable strategy for longer-term revenue under the second option. Clearly, it's preferable for Synchrony to hold onto its base of customers under this program and reap returns over a period of years, rather than sell the portfolio and use a one-time windfall of $2.5 billion to prop up EPS via a stock buyback.
Ultimately, both options will make Synchrony whole -- shareholders really aren't worried on the immediate earnings front. More to the point, it's unsettling that the company has parted ways with a long-standing, gargantuan retail partner. Such partnerships are the easiest tool Synchrony has for growing its retail credit business. A major retail brand pulls in new credit customers year after year.
Earlier this spring, I explained why deals like Synchrony's purchase of PayPal's credit portfolio are so important to its growth. The constant expansion of credit receivables boosts earnings and enhances shareholder value. In sum, investor skepticism isn't entirely misplaced at the moment. Management may be able nudge investors' opinions to positive ground by striking material -- and more profitable -- deals with new partners in 2019.
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