New Purchase for Portfolio: EZPW

"No one else here but us value investors."

After a month’s long hiatus, I’m back with another pick for the portfolio. Today, at market open, we will be adding Ezcorp (ticker:EZPW) to our portfolio.

EZcorp is the second largest pawnbroker in the United States and Latin America. Besides being badly portrayed by reality tv and decried by activists as predatory, Pawnbrokers are an easily misunderstood business. Most would see them as retailer with a hodgepodge of discount items that happens to provide credit to underbanked individuals. But if anything, pawn stores are the operated in the exact opposite of the manner I just described. These stores make the bulk of their revenue and gross profit through their lending arm, and just happen to sell merchandise to customers on the side.  Over the past three years, EZPW has generated 33% of their revenue and 66% of their gross profit from their loan book.

While EZPW may have been passed over by the general investing community, the enterprising investors over at Value Investors Club certainly haven’t missed its story. The small cap stock has been written up a staggering 9(!!) times by its members since the forum’s inception. To quote an old friend: “No one else here but us value investors”.

EZPW’s valuation is enough to make any value investor salivate. As of Friday, market close, the firm had an enterprise value of $350 million compared to its $331 million in tangible book value, $123 million in NOLs, an equity stake in Australian pawnbroker Cash Converters worth at least $50 million, and, oh, did I mention its U.S and Latin America operations generated $125 million in normalized EBITDA?

The Perils of being Counter-Cyclical:

If you merely stared at the economic data for this year, you would have thought that EZCorp would be poised to thrive in such a harsh environment. Between skyrocketing unemployment and collapsing credit markets, the pawn broker should have had no shortage of customers looking for a quick wad of cash. But the Covid-induced recession proved to be unlike any modern recession. Low-income households found themselves flush with cash after the federal government flooded the economy with stimulus and generous unemployment checks. This infusion of cash crushed EZCorp’s lending book with new loans down 33% YOY.

With reopening commencing and trillions of dollars of stimulus, the economy is expected to remain red hot for the next few years. So how well does EZPW’s business model hold up during the peak of the business cycle? In 2019, the last economic apex, the pawnbroker was able to generate over a hundred million in cash from operations and seventy-five million in free cash flow. If EZPW is able to achieve just 80% of the financial success they had in 2019, the stock will be trading at only five times cash flow- a discount that will certainly cause buzz in the investor community and a possible multiple rerating.

Corporate Malpractice

So how can a company trading for five times forward cash flow be so unloved by the market? What other reasons might justify this gargantuan discount?

Unfortunately, that answer lies in the C-Suite. For the better part of decade, Philip Cohen has plundered the company and destroyed shareholder value. Cohen, despite only owning an 8% stake in the company, holds all of the Class-B voting shares, giving him free reign over the company. For years, He paid himself a defacto preferred dividend by charging EZPW a consultancy fee before the courts struck it down in 2018.  Cohen has since reinstated his exclusive dividend. In 2019, He appointed himself executive chairman of the board of directors, which comes with a hefty $3 million-dollar salary.

Yeah, I know, this is textbook 101 destruction of capital. For most investors, Cohen’s behavior would be an immediate turnoff from investing in EZPW. However, I think it is possible for both shareholders to see material capital appreciation in their investment and for Cohen to continue to act incompetent. Shortly after his appointment to the board of directors, EZPW announced a sixty million dollar share buyback over the next three years. This deal has since been suspended due to the uncertainty of the coronavirus pandemic. Nevertheless, this shows that Cohen has the ability to keep both his and the shareholders’ interests in mind while serving on the board.

Looking ahead, I think the original share buyback plan will be reinstated and maybe even expanded within the next the 12 months. EZPW’s balance sheet is less levered than before the pandemic, free cash flow should approximate $70 million over the next year, and its shares are significantly cheaper than when the original buyback was announced.  

It’s also important to note that Cohen is in his early seventies. I highly doubt that he expects or wants to run this company until his death. I think there’s a significant chance that his retirement coincides with him selling the company. The most logical suitor would be First Cash: the largest pawnbroker in the United States and Latin America.

First Cash is a model of how pawn shops should allocate and distribute capital. The management team has done superb job of generating high returns on invested capital, strong free cash flow, and rewarding shareholders through buybacks and dividends. As a result, First Cash (rightfully) trades at a premium to EZPW. With twice the sales and free cash flow of EZPW, FirstCash trades at 25x earnings and 14 times EV/EBITDA, compared to EZPW’s 11x earnings and 4 times EV/EBITDA.

If EBITDA generation remains consistent among the United States and Latin America operations, Cohen could sell the company within the next three years for 7x EV/EBITDA to FirstCash. Nevertheless, EZPW doesn’t need to be bought out in order to become a successful investment. The firm should be able to easily generate its market capitalization in free cash flow over the next three to four years. While management is inept at best, I feel like I have reasonable enough margin of safety with the company trading 20% below tangible book value. We are going to add 1400 shares for the portfolio.

1400 shares were purchased for $5.20

Disclaimer: This does not constitute as investment advice in any shape or form. Please do your own research before investing in any of the securities discussed on this platform.