Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

On Deck Capital Inc. jumped as much as 11 percent on Thursday after a report that the New York-based online lender is an acquisition target of closely held rival Kabbage Inc. 

How realistic is a deal? Not very. That means for shareholders who have already endured quite a roller-coaster ride, it's not over yet. 

Assuming Kabbage were to propose a traditional takeover at a standard premium, it probably would be swiftly rejected by On Deck's earliest investors, who still own a combined stake of more than 45 percent, according to data compiled by Bloomberg. With the stock trading at less than a quarter of its 2014 initial public offering price, it would take a generous premium to get them interested. That's highly unlikely, given that the company's growth prospects haven't panned out as planned amid heightened competition and waning appetite for small-business loans from the kind of investors who buy them.

That Hurts
On Deck's venture capital backers aren't the only ones hurting. IPO investors have also suffered as the company was forced to hold more loans on its balance sheet.
Source: Bloomberg

A different type of merger arrangement might not be such a terrible idea, especially in the face of potentially heightened regulation. Together, Kabbage and On Deck could share the costs of compliance, if increased scrutiny of online lending is formalized.  The combined company could also cut overlapping costs and create scale, which may help it better compete against other providers of loans to small businesses including Square Inc., PayPal Holdings Inc. and CAN Capital. 

Drop in the Ocean
On Deck's loans under management are a fraction of the $80 billion to $120 billion in unmet demand for small=business credit lines
Source: Company presentation

But one key problem is currency. As a private company, Atalanta-based Kabbage can't easily offer cash and its equity to On Deck shareholders as a means of allowing them to participate in its future success. And a reverse merger seems unlikely as Kabbage's decision to raise capital from private investors -- to me -- underscores its desire to remain closely held for the time being. 

Could Kabbage's purported interest in On Deck draw other suitors? Compass Point analyst Michael Tarkan reckons the company could be a good fit for traditional banks seeking to bolster their exposure small-business lending. But as J.P.Morgan Chase & Co. has shown, it's possible to achieve that goal without buying an online lender outright. Instead of making such an acquisition or building its own technology in-house, the New York bank instead launched a partnership with On Deck in 2016 that speeds up its loan-making process to small businesses. That kind of arrangement could be made with other banks, too -- and would seem sufficient for all of them.

Credit Check
On Deck's profitability may rise and the rate of default on loans it has originated should decline if the company improves its underwriting standards, as it has pledged
Source: Company presentation

Most signs point to On Deck setting itself up to pave its own path in the long term, including a $20 million-a-year cost-savings initiative and the recent appointment of Jim Rosenthal, the former chief operating officer of Morgan Stanley, to its board. And with EJF Capital LLC -- the firm led by former FBR & Co. head Emanuel J. Friedman -- lifting its stake by 7 percent in February and indicating a willingness to take a more activist stance, the lender may find itself under added pressure to deliver. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Increased regulation is a risk for small business-focused online lending marketplaces, according to analysts, who believe that the probability of burdensome regulation is lower for online lenders focused on consumer lending.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net