A Bad Credit Risk Bonanza Gone

SELL RECOMMENDATION Anne Rife Cox Endowment Fund Spring 2003 Firm: AmeriCredit Corporation NYSE Ticker: ACF Sector: Financial Services Moody’s Debt Rating: B1↓ Current Exposure: 2,150 shares @ $1.73 = $3,719.50 Cost Basis: $79,150 Analyst: Cameron W. George Contact via e-mail at camgeorge@aol.com Past 1-Year Performance A Bad Credit Risk Bonanza Gone Summary Findings and Other Lowlights I. Current negative qualitative issues weighing heavily on investors A. Operations catch-22: AmeriCredit’s bond insurance company suggests it will no longer guarantee payment on its securitization transactions because of liquidity concerns. Scary, since asset-backed securitization is the business. B. Irate investors: AmeriCredit shareholders have filed at least 16 pending lawsuits alleging securities fraud against AmeriCredit and its executives. C. Debt doldrums: S&P, Moody’s, and Fitch have all reduced AmeriCredit’s rating on its senior notes and maintain negative outlooks for ACF. D. L-l-loss restatements: AmeriCredit restated its December 2002 quarterly loss, from $27.6 million to $44.7 million, based on securitization glitches. E. “Un-Fortune-ate” working conditions: One month after Fortune magazine honored AmeriCredit as one of the “100 Best Companies to Work For,” CEO Michael Barrington terminated 20% of the employees and closed 60% of the branch offices. F. Seasoned magic bean offering: Desperate for financing, AmeriCredit issued 67 million shares of common stock (at $7.50 per share) in a late-2002 follow-on equity offering. II. Suspect accounting practices, noted in the shareholder lawsuits, possibly misrepresent earnings and revenue and preclude reasonable comparable company valuation analysis. III. Common shareholders will be left holding the bag since the book value of debt comprises most of the firm’s value, and AmeriCredit does not pay dividends. Bondholders, of course, take priority over stockholders and thus require payment before any shareholders are paid. IV. Discounted cash flow (DCF) analysis most accurately values AmeriCredit according to the circumstances and scenarios already priced into the market. On March 5, 2003, DCF valued AmeriCredit generously at $1.77 per share. Key Competitors and Approximate Market Caps Closest competitor: WFS Financial ($748 MM) Others: TFC Enterprises ($15 MM), Credit Acceptance Corp. ($246 MM) ACF Performance Relative to WFS Financial, Dow, NASDAQ, and S&P 500 Relevant Performance Data (On March 5, 2003) Market Price: Shares Outstanding: Market Capitalization: 52-Week Low: 52-Week High: Price/Earnings: Industry Price/Earnings: Price/Book: Industry Price/Book: Price/Sales: Industry Price/Sales: EPS Estimate: Beta: Industry Beta: $1.73 154.7 MM $267.7 MM $1.59 $46.93 0.77 13.53 0.16 3.58 0.19 2.71 $0.43 2.22 0.61 Corporate Profile “AmeriCredit Corp. purchases auto finance contracts without recourse from franchised and select independent automobile dealerships, and, to a lesser extent, makes loans directly to consumers buying used and new vehicles. The Company targets consumers who are typically unable to obtain financing from traditional sources. Funding for AmeriCredit's auto lending activities is obtained primarily through the sale of loans in securitization transactions. The Company services its automobile lending portfolio at regional centers using automated loan servicing and collection systems. The Company's automobile lending programs are designed to serve customers who have limited access to traditional automobile financing. Its typical borrowers have experienced prior credit difficulties or have modest income.” Graph Source: Yahoo! Finance Performance Data Source: Multex Profile Source: Yahoo! Finance Origin of AmeriCredit AmeriCredit began in 1986 as UrCarCo—used car lots offering both sales and financing to customers with poor credit. It was the inspiration of Cash America Pawnshop executives Jack Daugherty and Clifton Morris, who financed UrCarCo with four other investors and created the nation’s first chain of used car lots. The company’s 1989 initial public offering met with great success, but the excitement was short-lived; after quadrupling in size to 20 lots, UrCarCo became mired in huge losses from poor underwriting and bad loans on top of declining car sales. In 1991 the company began reinventing itself, completely restructuring after receiving $10 million from Rainwater Management. In 1992 UrCarCo changed its name to AmeriCredit, liquidated its used car business, and expanded its indirect lending services to include asset-backed securitization as the primary source of revenue. Today, Clifton Morris remains Chairman of AmeriCredit. Description of AmeriCredit’s Core Business Model AmeriCredit engages in the indirect automobile finance business—buying consumer finance loans from automobile dealers, then conveying such loans to special purpose trusts which issue bonds that are secured by the loans in the trusts. Cash flow from the loans is retained in restricted accounts until the cash reserves reach a certain amount. Central Problems Affecting AmeriCredit’s Operations (1) As seen before in Chairman Clifton Morris’ past UrCarCo experience, the reincarnated AmeriCredit is faced again with troubles arising from extending credit to excessively risky and unworthy customers. Operations difficulties and liquidity crises result from increased default rates caused by the continued weakness in the economy, lower-than-expected recovery proceeds caused by depressed used car values, and the expectation that current economic conditions will continue for the foreseeable future. (2) Based on discussions with AmeriCredit about earnings quality, profitability, liquidity, and longterm forecasts, S&P, Moody’s, and Fitch have all downgraded AmeriCredit’s senior notes from lowermedium to low speculative (junk) grade. (3) Financial Security Assurance, Inc., a company that guarantees payment on AmeriCredit’s assetbacked securitization transactions, recently suggested it probably will not continue a business partnership with AmeriCredit due to AmeriCredit’s falling creditworthiness. AmeriCredit’s Proposed Short-Term Solution On February 12, 2003, AmeriCredit announced a new, revised operating plan in an effort to preserve and strengthen its capital and liquidity positions. The plan includes a decrease in loan origination volume and a reduction of operating expenses through downsizing its workforce and consolidating its branch office network by closing a majority of the branch locations. Assuming continued access to the securitization markets, AmeriCredit believes that it has sufficient liquidity to operate under its new plan through the 2003 calendar year. Conclusion: A Critical Problem of Order The “operations catch-22” mentioned on previous page: Without increasing revenue and cash streams, the debt rating agencies will not raise AmeriCredit’s credit grade, but without a better credit rating, Financial Security Assurance, Inc., will not guarantee AmeriCredit’s asset-backed securities, and without Financial Security Assurance, Inc.’s promising to insure AmeriCredit’s asset-backed securities, there will be no overwhelming revenue and cash streams. Therefore, AmeriCredit’s core cashgenerating operations seem to be paralyzed for a while. Sources: Hoovers, Yahoo! Finance, 2002 Annual Report COMPARABLE COMPANY VALUATION ANALYSIS (On March 5, 2003) Financial Data for Valuation Industry AmeriCredit Firm Name ACF Ticker 154,682,081 Shares Outstanding $1.73 Price 13.53 0.77 Price/Earnings 3.58 0.16 Price/Book Price/Sales 2.71 0.19 $347,480,000 Net Income $2.25 Earnings Per Share Sales $1,190,200,000 $267,600,000 Market Capitalization $1,432,300,000 Book Value of Equity Book Value/Share $9.26 0.61 2.22 Beta $46.93 52-Week High Price $1.70 52-Week Low Price Theoretical Value based on Comparable Industry Ratios Key Valuation Ratios ACF Value based on industry Price/Earnings ratio ACF Value based on industry Price/Sales ratio ACF Value based on industry Price/Book ratio WFS Financial WFSI 41,019,737 $18.24 9.15 1.21 1.27 $82,100,000 $2.00 $590,200,000 $748,200,000 $634,500,000 $15.47 0.99 $31.95 $16.23 Financial Data of Closely Competing Firms TFC Enterprises Credit Acceptance Corp. TFCE CACC 11,538,462 42,379,310 $1.30 $5.80 4.74 8.5 0.31 0.76 0.36 1.63 $5,100,000 $29,700,000 $0.44 $0.70 $51,400,000 $154,300,000 $15,000,000 $245,800,000 $51,100,000 $323,800,000 $4.43 $7.64 0.79 0.67 $1.85 $14.95 $0.70 $5.25 Firm Name Ticker Shares Outstanding Price Price/Earnings Price/Book Price/Sales Net Income Earnings Per Share Sales Market Capitalization Book Value of Equity Book Value/Share Beta 52-Week High Price 52-Week Low Price Firm Values (Equity) $4,701,404,400 $3,225,442,000 $5,127,634,000 Averages $3,963,423,200 Stock Prices $30.39 $20.85 $33.14 $28.12 Note: Net income, sales, market capitalization, and shares outstanding figures approximated for consistency among firms. Metrics from trailing twelve month periods, except Price/Book. Price/Book from most recent quarter. Source of information: Multex Investor Services Key Explanations: Very obviously the Earnings Per Share (EPS) from fiscal year 2002 seems unusually high, considering the current $1.73 market price. We must discount the credibility of this figure since the purchase of one $1.73 share would yield $2.25 in earnings. If this were the case, then theoretically AmeriCredit could shut down, divide the earnings, and all the shareholders would make money immediately. The .77 P/E metric above, from Multex Investor, represents AmeriCredit's stated net income in the chart. However, consensus earnings for 2003 indicate a 4.1 P/E for AmeriCredit. AmeriCredit has long been accused of unsavory and questionable accounting practices involving its treatment of loan losses and loan loss reserves. These loan losses seem not to flow through the income statement as per standard practice--instead, they show up in the cash flow statement as a "non-cash item" from operations. If 4.1 is a more appropriate P/E, then net income should be closer to $65,268,293 with EPS of $0.42. After we deem AmeriCredit's earnings assertions to be suspicious and misleading, we must then ask what else could have been misrepresented. Revenues from securitization transactions may also have been creatively increased based on improper booking of loan loss reserves. If so, then Price/Sales could be wrong, too. Price/Book is among the only remaining valuation multiples. However, this figure does not specifically take into consideration AmeriCredit's particular qualitative issues that are dragging down the stock price. Comparable multiples assume the companies are actually comparable, an underlying requirement not applicable here. Quickly we realize that we cannot rely on comparable company analysis for valuing AmeriCredit. The method of comparables uses "big picture" multiples to value companies. To determine the intrinsic value of AmeriCredit, we must delve into the individual line items in AmeriCredit's cash flow statement to separate fact from fiction. Therefore, the discounted cash flow (DCF) analysis, which follows the determination of free cash flows, is our best option. DETERMINATION OF FREE CASH FLOWS AVAILABLE TO THE FIRM (Note: All numbers in thousands of U.S. dollars, unless otherwise indicated.) 2001 Actual 222,900 19,700 82,900 -271,400 -1,044,500 -990,400 71,920 -34,300 -64,600 -98,900 -1,017,380 2002 2003 2004 Actual Forecast Forecast 347,500 407,334 468,434 38,400 38,400 38,400 61,400 61,400 61,400 -594,400 -594,400 -594,400 -227,400 -227,400 -227,400 -374,500 -314,666 -253,566 84,258 98,582 115,341 -11,600 -11,600 -11,600 -15,100 -15,100 -15,100 -26,700 -26,700 -26,700 -316,942 -242,784 -164,925 2005 2006 Forecast Forecast 538,699 619,504 38,400 38,400 61,400 61,400 -594,400 -594,400 -227,400 -227,400 -183,301 -102,496 134,949 157,890 -11,600 -11,600 -15,100 -15,100 -26,700 -26,700 -75,052 28,694 2007 Forecast 712,430 From income statement below. 38,400 61,400 -594,400 -227,400 -9,570 184,731 -11,600 -15,100 -26,700 148,461 FCFs into chart on next page. Finish here: Net Income Depreciation/Depletion Deferred Taxes Non-Cash Items (Purchase of Receivables) Changes in Working Capital OPERATING CASH FLOWS Interest Expense/Income, Net of Tax Capital Expenditures Other Investing Cash Flows INVESTING CASH FLOWS FREE CASH FLOWS Start here: Sales COGS Gross profit Operating Expenses Income before taxes Income tax expense Net Income 2001 Actual 818,200 10,000 808,200 445,800 362,400 139,500 222,900 2002 2003 2004 Actual Forecast Forecast 1,190,200 1,368,730 1,574,040 12,900 13,687 15,740 1,177,300 1,355,043 1,558,299 612,300 698,052 802,760 565,000 656,990 755,539 217,500 249,656 287,105 347,500 407,334 468,434 2005 Forecast 1,810,145 18,101 1,792,044 923,174 868,870 330,171 538,699 2006 Forecast 2,081,667 20,817 2,060,851 1,061,650 999,200 379,696 619,504 2007 Forecast 2,393,917 23,939 2,369,978 1,220,898 1,149,080 436,651 712,430 Feed into FCF chart above. Assumptions: Sales will grow by 15% every year through 2007. COGS derived based on known Sales and Gross Profit. Tax rate is 38%. COGS will be 1% of Sales. Operating Expenses will be 51% of Sales. Depreciation/Depletion kept constant at 2002 level until 2007. "Non-cash items" refer to the purchase of receivables for bundling and sale as asset-backed securities. "Non-cash items" has increased by a geometric mean return of 115% each year since 1998. Above, "Non-cash items" kept at 2002 level until 2007 for conservatism. Deferred taxes kept constant at 2002 level until 2007. Change in 2001 working capital considered extraordinary, unusual, and non-recurring. Changes in working capital kept constant at 2002 level until 2007. Capital expenditures have been relatively constant. Capital expenditures kept at 2002 level until 2007. "Other investing cash flows" kept at 2002 level until 2007 for conservatism. DISCOUNTED CASH FLOW (DCF) ANALYSIS Key Assumptions: $1.73 154,723,618 -$316,942,000 15.00% 3.00% $449,400,000 $274,134,000 2.22 B1 6.50% 0.51 0.49 38% 1.5% Market stock price on March 5, 2003 Common shares outstanding Unlevered free cash flows at Time 0 Forecasted 5 year sales growth rate Terminal growth rate Interest-bearing liabilities (book) Interest-bearing liabilities (market) Beta Moody's Bond Rating Market Risk Premium =Wd =Ws Tax rate Risk-free rate Equity financing= $267,671,859 Current market capitalization. Debt financing= $274,134,000 Market value of senior notes + other notes payable from most recent balance sheet. See explanation. 0.51 =Wd 0.49 =Ws 15.93% =Kd 15.93% =Ks 12.87% =WACC Time FCFs Terminal Value CFs PVs Disregard Disregard -$242,784,000 -$215,105,894 -$164,925,000 -$129,464,586 -$75,052,000 -$52,198,619 $28,694,000 $17,681,540 Weight of debt financing in corporate capital structure. Weight of equity financing in corporate capital structure. Same as cost of equity for valuation. See below for explanation of use. Derived from Capital Asset Pricing Model. Weighted average cost of capital. 1 -$242,784,000 0 -$316,942,000 2 -$164,925,000 3 -$75,052,000 4 $28,694,000 5 $148,461,000 $1,549,728,630 $1,698,189,630 $927,144,487 $548,056,928 =Value of firm -$274,134,000 =Value of interest-bearing debt (market value) $273,922,928 =Value of equity Find the value of equity on a per-share basis: $1.77 =Intrinsic value of ACF stock Comparing this price to the current price, we can assume that we have accurately represented the market's concern about qualitative issues discussed herein. However, this price may still be too high given the conservatism of my estimates. Key Explanations: Senior notes currently trading at 61% of par. Given $1000 par value, this implies current price of $611.25. Since the bonds are trading at such a steep discount, consider 61% of the value of interest-bearing debt: $274,134,000. According to www.bondsonline.com, the yield-to-maturity on AmeriCredit's most recent senior note issue is 20.71%. Given the risk-free rate and market risk premium assumptions we made, AmeriCredit's cost of equity capital is 15.93%. I argue that the costs of equity and debt capital should be similar, since (1) the market value of debt almost exactly equals the market value of equity, and (2) the debt is trading at a very large discount. The comparable relationship between debt and equity would not be such a problem in more stable, "AAA-rated" companies, but in this case the discount creates a unique situation in which the book value of debt comprises almost the full value of the firm. Notice that AmeriCredit does not pay dividends--bondholders will not allow stockholders to receive a dime until they get paid. Thus, debt "acts like" equity. Another reason: the chance of default is high and bondholders will likely not receive the full YTM on the senior notes. AmeriCredit Corporation BALANCE SHEET (Note: All numbers in thousands of U.S. dollars.) 1997 Year End Assets: Cash and cash equivalents Finance receivables, net Interest-only receivables from Trusts Investments in Trust receivables Restricted cash - gain on sale Trusts Restricted cash - securitization notes payable Restricted cash - warehouse credit facilities * Property and equipment, net Other assets Total assets Liabilities and Shareholders' Equity Liabilities: Warehouse credit facilities Securitization notes payable Credit enhancement facility Senior notes Other notes payable Funding payable Accrued taxes and expenses Derivatives financial instruments Servicing liability Deferred income taxes Total liabilities Shareholder' equity: Common stock Additional paid-in capital Accumulated other comprehensive income Retained earnings Treasury stock Total shareholders' equity Total liabilities and shareholders' equity $6,027 266,657 53,465 50,788 57,142 1998 Year End $33,087 342,853 131,694 98,857 55,758 1999 Year End $21,189 456,009 191,865 195,598 107,399 2000 Year End $42,916 871,511 229,059 341,707 253,852 2001 Year End $77,053 1,921,465 387,895 493,022 270,358 2002 Year End $119,445 2,198,391 514,497 691,065 343,570 2003 YTD $215,826 3,779,648 356,805 791,343 356,138 57,883 267,377 121,320 343,681 $6,290,021 13,884 27,530 $475,493 23,385 28,037 $713,671 41,145 50,282 $1,063,487 44,535 78,689 $1,862,269 67,828 167,286 $3,384,907 120,505 237,458 $4,224,931 $72,045 $165,608 $114,659 $487,700 66,606 375,000 19,691 61,664 70,627 $1,502,879 36,319 375,000 23,077 60,460 114,041 82,796 130,139 2,324,711 $1,751,974 $1,750,000 1,792,399 379,668 69,683 122,278 159,490 88,020 3,720 34,123 4,399,381 125,000 27,206 20,819 14,039 175,000 6,410 40,444 6,688 375,000 17,874 39,301 42,928 8,123 267,232 31,673 425,823 73,995 663,757 92,402 1,173,690 418,074 66,811 126,893 188,740 85,922 5,520 148,681 2,792,615 667 203,531 4,355 23,469 232,022 (23,761) 208,261 $475,493 693 230,269 7,234 72,770 310,966 (23,118) 287,848 $713,671 715 252,194 21,410 147,610 421,929 (22,199) 399,730 $1,063,487 837 401,979 44,803 262,111 709,730 (21,151) 688,579 $1,862,269 899 520,077 73,689 484,963 1,079,628 (19,432) 1,060,196 $3,384,907 917 573,956 42,797 832,446 1,450,116 (17,800) 1,432,316 $4,224,931 1,603 1,063,852 (15,996) 857,970 1,907,429 (16,789) 1,890,640 $6,290,021 * Prior to September, 2002, Restricted cash - warehouse credit facilities was included in Other assets. Source of information: AmeriCredit AmeriCredit Corporation INCOME STATEMENT (Note: All numbers in thousands of U.S. dollars.) 1997 Year End Revenue: Finance charge income Gain on sale of receivables Servicing fee income Other income Total Revenues Costs and expenses: Operating expenses Provision for loan losses Interest expense Charge for closing mortgage operations Total Expenses $44,910 52,323 23,492 2,631 123,356 1998 Year End $55,837 103,194 47,910 2,395 209,336 1999 Year End $75,288 169,892 85,966 4,310 335,456 2000 Year End $124,150 209,070 170,251 6,209 509,680 2001 Year End $225,210 301,768 281,239 10,007 818,224 2002 Year End $339,430 448,544 389,371 12,887 1,190,232 2003 YTD $224,572 132,084 131,861 10,633 499,150 51,915 6,595 16,312 74,822 94,484 7,555 27,135 129,174 165,345 9,629 38,792 213,766 223,219 16,359 69,310 10,500 319,388 308,453 31,387 116,024 455,864 424,131 65,161 135,928 625,220 225,068 152,676 79,903 457,647 Income (loss) before income taxes Income tax provision (benefit) Net income (loss) Source of information: AmeriCredit 48,534 18,685 29,849 80,162 30,861 49,301 121,690 46,850 74,840 190,292 75,791 114,501 362,360 139,508 222,852 565,012 217,529 347,483 41,503 15,979 25,524 AmeriCredit Corporation CASH FLOW STATEMENT (Note: All numbers in thousands of U.S. dollars.) 1998 Year End 49,300 4,500 31,000 -55,900 -10,700 18,200 -9,500 -115,700 -125,200 0 0 17,800 116,300 134,100 0 27,100 1999 Year End 74,800 12,600 43,400 -116,100 30,100 44,800 -14,700 -194,100 -208,800 0 0 12,900 139,200 152,100 0 -11,900 2000 Year End 114,500 19,400 15,400 -274,200 -405,700 -530,600 -9,800 -11,200 -21,000 71,900 0 139,400 362,000 573,300 0 21,700 2001 Year End 222,900 19,700 82,900 -271,400 -1,044,500 -990,400 -34,300 -64,600 -98,900 57,000 0 56,600 1,009,800 1,123,400 0 34,100 2002 Year End 347,500 38,400 61,400 -594,400 -227,400 -374,500 -11,600 -15,100 -26,700 160,000 0 20,800 262,100 442,900 700 42,400 Net Income Depreciation/Depletion Deferred Taxes Non-Cash Items Changes in Working Capital OPERATING CASH FLOWS Capital Expenditures Other Investing Cash Flow Items, Total INVESTING CASH FLOWS Financing Cash Flow Items Dividends Paid Issuance/Retirement of Stock, Net Issuance/Retirement of Debt, Net FINANCING CASH FLOWS Foreign Exchange Effects Net Change in Cash Source of information: Multex Investor Services