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Morningstar | The Synchrony and Walmart Divorce Gets Messy

Synchrony, whose moat was recently downgraded by us to none from narrow, is now facing an $800 million lawsuit from Walmart. Specifically, Walmart claims Synchrony’s underwriting standards financially harmed Walmart’s business. In response to this, Synchrony said in a statement, “This lawsuit is nothing more than an attempt by Walmart to exert leverage and avoid the contractually defined process for valuing the loan portfolio that Synchrony has serviced on behalf of millions of Walmart customers for the last 20 years.” We won’t be changing our fair value estimate over this and don’t believe this lawsuit merits a substantial sell-off in the stock, but the litigation does seem to confirm that Synchrony has zero chance of retaining Sam's Club, which we already expected. After the sell-off, Synchrony is selling below our fair value estimate of $28.50, but we would encourage investors to demand a greater discount before buying.

We’ll remind investors that in July after announcing the loss of Walmart, Synchrony CEO Margaret Keane said this regarding its relationship with the retailer, “…we would hope to renew Sam's, and we're going to be in that process. We'll be aggressive. And again, I think the important point here is we don't have a bad relationship with Walmart. Our teams work really well together with Walmart and Sam's.” This lawsuit would seem to suggest the exact opposite--the company has a bad relationship with Walmart and will not retain Sam’s Club. We are finding it harder and harder to trust Synchrony’s management team and at this point would appreciate greater candor from the company. We’re not ready to downgrade the company’s stewardship to poor, but after today's lawsuit and the apparent mishandling of its largest retail relationship, we’re getting closer.

The one place we do agree with Synchrony’s management is this lawsuit may be used to increase Walmart’s leverage in the deal. CEO Margaret Keane has said Synchrony believes it has the potential to sell the Walmart portfolio at a gain, which we find hard to believe. We don’t know why Synchrony thinks the portfolio can be sold at a price greater than the amount held on its balance sheet. Though premiums have been paid in the past, it's much more common in a competitive takeaway such as this for the portfolio to be sold at book value. In addition, Capital One CEO Richard Fairbank said the company would only agree to acquire the portfolio “at price and terms that are attractive to us…” This lawsuit may amount to nothing more than Synchrony having to accept a lower price for the portfolio.

We would encourage investors to read our recent piece, “Capital One: A Moat in Tech Vikings Can’t Surmount” which highlights the gap in technology between Synchrony and Capital One. Though we still think Capital One’s technology advantage played a key role in wooing Walmart, this lawsuit would suggest that the decision didn’t come down to solely technology as it appears the underwriting was problematic.