Stocks I'm Looking At - Rent-A-Center

I thought it might be an interesting exercise to write a bit here and there about stocks I'm looking at as possible watchlist or portfolio additions. Maybe the process of writing out a thesis will help clarify my thinking.

Also, I encourage anybody with opinions/comments to please contribute them.

The quick take-away:
Rent-A-Center (RCII) is a leader in its rent-to-own (RTO) space.  RTO is basically like payday lending for merchandise; the company does not bother with normal credit checks, but charges people on the basis of significant mark-ups (200-400%+) to the normal retail price of electronics and furniture. It's a controversial space, but one that seems here to stay - people in a pinch (or who really have short-term furniture needs) need the flexibility, and people who always want to have more than they can really afford will always be lured in by the idea of "low" weekly payments for electronics they could otherwise never afford.

Moreover, the valuation here is interesting. The company has a long-term free cash flow margin of just under 9%, and a long-term book value growth rate of about 8%. Although the return on invested capital is below my normal double-digit cutoff, 8.3% is not terrible. The company is trading just a bit above book value and carries a sub-6 EV/EBITDA.

When I model this out, all it takes is low single-digit free cash flow growth to get a price target of $32, and that's with a 12% discount rate

The down-side:
I have long had some issues and concerns with this company. I will grant that the RTO industry is itself seen as shady by a lot of people, but RCII has not helped its own case. The company has had numerous court rulings go against it over the years, as well as settlements along the way. Allegations have ranged from unsavory collections practices to incomplete disclosure in the rental agreements to employee mistreatment. When I wrote about negatively this stock for The Motley Fool, I got a lot of emails - mostly supportive emails from current RCII employees. So, if your own employees are cheering and supporting harsh outside criticism, what does that say about the company?

Also, I am wondering how RCII grows further from here. I feel like they have penetrated the market pretty fully, and the company's 10-K's suggest the same. Growth, then, is going to have to come from getting more business out of its existing store base. I am not sure how they do that ... which suggests low-to-mid single digit revenue growth is about as good as it may get. Then again, the company could explore expansion into markets like Mexico. That would be a good move on my part, but I have no idea whether management is considering it. 

Outstanding questions:
Aarons (AAN) seems to enjoy a marginally better reputation than RCII and has a lower store count. Can AAN beat RCII at its own game by offering better customer service?

Can/will RCII clean up its act and be a "good citizen" while still making enough money to appeal to shareholders?

Would a company outside the industry (like Cash America (CSH) or First Cash (FCFS)) consider getting into the rent-to-own business. Would an electronics retailer like Best Buy (BBY) or hhgregg (HGG) ever consider any sort of rental or leasing business? The answer to the second question seems like a very strong "no way", but I am not so sure about the first question ... after all, First Cash did attempt (unsuccessfully) to branch out into the buy-here/pay-here auto sales industry a few years ago.

Bottom line:
This one is both interesting and frightening to me. I do not mind controversial businesses, but I am put off by operators in controversial businesses that do not conduct themselves beyond any reasonable reproach. Clearly, there is plenty of reproach for RCII. That valuation, though, is enticing ... so much so that I wonder what I am missing or overvaluing. It is no great surprise to see "sin stocks" carry a discount, but a 60% discount either means the Street is asleep, or I am missing something.

Again, feel free to chime in!

Disclosure - I own shares of First Cash Financial