Quick Pitch: Green Dot (GDOT)

Portfolio Transformation: 30% Upside (at $12.78/share)

This investment idea boils down to getting exposure to a fintech sponsor bank at ~0.75x TBV, right as it transitions to a new management team with a strong track record. The incoming team plans to reposition the bank’s under-earning asset portfolio and materially improve profitability, arguing that this will drive the valuation closer to peers that trade at a substantial premium to book value. At ~0.75x TBV, the downside looks well protected.

Green Dot is a fintech company that provides a range of services, including prepaid debit cards, checking accounts, bank-as-a-service, and tax refund processing. Its regulated bank subsidiary, Green Dot Bank, is the engine behind the fintech services, responsible for issuing cards, sponsoring programs, and holding customer deposits. Such banks are commonly referred to as sponsor banks or partner banks, and they resemble financial infrastructure companies more than traditional lenders.

GDOT is selling all of its businesses in two separate but related transactions. The fintech side will be acquired by private equity firm Smith Ventures, while Green Dot Bank is merging with CommerceOne, a smaller but very well-run private bank. The fintech sale is expected to generate $690m in gross proceeds. Of that, $470m ($8.11/share) will be returned to shareholders as a cash distribution, and $155m will be contributed to the new BankCo as a capital injection. In total, GDOT shareholders will receive an $8.11/share cash payout plus a 72% stake in the new BankCo, which will stay public under a new ticker “CONE.” The shareholder vote for both transactions is set for June 23, and closing is expected shortly after. There should be no major hurdles to closing: antitrust approval has already been received for both transactions, while banking regulatory reviews are ongoing.

The market values GDOT’s 72% stake in the new BankCo at $270m, compared to the $355m in TBV attributable to that stake (based on a total BankCo TBV of $490m). That seems like an attractive price, if the intended business transformation plan delivers.

As a result of sponsoring fintech programs, Green Dot Bank has access to super cheap, basically free deposits. They currently sit at $4.5bn, mostly in non-interest-bearing accounts, with a total cost of funds of just 0.16%. However, due to the same corporate umbrella as the fintech business, the bank was constrained by strict regulatory limits from properly benefiting from these deposits. Historically, half of the bank’s earning assets have been sitting as cash, with the other half invested in securities, generating a timid combined yield of 3.5%. As a standalone operation, the bank is not generating any meaningful profitability.

CommerceOne’s management will take the helm of BankCo after the merger. It estimates that simply redeploying all of the low-yielding securities into cash would increase earnings by $35m, a massive increase compared to TBV. Longer term, it also plans to start issuing loans, potentially doubling the current yield on earning assets from 3.5% to 7%.

During the transition period, the new BankCo will also receive substantial fees from the divested fintech businesses: the parties have entered into a seven-year exclusive services agreement. As I understand, under the current GDOT structure, the bank is not generating any of these fees (only interest income on deposits). At the merger closing, these fees are estimated to go from zero to $30m annually. The new team also intends to expand Green Dot Bank’s client list and start selling sponsor services to other fintechs.

It’s difficult to put any precise figures on BankCo’s potential profitability, as all of those operational changes will undoubtedly demand much more investment in marketing and operational infrastructure. However, the new management expects the combined BankCo to eventually reach 15%+ ROE, in line with peers and CommerceOne’s current profitability.

The whole playbook is basically taken from peers CASH and TBBK, both of which are pure-play sponsor banks that facilitate fintech programs, access super cheap deposits, and deploy them into high-yield assets (loans, etc). Both of these peers are way larger than pro-forma BankCo, generate ROEs in the 20% to 30% range, and trade at 3x TBV. Smaller peers that operate more like traditional or digital banks but still maintain some sponsor or fintech infrastructure businesses (MVBF, FINW, AX, CCB) trade at 1x, 1x, 1.7x, and 2.1x respectively.

As per illustrative calculations in the transaction presentation (slide 24), with a 1.0x-1.8x TBV multiple on the new BankCo and factoring in the $8.11/share cash distribution from the fintech sale, the total value for GDOT shareholders adds up to $14.23-$19.18/share. That’s 11-50% upside from current levels. While the full re-rating will probably take some time to play out, the pending transactions are expected to close in a month and could serve as a soft catalyst.

 

More on CommerceOne

CommerceOne is a private bank that operates a branch-lite model and currently runs only one branch. Despite holding just $840m in assets, it boasts great operational efficiency, solid historical growth, and a mid-teens ROE. The numbers below are taken from FDIC reports and match the figures provided by management in the merger materials.

Its loan book is primarily exposed to multifamily and CRE (32%), C&I (27%), and 1-4 family (17%) loans. This tilts a bit toward the riskier side, which probably explains the fairly high yield on earning assets. However, as seen in the table above, the credit loss provision has historically been low and stable. CommerceOne is also well capitalized, with a CET1 ratio of 12%.

Overall, this seems to be a well-run banking operation. The bet here is that combining Green Dot Bank’s access to cheap deposits with CommerceOne management’s underwriting know-how will drive a strong outcome for shareholders.

 

Other details

Smith Ventures, the PE firm buying Green Dot’s fintech business, is owned by Bill Smith. He is a serial entrepreneur with a good track record of building and selling companies. He also happens to be a co-founder and the largest shareholder of CommerceOne Bank, with 17.5% ownership. So both sides of this Green Dot transaction have been orchestrated by the exact same people. Bill Smith has personally guaranteed the reverse termination fee (5.8%), so he seems confident the deal will close as expected.

Smith did not want to take the sponsor bank operations private, and instead chose to essentially list CommerceOne. He clearly is primarily interested in the fintech assets, and the BankCo part of the transaction might be just a convenient liquidity opportunity for the current holders of CommerceOne.

After the close of both transactions, some GDOT shareholders who invested primarily for the fintech business will likely look to exit, while some CommerceOne shareholders may want to use the liquidity event. If this results in a sell-off in the new BankCo, then there might be better entry opportunities after the closing.

The agreed transactions are the culmination of a strategic review run last year. During that process, one other bidder also made a $14/share offer for the whole company. Competing bids for the fintech business were in a similar range of $500m-$610m. This provides some underlying valuation support for GDOT. However, most of the other bids for the full company were much lower, coming in around $10-$12.5/share, and interestingly, the banking entity received no separate bids.

The strategic review was likely prompted by activist engagement behind the scenes. Starboard Value had been sitting on the register with a 9.4% stake since 2020, and Steel Partners filed a 13D disclosing a 5.7% stake just a few weeks before the strategic review was launched. However, Starboard exited its position few months after the review kicked off, selling at prices close to where the stock trades today. Steel Partners also trimmed its position, unloading a third of its stake two months ago at lower prices than today’s.