Have $1 Billion, Will Spend

Alliance Data is building its war chest in anticipation of serious deal-making. An interview with Charles Horn, CFO, Alliance Data Systems.
Kate O'SullivanFebruary 1, 2012

As companies invest more money in customers — both to win them and to analyze their preferences and behaviors — Alliance Data Systems (ADS) is positioned to reap the rewards. Based in Dallas, the affinity-card and customer-loyalty program provider outperformed the generally sluggish economy last year, watching its sales and earnings grow and its share price soar as all three of its divisions — private-label and co-branded credit cards, loyalty marketing, and a Canadian marketing business — benefited from a recovery in consumer credit and an increase in retailers’ spending on loyalty programs.

As his company enters 2012, ADS finance chief Charles Horn says he expects continued growth at home and in new and existing ventures abroad. The company is also launching a push to buy back up to $400 million of its own stock this year. Here, Horn describes the capital structure needed to support the company’s growth, as well as the potential challenges that ADS may face in the months ahead.

Alliance Data has shown strong growth through the downturn. How were you able to do that?
Fortunately for us, when we went into the downturn we had very low debt levels and we had the ability to generate strong liquidity. So the company took what I call controlled risks. When many companies were going into their shells and protecting liquidity at all costs, we were deploying that liquidity to take advantage of disruptions in the market and buy undervalued assets.

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With our private-label operation, we were aggressive in trying to acquire credit-card portfolios because no one else was showing up to bid. Internally, we saw that our own stock was undervalued, so we were very active in repurchasing shares. Our stock had dropped into the 20s, and we said, “Let’s be very aggressive.” We bought back close to 40% of our company at an average price of around $50, and currently we trade at $104.

When you have market disruptions, that’s when the best opportunities present themselves. Companies might be in trouble, and that’s when you get your best price multiples.

How are you thinking about the company’s capital structure today?
If you look at where we are from a funded-debt-to-EBITDA standpoint, we’re about 2.3:1, so we have a very good position. So over the next year we will probably add an incremental $1 billion of liquidity, about half from free cash flow and about half from new debt, again building up a war chest, so that down the road when opportunities present themselves we will be able to take advantage of them.

As you think about raising debt right now, how is the market looking?
I’d call it choppy. If you’re investment-grade and you’re a seasoned issuer, meaning you’ve been in the public markets many times, you’re in good shape. But if you’re not — like us, we’ve never done public debt before — it’s a very choppy market. Windows of opportunity present themselves, then concerns about sovereign debt pop up, everyone pulls back, you have an outflow of funds, and the market closes. So what we’re looking to do is just be opportunistic. We can be ready to access a number of different markets on a moment’s notice based upon when those windows open up.

We have good, strong liquidity right now. We don’t have to do anything, so we don’t have to chase higher rates. We can just wait, let the windows of opportunity develop, and then when they are open we can step in quickly.

Where are you looking for growth?
We are very focused on organic growth. That would be especially true within our Epsilon marketing division, where we can look to expand into new channels to provide our services.

Overall, we really have a four-pronged approach. First, we want to drive the organic growth we just talked about. Second, we want to continue to find portfolios for our private-label operation that make sense and fit within our expertise. Third, we want to expand our international operations for our LoyaltyOne business out of Canada; we think the opportunity to go into markets like Brazil and India is very much there, and we may add a tuck-in acquisition if it makes sense. And then the fourth piece will be continuing to invest in the company through our share-repurchase program.

How much of the company’s business is based overseas?
It’s still pretty small aside from our operation in Canada. That is by far the biggest piece, at about 25%. In Brazil we have a joint venture where we are a minority owner. And in India our business is a start-up. We haven’t even moved to a pilot yet.

How long have you had the joint venture in Brazil, and how did you find that opportunity?
That opportunity [presented itself] in the third quarter of 2009. We liked the management team that was trying to start up the effort in Brazil. They needed a little bit of intellectual property and they also needed some capital, and that’s where we fit in nicely. It’s a market that is very receptive to coalition programs, meaning companies don’t mind working together with a common card or common royalty mechanism, and consumers are very receptive to it as well. (See related story, “Global Positioning.”)

In a country like Brazil, it can be very useful to have a joint-venture partner that really knows the local market. Have you found that to be the case?
Definitely. Their relationships and their knowledge of the market are very important. From both the tax and regulatory standpoints it’s a unique market. I can’t think of a better way to go into that market than with a joint venture.

What do you see as the biggest challenges to Alliance Data’s growth right now?
Like any CFO, I worry about two things. First, liquidity. You always want to make sure you’re prepared before there’s a disruption in the market so that you have money before you absolutely have to have it. The second thing is to make sure that when you’re growing quickly, as we are, you have the appropriate controls and structures in place, and the proper oversight in place. While we love international expansion, and we like the green-field opportunities, we want to make sure that everything is being done correctly.

A related challenge is the pace of change in accounting regulations.
When I first started as an accountant, everything was about matching revenues and expenses. Now it’s more about fair value, and it seems like the pace of rule-setting is very fast. But if you look at the Securities and Exchange Commission, it seems very focused on enforcement. That will drive it more to a specific rules-based environment versus a guidelines-based environment, because the SEC wants specific things that it can point to and say a company did them right or it did them wrong. I think that’s going to put us further away from IFRS [international financial reporting standards] convergence down the road.

One scenario I could see happening is having general guidelines for IFRS but then having region-specific accounting rules underneath those.