After Synchrony Financial's failure to renew a key co-branded card program with Walmart Inc., the lender's other major retail partner renewals could be in jeopardy.
The two companies confirmed July 26 that they will not renew their co-branded card program, with Walmart instead switching to Capital One Financial Corp. Synchrony's relationship with the superstore began in 1999 and accounted for more than 10% of Synchrony's total interest and fees on loans in 2017.
On a July 27 call to discuss Synchrony's second-quarter earnings, President and CEO Margaret Keane said she is "very confident" that the Walmart nonrenewal is a "unique situation" and that Synchrony will be able to renew other relationships in the pipeline, including Walmart-owned Sam's Club.
Analysts on the call and interviewed afterward were not as sure. Most agreed investors should be concerned for all of the company's retail partnerships entering the renewal cycle in the near future.
"It's really difficult for these types of relationships to switch given how deeply entrenched the private-label player typically is with the merchant," Keefe Bruyette & Woods analyst Sanjay Sakhrani said in an interview. "I don't see how one wouldn't be concerned based on what happened with Walmart."
Sam's Club, Gap Inc., J.C. Penney Co. Inc., Lowe's Cos. Inc. and Walmart are Synchrony's five largest retail card partners, according to its most recent annual filing. The current agreement with Sam's Club does not expire until 2021, which gives Walmart ample time to figure out "whether the grass is actually greener" with Capital One, Credit Suisse analyst Moshe Orenbuch said in an interview. And Synchrony can use that time to learn what it needs to do to secure the partnership, Orenbuch said.
Walmart has kept the negotiations of its and Sam's Club's contracts separate and independent in the past. But the retailer could have a heavier hand in its warehouse business' next negotiation with Synchrony.
"I have to assume that Sam's Club goes with Capital One as well," Morningstar analyst Colin Plunkett said in an interview. "Capital One would be in prime position to win that business."
Investors fled Synchrony's stock when media reports emerged about Walmart's decision in the afternoon of July 26, and the selloff continued after the opening bell July 27. The lender's shares were down 10.52% at the close July 27 compared with their closing price July 25.
Losing its retail giant
Synchrony's CEO said the company was unable to agree with Walmart on terms that "made economic sense" for Synchrony and its shareholders.
"In our heart of hearts, we believe we have the same if not better capabilities [than Capital One]," Keane said. "We could have delivered on all fronts that Walmart wanted us to deliver on. We just could not get there in terms of what our economic expectation was for the program."
Details of the Walmart-Capital One tie-up have not yet been made public, but Credit Suisse's Orenbuch believes that Capital One will likely have to offer Walmart "significantly better economics" than its current program with Synchrony, he wrote in a July 26 note.
Adding Walmart to Capital One's portfolio is likely to be 3% to 4% accretive to its earnings per share over time, Orenbuch said. Since the portfolio will only transfer to Capital One upon the current contract's expiration on July 31, 2019, the partnership will have a "very minimal" effect on EPS in 2019, the analyst wrote.
Walmart is the latest large retailer that Capital One is adding to its credit card portfolio. The company acquired the credit card assets of Cabela's Inc. in September 2017 through an alternative transaction structure.
On Capital One's July 19 earnings call, CFO Richard Scott Blackley said the company will be disciplined when it comes to credit card partnerships with retailers, adding that these partnerships are increasingly important in the digital space. But KBW's Sakhrani said the bank still has the capital to go after Sam's Club.
Synchrony to diversify
After losing one of its largest card relationships, Synchrony's management team said it is looking to diversify the business and has been doing so through its payment solutions and CareCredit segments.
"Payment solutions [and] CareCredit are great ways to diversify out of large program concentrations that we have today, at very attractive returns," CFO Brian Doubles said on the earnings call. A general-purpose card, one of Synchrony's potential scenarios for its Walmart business, is another way to diversify, Doubles added.
The specialty finance company outlined two scenarios July 26 for the approximately $10 billion portfolio related to the Walmart business. It said either option would fully replace the earnings lost by the program nonrenewal. Synchrony expects to share details about the direction it will take and the timing of its plan later in 2018.
One option is to retain the portfolio and convert the co-branded cards to general-purpose credit cards beginning in the first quarter of 2019. Synchrony started to build out this strategy with its former Toys R Us Inc. portfolio after the store filed for bankruptcy. In addition to diversifying the business model, this option also allows Synchrony to retain all the economics generated from the Walmart program and gain flexibility in potential future offerings to existing cardholders, Doubles said in his prepared remarks.
Synchrony believes it can convert a "fairly significant" number of Walmart customers to a general-purpose card, he said.
About 50% of the company's current Walmart portfolio uses a dual card rather than a pure store card, meaning half of consumers are acting as general-purpose cardholders already, according to Doubles. About 60% of the spending on those cards comes from outside Walmart, indicating there are consumers who would be receptive to a Synchrony-branded card.
The other option is to sell the portfolio, which would create a gain to be determined in the first quarter of 2019. It would also create $300 million to $350 million in cost savings and a 60- to 70-basis-point reduction to net charge-offs, Synchrony said.
This option would free up $2.5 billion of capital, which the company said would be devoted to share buybacks and other high-returning options, including bigger investments in its fast-growing programs such as Amazon.com Inc., T.J. Maxx Inc. and PayPal Holdings Inc., as well as the CareCredit and payment solutions segments.
"Lastly, I think we will take a harder look at M&A opportunities," Doubles said. "But we're going to maintain our discipline and look for attractive entry points and good returns for shareholders."