FOOL PLATE SPECIAL
An Investment Opinion
A Look at NextCard Dale Wettlaufer (TMF Ralegh)
August 9, 1999
Shares of San Francisco-based credit card issuer NextCard Inc. (Nasdaq: NXCD) continued a steep slide begun in July, losing another $1 7/8 to $21 1/8. The stock is now trading far below its first-trade price and is within a hair's breadth of its $20 IPO price. One might be tempted to look at the nominal trading range of the company's shares and conclude that the company must be closer to reasonably priced at the bottom of that trading range, but at the current quote, the company's equity is still valued at $983 million, or about 6.8 times book value of $145 million, 68 times annualized Q2 revenues, and 7 times net loans of $140.5 million.
Simplistic multiples to current accounting data aren't going to go a long way in capturing the intrinsic value of a company such as this, however. Comparative analysis of such multiples with a peer group or near-peer group won't show where value lies. However, it is instructive to look at the market value added to invested capital and consider the expectations embedded in the stock price.
One of the first things that jumps out at you when you look at some of the pure-play Web-based financial services companies such as NextCard or Net.B@nk (Nasdaq: NTBK) is value per customer, which at present is well over $10,000 per customer. Obviously, you can't ascribe all the value in these companies to the current set of customers, though. Some of the value lies in the net present value of the current set of customers and most of the value lies in the expected value of future customers. The key set of assumptions, then, comes down customer acquisition and retention costs and how well the company leverages those ongoing investments.
In the case of NextCard, the company attracts customers through multiple channels:
NextCard then looks at its underwriting experiences with customers coming in from the different channels and is able to target those channels that funnel to it those customers with the best profitability characteristics. In other words, if NextCard advertised with financial site A and found those customers to be deadbeats, it would either drop that site or demand a much lower rate for advertising there. If it found that financial site B fed NextCard customers who have desirable credit behavior and carry higher-than-expected card balances, it would step up advertising on that site.
- Direct response Web-based marketing
- Affiliate network
- Affinity programs
- Co-branding initiatives
- Offline brand-building initiatives
Like a Capital One Financial (NYSE: COF), the reigning information-based marketer in the credit card industry, NextCard realizes the value of closely managing customer data and tailoring marketing and risk management programs according to the findings of its data management. It's not that the company engages in data manipulation; it's nice to know who your customer is. NextCard managers customer date because its product changes for each customer according to their past behavior and expected future behavior.
For instance, it takes only two delinquencies for the company to reprice an account. The company can also ascertain whether a potential customer is a yield hunter, who is not going to stick around long, and price the account outside of the potential customer's point of rate indifference. All of these fall within the "state of the art customer acquisition platform," which is designed to cut acquisition costs to half the industry's $80-$120 per-account costs, according to CIBC World Markets.
In following NextCard, this is perhaps one of the key metrics to assess as the company matures. At this comparatively immature stage, those costs are dropping immediately into earnings as a negative number, reducing retained earnings and owners' equity. As in other hypergrowth situations, an investor can approach the financials with more of a management accounting mindset, capitalizing the customer acquisition costs and amortizing them over an assumed customer life. Of course that doesn't match GAAP convention, but GAAP conventions aren't optimized for portraying the economics of a business, and especially immature businesses.
Even after a fall into the mid-$20 range, NextCard isn't a no-brainer, in my opinion. But it is one of those situations where you can look at the company at its IPO price. It's also a Web-based financial services company that has its act very tightly wired, in my opinion. The company's information-based strategy to lower customer acquisition and retention costs and maximize the profitability of customers is impressive and reminiscent of other credit card companies that have been successful in such efforts. While I don't have a valuation opinion of the company at this time, I think it is one of the more interesting spring-1999 IPOs that have fallen from their highs. Tune into the company's Q2 conference call for more discussion on the business model.