Why Debt Collection Is Such a Great Business

by Lawrence Meyers | August 9, 2013 10:15 am

I’ve been writing about debt collectors so much lately, my editors are starting to get sick of it. Still, I just can’t help it. Portfolio Recovery Associates (PRAA[1]) and Encore Capital Group (ECPG[2]) are fantastic businesses that generate lots and lots of cash flow.

For those of you who aren’t yet believers, let’s take a look at why these companies make as much money as they do.

The answer lies in several places. The first: Companies like Portfolio Recovery Associates get money cheap. On Wednesday, in fact, the company announced it’s raising $250 million[3] in a convertible debt offering, and the interest rate is only 3%. The company also pays about $11 million in annual interest on $327 million in long-term and line of credit debt, which is just over 3%.

PRAA then takes that money and buy all kinds of debt. Most of it is consumer debt, while it’s lately taken to scooping up bankruptcy debts. The company buys this debt for 6 to 8 cents on the dollar. That brings us to the next key: Buying the right debt at the right price. Of course, the company has super complex analytics to help them choose properly.

While Portfolio Recovery engages in some typical collection practices, it really likes to focus on getting people to voluntarily enter a payment plan. Let’s say they get a debtor to pay off what he or she owes in ten installments. If PRAA collect even one payment, that’s 10% of the debt owed, which exceeds the 6% to 8% of face value they paid for it.

The company is already ahead.

How good are are debt collectors at doing this? Well, just look at PRAA’s recent press release[4] and you’ll see several tables that show how efficient the company is in terms of buying and collecting.

The first table (below) shows purchase price multiples of the company’s entire domestic portfolio as of the end of the second quarter. Look at the purchase price of the debt, and look at how much has been collected. As you can see, it’s often double or even triple what they paid.

Click to Enlarge

 Plus, for stuff that’s less than ten years old, there are still balances that remain uncollected, which should drive up that yield even higher.

There’s also a table of ratios (below). Notice that returns and margins are rising, operating expenses to cash receipts are falling significantly and employment is increasing. This is a tale of amazing returns from a highly efficient operation.

Click to Enlarge

For the cherry on top, PRAA is slated to keep on growing. Earnings are expected to grow from $2.46 per share last year to $3.31 per share this year — an increase of almost 35%. In 2014, analysts look for $3.80 in earnings, which is an increase of another 16% … and I think they’ll be closer to $3.95.

The company should be trading at a 20x multiple in my opinion, putting fair value at $65. It’s hovering at $50. I see a great growth and value play right here.

Lawrence Meyers owns shares of PRAA and ECPG. He is president of PDL Capital, Inc.[5], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[6] and blogs about public policy, journalistic integrity, popular culture, and world affairs[7]. Contact him at pdlcapital66@gmail.com[8]and follow his tweets @ichabodscranium.

Source URL: https://investorplace.com/2013/08/why-debt-collection-is-such-a-great-business/

---