GreenSky Looks Fairly Valued, But That Could Change If Visa or MasterCard Step Into The Arena

GreenSky (NASDAQ:GSKY) followed through with its plans to go public within weeks of confidentially filing with the SEC last month – making it the largest fintech IPO in the country since LendingClub and OnDeck went public nearly four years ago. The company offered 38 million shares at $23 apiece to raise $874 million (with the actual proceeds being $830 million after underwriting fees). The company’s shares have largely traded around this level since then. This points to a valuation of $4.4 billion for GreenSky – around the figure we captured in our interactive dashboard for the company within days of its SEC filing.

GreenSky’s role as an intermediary between lenders and potential borrowers with strong credit histories makes its overall business model a risk-averse one, as it bears negligible credit risk. At the same time, the relationships it has built with banks, home improvement companies and healthcare providers promise to drive growth at a steady pace over the foreseeable future, even as the company explores other growth segments.

However, the simplicity of GreenSky’s business model also presents the biggest risk for the company in the long run. This is because its services could be replicated at a fairly small incremental cost by established payment giants like Visa or MasterCard – who have maintained partnerships with banks, retailers and service providers for decades. While these payment processing firms have made the most of growing card usage globally, they have also been keen to invest in alternative payment solutions and services to ensure long-term sustainability – making this a very plausible scenario.

How Would GreenSky Be Affected If Visa or MasterCard Become Direct Competitors

As we pointed out earlier, GreenSky’s business model has a low risk profile, and the industry in which it operates has fairly low barriers to entry. This makes the company vulnerable to increased competition. However, the fact that GreenSky has been around since 2006 and has established itself in the home improvement area has helped it keep new entrants at bay. This would explain why GreenSky is one of the rare tech startups that turned profitable within a decade of being founded.

This scenario could change, though, if GreenSky faces competition from an established company – especially the likes of Visa or MasterCard, who partner with all banks and nearly all retailers for their card processing services. If Visa, MasterCard or another established leader were to launch a competing platform in the near term, the impact on each of GreenSky’s 7 core value drivers would be as detailed below:

• Number of Active Merchants: The total number of merchants who used GreenSky’s platform grew at roughly 50% each year over 2015-2017, and we forecast it to grow at roughly the same rate in 2018 under our base case scenario. But the entrance of a high-profile company will weigh on growth in this figure for the rest of the year. We assume the growth rate would fall to 40% for the downside scenario.
• Transaction Volume Per Merchant: GreenSky’s transaction volume per merchant fell from about $409,000 in 2015 to ~$346,000 in 2016, and we expect the figure to continue to decline to about $320,000 in 2018 under the base case. However, increased competition will drag down total transaction volumes for the company, and could result in the figure falling to $300,000 for the year.
• Transaction Fees as % of Volume: GreenSky’s total transaction fees fell from 7.9% of total transaction volume in 2016 to 7.4% of the volume in 2017. As GreenSky is likely to ultimately cut its transaction fees in order to attract more merchants as well as banks on its platform, we forecast the figure to fall to around 7.2% for 2018 under the base case. However GreenSky may have to sweeten the deal further to stay ahead of a large competitor, which could result in the figure falling to 6.9% under the downside scenario.

• Number of Customer Accounts: The total number of customer accounts created on GreenSky’s platform has grown at roughly 40% over recent years, and we expect it to continue at this pace in 2018. However, a competing platform from an industry leader could curtail the pace of additions in customer accounts to 30% for the year.
• Average Loan Per Customer Account: The average value of outstanding loans per customer on GreenSky’s platform has fallen steadily from $3,699 in 2015 to $3,444 in 2017, and we expect it to fall to $3,350 in 2018. Even under increased competition, this figure is unlikely to fall below $3,350 for the year.
• Servicing Fees as % of Loans: GreenSky’s share of the revenue from servicing fees is about 0.8%, and we do not expect this to materially change in the face of increased competition.

• Net Margin: We currently expect GreenSky’s net margin to largely remain constant at 42.5% in 2018. However, GreenSky will be forced to increase its sales & marketing expenses considerably if it faces competition from established companies in order to maintain its market share. This will drag down its net margin materially – down from our original estimate of 42.5% to 40% under the downside scenario.

Finally, the fact that GreenSky’s business model is largely identical to the payment processors points to a forward P/E ratio in the 20x-25x range for the company. While we use a P/E ratio figure of 25x for the base case valuation, significant competition will require this figure to be adjusted lower to around 22x for the downside scenario. This points to a fair value of just $3 billion for GreenSky if a payment processing giant launched a similar platform. This is a ~30% valuation downside for the company from our base case estimate of $4.4 billion.

However, if you disagree with any part of our analysis, you can create your own model by making changes on our dashboard.

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