QC Holdings

Ticker: QCCO
Date of Report 15/06/2010 52-Week Range 3.38-7.15
Market Cap, mlns 65 Current Price 3.65
Tangible Book Value, 1Q2010 mlns 51.4 Dividend yield 4.00%
Price/ Tangible Book Value 1.27 Insider Holdings 55.3%
FY 2009 (as reported, mlns) 19.8 Institutional Holdings (Top 10) 22.67%
PCurrent/ EFY2009 1.1
FY 2010 (forecasted, mlns) 16.5-15
PCurrent/ EFY2010F 4-4.3 Holding period 12 months
Industry Payday lending Target share price 5.10

Investment thesis
Despite:
1. ongoing industry challenges stemming from legislative changes
2. resultant permanent shut down of some regional markets
3. and further declines in revenue and profits in the near future
I believe that:
1. the Company’s current market capitalization of $63 million, trading at all-time low;
2. ca. $ 21 million in cash being available for distribution to shareholders, or 37% of current
market cap;
3. and its 2009 net income of $19.8 million, implying a P/E of just 3.3
offers a 40% upside potential, given that my assertions are correct and ca. 16% if the market’s is
correct.
I have derived the intrinsic value based on a combination of liquidation, comparative and multiples
based valuation, which would be presented below.

QC holding business and industry overview

QC Holding is specializing in payday lending (71% of
Top 5 companies in industry
revenue generated in 1Q2010) as well as other Company Name # of centres Ticker
consumer financing products, largest being auto Advance America 2,553 AEA
ACE Cash 1,800 private
sales (10%) and instalment loans (9%). With 533 Check ’n Go 1,000 private
Check into Cash 1,000 private
branches in operation and 24-old history the QC Holding 533 QCCO

Company is one the largest and oldest players in a $42.1 bln 1 industry.

1, 3
The cost of providing Payday Loans in a US Multiline Operator Environment, by E&Y, Sep 2009
Niche market:
The payday loan represents a small cash advance, typically $350, intended to cover a borrower’s
expenses until his or her next payday (usually a two week term). What makes the industry a niche
play is that the loan is advanced against posted check and is essentially credit extended in good
faith. Consequently losses are running high at 3.74% of notional principal. This means that the
interest has to be 13.15% on average over the life of a loan for the lender to breakeven, implying a
nominal percentage of rate (nominal APR) of 316%.
A nominal APR of 316% effectively precludes large financial institutions to serve this market due to
imminent hike in cost of funding and to a lesser extent increase in reputational risk. It also means
that the opportunities to leverage up for current players are limited to 2x the equity.
Catering this market segment also means that loan portfolio turnover rate is high and so is the
customer churn rate, translating into high administrative and processing costs.
On the upside the inflation and most importantly fat-tail risks are limited for exact same reason.

Intra industry competition is limited:

Entry barriers are low- a permit, a lease contract and starting capital is all that is required to enter.
The exit barriers are low as well, since there is no accretion of specialized fixed assets through time
or a build-up in legacy costs. The exit value is largely determined by existing loan portfolio, which is
highly liquid and acquired clientele, proxied by centres geographic coverage (fixed assets). In this
two part equation, cash underlying the loan portfolio allows shareholders to easily redeploy most of
the funds into more attractive opportunities even if fixed assets carry little to no value.
This creates (absent of external pressures) a stable level of moderate profitability.
The dormant risk exists in irrational response (pricing below cost) from local players in the light of
impeding industry consolidation. Such as risk however is highly improbable and unlikely persist for
prolonged period.
Mobility barriers (how freely one firm can mimic strategies employed by others) are moderate to
high- as shown larger firms are able to exploit economies in scale and marketing e to significantly
drive up the performance of the top and bottom line through sheer size. Smaller firms (97.9 of all
population) are more dependent on client focus strategies.

Bargaining power of Suppliers (of capital) is moderate to high:

The main inventory of financial intermediation is money. The suppliers to the industry are mainly
banks (via extension of loan and overdraft lines). Bearing in mind structural impediments outlined
above the banks nevertheless pose a credible threat of forward integration. This can be seen in such
bank products such back-ended load products as credit cards and overdrafts, where money is being
made through overdues and other similar charges.
The second source is the capital market, which at the moment ascribes very low valuation to the
sector effectively precluding from raising additional capital on favourable terms.

Bargaining power of Buyers is low:

The buyer group taken as a whole is not highly concentrated, nor possess full information about
product pricing. However it does seem to exhibit mild segmentation, as evidenced by revenue and
cost discrepancy in financial performance of Advance America and QC Holding (see comparison
tables of revenue and cost structure).

Government role
As a result of availability of cheap credit and favourable consumer trends the industry has grown
rapidly over the past decade. In recent years however the industry is facing significant headwinds
with consumer retrenchment and general push at federal and state level to tighter regulation. A
number of legislations at federal level being passed preclude doing profitable business based on
current modus operandi at such states as Ohio, North Carolina, Virginia, and New Mexico (QC
Holding has discounted its operation in abovementioned states as a result).
In addition The Payday Lending Limitation Act of 20102 currently in the works sets the ceiling on
number of loans per individual, sets out tougher renewal procedures and requires effectuating of
monitoring and data base systems.
The probable effect on the industry is to reduce client captivity, while raising the processing costs.

Market participants observable strategy

The Industry helped by legislative changes is nearing maturity.
The largest market participants’ response has been to:
 Expand into new markets, e.g. Check ’n Go- the UK, EZ Corp- Mexico, Advance America- the
UK, Canada
 Build switching costs and increase consumer captivity by introducing sticky products- e.g. bill
payments, prepaid credit cards, online lending
 Increasing sales to existing customers- Partnership with Western Union by Check into Cash,
Auto Insurance by ACE Cash
 Maintain market leadership- Advance America

2 th
S.3245.IS 111 Congress
  Enter new business line- QC Holding entrance into buy here, pay here market

On QC Holding current strategy

The Company has stated that it is willing to acquire opportunistically payday lending companies, but
none has come up yet at attractive price.
The Company is also entering a buy here pay here market via acquisitions. Although insignificant in
size it might have majort impact on the Company’s profitability in the future.
The Company’s inroads into buy here pay here market puts significant drain on free cash flow while
simultaneously decreasing ROIC margins and introduces inflation risks due to longer (on average 30
months) holding periods.
At this stage it is unclear whether the Company intends to establish a network as operator to
originate and hold the loans or mere attempts to build market presence to purchase the loans from
existing player. In case of the former the Company will likely to become more capital intensive and
permanently lower it’s ROIC. In case of the latter the Company might be able to achieve better fixed
assets utilization and spread its operational costs over large pool of loans- the strategy successfully
used by Nicholas Finance Company (ticker NICK).

On Market participants response

Market Participants response (save for Advance America) in relation to QC Holding strategy is non
confrontational in nature smoothing industry rivalry.
However delay in attempts to introduce switching costs across Company’s own product line might
increase customer churn rate.
QC Holding tentative strategy of entering the buy here, pay here market might signify the lower
value placed on the existing business. This combined in conjunction with Advance America strategy
yields a possibility an asset sale to Advance America.
Prospective market consolidation:
As a supporting argument note that the average Comparison of revenue and cost structure
Industry Leader Target
EBITDA of both the Target (QCCO) and market 3
Per $100 loan Average AEA QCCO
leader (AEA) is significantly above the industry Revenue 15.3 19.1 17.5

average and that top 5 companies are operating Other revenue - - 3.0
Total Revenue 15.3 19.1 20.5
out of 31% of all locations are accounting for not Operating Cost 9.41 10.0 11.1
more than 2.1%4 of companies in the industry. Bad Debt cost 3.74 2.9 4.1
Total Loan Cost 13.2 12.9 15.2
EBITDA 2.1 6.1 5.3

QC Holding in transitional stage however might fall into stuck in the middle trap- failing to leverage
its strengths in achieving lower cost and higher asset utilization and loosing market position to
Advance America.

4
Inference based on top 5 companies and Table 2: Company distribution by size of the E&Y Sep 2009 report
 Income Statement (in 000’s) 2012f 2011f 2010f 2009a 2008a 2007a
“As is” financial projection5:
Total Revenue 178,695 200,781 210,688 220,616 227,745 211,607
To get the sense of the earnings power the Company’s financial Change y-o-y -11% -5% -5% -3% 8% 23%

projections being constructed on “as is” basis, that is ignoring the

Salaries and benefits 39,939 43,536 45,639 45,754 49,441 46,427
impact of buy here pay here business. Occupancy 22,168 24,164 25,332 23,988 26,780 26,715
It is important to note that the possibility of distressed asset sale and Other 16,373 17,848 18,710 20,177 18,339 15,323
Total branch expenses, gross 78,481 85,549 89,681 89,919 94,560 88,465
permanent loss of capital is remote as debt outstanding is more than
Provision for losses 36,632 42,164 45,402 47,541 58,184 53,022
covered by net loan portfolio (adjusted current assets are also Depreciation 2,144 2,409 2,528 4,158 4,446 4,700

significantly higher than current liabilities). The Company is revenue is Total branch expenses, net 119,133 131,225 137,611 141,619 157,191 146,188

Branch gross profit 59,562 69,556 73,077 78,997 70,554 65,419

projected to decrease sequentially by 5% in both 2010 and 2011 due
to Arizona market shutdown in June 2010.The cost alignment is Total overheads 40,135 40,435 44,882 44,625 45,603 40,485

expected to be achieved in 2011, resulting in significant drop in net Profit before tax 19,427 29,120 28,195 34,372 24,951 24,934
Net income 11,775 17,189 15,958 19,828 13,578 14,601
income and its revival in 2011. The decline of 11% in total revenue is
Net income margin 7% 9% 8% 9% 6% 7%
expected due to sunset of Mississippi legislation on payday lending.
2012f 2011f 2010f 2009a 2008a 2007a
The funds available for distribution are assumed to be used to repay
Gross Loans 69,822 78,452 82,323 85,776 80,359 77,345
debt outstanding, resulting in significant debt reduction from $58 mln Less: allowance 10,479 11,550 11,750 10,803 6,648 4,442
to $13 mln by 2012. As a result the funds available for distribution to Net Loans receivables 59,343 66,901 70,573 74,973 73,711 72,903
Debt outstanding 13,185 24,960 42,149 58,107 70,750 75,266
shareholders (excluding any value that might reside in fixed assets)
Loan less debt 46,158 41,941 28,424 16,866 2,961 (2,363)
increase from $38 to $67 over projection period. Cash and equivalents 21,151 21,151 21,151 21,151 17,314 24,145
Assets avail. for distribution 67,309 63,092 49,575 38,017 20,275 21,782

5
Revenue is assumed to constant over projection period, except for anticipated adverse impact of Arizona and Mississippi market shutdown
Costs are a median of observable period, except for Provision for losses that are driven by portfolio decline and overheads costs
Management team and principal shareholders
QC holding is very closely held Principal Shareholders Percent of Share outstanding
Founding members 55.3%
company with its founders still at the Gregory L. Smith 18.5%
helm. Granahan Investment Management 4.94%
Century Capital Management 4.38%
Dimensional Fund Advisors 3.76%

Don Early (CEO) , company’s founder, his wife- Mary Lou Early (VC) and her son Darrin J. Anderson
(COO) together control 55.3% of stock outstanding. As a result acting together they control all
matters requiring shareholder’s approval, including election of directors and approval of significant
corporate transactions. Thus the corporate governments and treatment of minority shareholders
rests solely on management integrity.
Unfortunately there is not enough information around to draw decisive conclusion on the
management integrity. It is worthwhile to note generally compensation package is in line with that
of competitors, except for Mr. Wood (VC Eastern US) being compensated disproportionately for two
branches that are leased from him, but perhaps such decision was dictated by strategic reasons.
Wayne S. Wood prior to joining QC Holding spent four years as a division manager with Advance
America.
QC holding is also supporting certain politicians such as Mark Taddiken (Kansas), Bob Marshall
(Kansas) and Luis Gutierrez (House of Representatives).
Valuation
Multiples based valuation:
Even after factoring in Arizona ban on payday Multiples Valuation (over 5 year period)
lending and assuming no offset from other business Company QCCO AEA EZPW
P/OE, median 3.83 2.81 6.95
lines the net income for 2010 is anticipated in
P/E, median 9.24 12.29 11.99
$16.5-15.1 mln. range and operating earnings (OE)6
of ca.$34 mln, implying a leading P/E of 4-4.3 and P/OE, avrg. 6.92 3.39 6.97
P/E, avrg. 15.57 10.70 13.03
P/OE of 1.9 , well below median and average
multiples. Assigning a median P/E of 9.24 and P/OE of 3.8 yields a stock value between $ 129-145
mln.
Comparative based valuation:
Although superficially simplistic a comparative valuation was modelled after ACE Cash acquisition by
JLL Partners in Oct. 2006 yielding an implied value of $154 mln at high end of multiples valuation.
Value in liquidation:
Assuming that the Company will stay solvent in 2010, but would be forced to liquidate at some point
in time in 2011 due to hypothetical state wide ban on payday lending then a floor value in
liquidation would be between $63 mln and $50 mln with midpoint estimate of 56.5 mln.
Derived probabilities
Thus a probability of failure implied in the current market valuation is ca 88% on undiscounted cash
flow basis. Although I do believe that the possibility of bankruptcy and a distressed sale in which the
Company is far and remote, being conservative I claim no informational advantage but merely
assert (and base my payoff expectations) on a possibility of the mean reversion with more unbiased
50/50 probability of success or failure yielding an intrinsic business value of $92.8 mln.

6
Operating earnings are defined for the purpose of this presentation as branch gross profit less corporate
overheads, but excluding the depreciation and interest expense as well as P/L flow-through adjustments.