To Be Frank
Some thoughts on diligence
We recently discussed the headlines of the JP Morgan / Frank diligence saga. For those unfamiliar with the Frank story, buckle up, because it’s a good one.
Frank, a fintech company founded by Charlie Javice in 2016, was an online platform that helps students fill out college financial aid forms.
JPMorgan Chase, seeing an opportunity to cross-sell its (lucrative) financial products to Frank’s college-age customers, purchased the company for $175 million in 2021. Unfortunately for both parties, things went south quickly after the acquisition, as Frank’s customer list was (allegedly) not quite as robust as advertised. From the always excellent Bloomberg Money Stuff:
“In January 2022, after JPMC acquired Frank, JPMC began work on a marketing campaign to test the quality of Frank’s customer account list and the receptiveness of these customers to JPMC’s products and services. To facilitate this marketing campaign, JPMC asked Javice and [Frank Chief Growth Officer Olivier] Amar to provide Frank’s user list so that JPMC could send the marketing test by email.…JPMC reached out via email to a random sample of the list Frank provided – approximately 400,000 purported customers of Frank – with offers to open Chase checking or savings accounts. Of those 400,000, only 103 even clicked through to Frank’s website.”
Now, we are not marketing experts, but we do know that a 0.026% click-through rate on an email campaign is not very good. To be frank, it’s quite bad. Upon seeing these results, JPMorgan’s spidey sense kicked in and they began to dig a bit deeper into the company.
We won’t delve into the details, but the gist of it is that during diligence, Javice represented that Frank had 4.265 million college-aged “users” (defined as individual accounts with first and last name, email, and phone number). Except, Frank only had about 300,000 customer accounts, and Javice had worked with an external data scientist engineer to fabricate a customer list (for $18,000). She also purchased a generic customer list from a market research firm (for $175,000). Not a good look.
The lawsuit will play out in the courts, but it begs the question, how does this happen? It all seems so obvious after the fact. Monday-morning dealmaking is pretty easy and JP Morgan is a big, sophisticated firm. For us, a couple of things stand out.
Relative Size: For most of us, $175 million is a lot of money. For JP Morgan, this was quite a small acquisition. When conducting diligence for small deals, there is a danger to gloss over details and it’s likely the team working on this was either inexperienced, lazy and/or distracted by larger “more important” deals. It’s a good reminder to pay attention to detail, regardless of whether it’s for $10 million or $100.
Competition: We don’t know this for sure, but it’s possible JP Morgan was not the only suitor in the acquisition process. There may have also been a time pressure associated with conducting diligence. The pressure of a deadline combined with a fear of missing out can lead to incredible justifications, even if your gut is telling you something is off. To mitigate this risk, we remind ourselves that no deal is better than a bad deal. If the other party is trying to fabricate external pressure during diligence, often it’s best to just walk away.
External Consultants: Much of M&A relies on some set of external consultants. In this case, JP Morgan’s third-party due diligence consultant actually reviewed the list of (fake!) customer accounts and okayed it. Tough to blame JPM for that. In the small business space, the person holding the risk needs to be involved. We must either do the work ourselves or take the time to understand what the consultants are actually doing.
A Teeny Bit of Common Sense: It’s incredibly easy to get lost in the details of acquisition analysis. Back-of-the-envelope “does-this-make-sense” math can be surprisingly useful in diligence. From a NY Times article about the deal:
Mr. Salisbury, a former director of institutional research and assessment at Augustana College, estimates that two million students start college each year for the first time. Having done the FAFSA once, he figured, most families wouldn’t seek help from a company like Frank the second time they needed to and beyond. So if Frank had served five million people in just half a decade, it would have captured a sizable share of new college students who needed financial aid. Reaching all of those people within the year that they might seek help, however, isn’t easy. ‘To break through all of the noise on the internet, that is incredibly difficult to do, and it costs an insane amount of money to pull it off,’ Mr. Salisbury said.
Could Frank have actually spent the money or cracked the code? ‘It just always smelled,’ Mr. Salisbury said.
Mr. Kantrowitz, who had filed the Freedom of Information Act request a few years earlier, was surprised, too. He used a web traffic measurement firm to run some searches and found that Frank had just 67,000 unique website visitors per month around the time of the acquisition. Even if you multiply that by the total months of the company’s existence, it doesn’t get you to five million.
We would put this in the category of things that seem obvious…after the fact. The reality is that even the most sophisticated investors make mistakes. For JP Morgan, this is an annoying PR debacle and a small write-off. In our world of small business, this type of mistake can be disastrous. We must do everything possible to avoid getting caught up in the heat of the deal and remind ourselves that the point of diligence is to apply unbiased scrutiny to the available data, not to confirm a desired result. And frankly, sometimes things just don’t add up.
Have a great week,
Your Chenmark Team