One of the challenges in valuing elevate is that their reporting is terrible. It’s gotten worse in recent years as the company has changed its non-GAAP reporting to cover up mediocre results. Dickering with accounting practices is often treated as synonymous with fraud, but most of the time, it’s just executives trying to avoid getting fired.
The key top-line number for is what I’m going to refer to as contribution 1 the reason I think this number is more relevant than gross profit (as management defines it – not including interest) is that interest is a key component of their cost of sales – their interest expense is way higher than it should be because there are a limited number of banks that are willing to work with them.. Here’s how I calculate that (numbers for Q2-22):
- Revenue: interest and fees from loans = $117,606,000
- Net charge-offs: -$65,050,000
- Direct marketing and other cost of sales: -$11,108,000
- Net interest expense: -$12,170,000
- =contribution: $29,278,000
This was in what was, all things considered, a remarkably crappy quarter. Long term, I think their sustainable contribution per quarter is in the neighborhood of $40 million.
Operating Costs
Of course, they also have to spend money to actually run the business. These costs totaled $38.2 million in the latest quarter. Over half of that went to compensation and benefits, but they also spent quite a bit on professional services (e.g., lawyers, accountants), and tech costs that they’ve hidden under O&E or D&A to make their EBITDA look better 2 If you don’t know what these acronyms mean don’t worry about it, they mean very little.
It’s always tempting to blame bloated compensation expenditures on a handful of fat cat executives. Elevate does have those – the named officers and board of directors made over $10 million in 2021, with over $4m to their CEO, but their total compensation expenses were over $76 million. In other words, about $66 million went to their ~430 other employees, or about $150,000 each in compensation and benefits.
Their rank-and-file compensation numbers seem like they’re in line with market norms. As a tech-driven company, they rely on software engineers, data scientists, and product managers (among others). Those are all highly-demanded roles where compensation is well in the six figures.
The thing is that Elevate hasn’t demonstrated an ability to utilize these employees effectively. A highly paid-technology organization with poor management is effectively worthless. This is supported by employee reviews. These call out:
-Alarming lack of strategy at both org and team levels
-Immature software development practices
-Very low technical skills amongst leadership
Anon former employee
Bringing highly skilled people into a mismanaged organization is akin to flushing money down the toilet.
I actually don’t think that overall compensation costs are too high but I do suspect that they’re maldistributed: the company should pay high salaries to attract top engineers and data scientists. They should not pay top salaries to mediocre managers and other bureaucrats.
Implications for the stock
Elevate is a small, obscure company in an unattractive industry, so it’s not of interest to a lot of activist investors. The board seems to be pliant without significant stakes in the success of the company. As such, it’s entirely possible that all stakeholders are just seeking to extract whatever money they can from the operation before moving on.
In the absence of any significant shareholder push for change, I suspect the fate of the company will largely depend on their ability to return the core business to growth in order to get the contribution level above $30m and return to profitability.
Above that level (more or less) contribution almost all goes to the bottom line. While I’m not overly impressed with Harvisson’s leadership, I think he’s competent enough to recognize this basic fact and is currently working on getting costs down (hence the recent employee furloughs)
This is where the margin of safety is valuable: Even if the company remains mismanaged and executives remain overpaid, EPS should exceed $1 in 2023 for a a PE of approximately 1x, and management has shown a willingness to spend earnings on share buybacks, which I believe will push the stock to at least $10 within 12-months.
Disclosure: I am long ELVT.