asfi corporate logoBy Whopper

Asta Funding (ASFI) is a collection company that’s trading significantly below book value, which I believe actually understates, perhaps significantly, the company’s true value.

Before I start, let me point you to an excellent write up over at totally invested. He wrote this about a week before the company announced a big stock buyback that has sent the shares up a bit… great timing haha. One last note- they’ve released their quarterly numbers but have yet to file the 10-Q, so unless I note otherwise I’m using numbers from their 8-K.

Anyway, Asta is in the consumer receivables business. They acquire delinquent consumer receivables for pennies on the dollar and then collect on them. Unlike most of their other competitors, Asta outsources most of the actual collection process. The company believes the price for portfolios is currently too high, so they aren’t purchasing new portfolios. So their book is currently running down, which is generating huge cash flows, well in excess of what the profits of the company would tell you. They are run by the Stern family, who control almost 27% of the shares outstanding.

On the investment characteristics. On a simple first glance, Asta is awfully cheap. Tangible book value stands at over $11.60 versus a current price of $7.70 (as of close August 8th… given how rocky the markets are, who knows if that will be the case when this post goes up!). The company is sitting on over $7 per share in cash and over $2 per share in net cash (cash minus debt).

However, on a deeper dig, I believe the company’s book value significantly understates their true value because of two things: 1) an accounting quirk and 2) optionality value. Before we can discuss those, however, we need a little bit of background on the company. In March 2007, they acquired the Palisades Portfolio for $300 million, by far the largest acquisition they’ve ever done. To put the size of this portfolio in perspective, their balance sheet currently contains just over $252m in assets. They paid for the portfolio with a ~$225m in non-recourse loans and ~$75m from their credit line. The portfolio has been significantly written down significantly (almost $100m in write downs) and currently sits on the books for $81m versus $74m in non-recourse debt.

Let’s start discussing their undervaluation by digging into the accounting quirk, because it plays a role in the optionality value. When the company can no longer determine the timing of cash flows from one of their portfolios, the switch from the interest method of accounting to the cost basis method of accounting. Under this accounting system, all cash flows from the portfolio go immediately towards a reduction in the principal of the portfolio. Compare this to the interest method, where a portion of the cash flows are recorded as revenue and a portion as principal reductions. Eventually, the entire portfolio is written off under the cost basis method.

Thus, the cost basis method does three things. One, it substantially reduces revenue in the near term, as the company recognizes basically no revenue until the entire portfolio has been recovered, even though the portfolio could be generating significant cash flows. Second, by deferring revenue, it defers profits and thus taxes. Third, it eventually creates a portfolio with no cost basis (and thus no book value) that is generating substantial cash flow. How much cash flow do these “zero basis” portfolios generate? Pretty substantial amounts- they’re on pace to generate ~$35m in zero basis revenue this year, and generated a similar amount last year, versus total revenue run rate around $45m. In other words, almost 80% of revenues are coming from assets carried at zero on the books!!! Crazy!

That brings us to our second quirk: optionality value. The Palisades Potfolio is carried under the cost basis method and is valued at just $7m more than the debt taken out to purchase it. All cash flows from the portfolio are going straight to pay down the debt. Management has already said in the event cash flows from the portfolio detororiates, they will just turn the portfolio over the the bank of Montreal and walk away.

Personally, I think the cash flows from the Portfolio aren’t coming in quite fast enough to justify it’s current book value and will require a write off. Let’s say I’m right, what happens? The company walks away from the portfolio and writes off the difference between the debt and the book value, or $7m (under $0.5 per share). Now what if I’m wrong? Then you have a free option on all of the cash flows this portfolio will generate, which given how big this portfolio is, could be huge. Not a bad deal.

You also get a nice catalyst. Management thinks the shares are undervalued and announced a $20m share buyback, or just under 20% of shares outstanding. On their most recent conference call, they announced that they couldn’t start repurchasing shares until…. after Monday (August 8th). So their potentially huge share buyback program is going to start just after one of the greatest two week sell offs in recent memory???? Not too shabby on the timing!!!

I know the accounting is complicated, so I’m happy to answer any questions you might have. Let me also refer you (again) to totally invested‘s excellent write up.

Disclosure: Long ASFI

 

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