Bad Debts Make for Very Good Business

by Lawrence Meyers | May 3, 2013 1:05 pm

Hey there … let’s have a little chat about that debt you owe — the debt you decided not to fulfill your obligation to repay.

Well, turns out your creditor sold it off to Portfolio Recovery Associates (NASDAQ:PRAA[1]).

The company’s business plan is pretty simple. It paid around 8.5 cents on the dollar for your debt and would like to collect at least 9 cents from you (but would settle for more, of course).

Debt collectors use a variety of legal tactics to extract obligations from people and Portfolio Recovery, for one, does its job well. Combining that skill with buying the debt at the right price can make for a very healthy business; just take a look at its earnings report for for Q1, released in April.

Cash collections jumped 26% to $275 million, which includes $77 million from people who can, but won’t, pay their debt — a gain of 33%. Payments from bankruptcy accounts were up 37% to $109 million.

Revenues as a whole were up 21%, while operating expenses only increased 8%, with net income up a whopping 52% to $38.6 million. In EPS terms, the company settled out at $2.26 per share, up from $1.47 last year.

Still not sold? Well, to top it off, because of strict regulatory compliance issues, debt sellers don’t want to get involved with debt buyers that don’t have a proven history of following the rules.

Thus, competitive bidding for portfolios is decreasing and Portfolio Recovery was able to purchase $1.9 billion in bad debt for a mere $214 million, or about 11 cents on the dollar.

That’s a record for the company, although it doesn’t expect to spend so much every quarter. Plus, the amazing thing is that it is are able to fund these purchases from a robust credit facility.

Given that the American consumer holds $12.8 trillion worth of household debt, there will be no shortage of bad debt to purchase. Between the company’s credit facility and the ample cash flow it generates, it can purchase whatever it needs.  Furthermore, the returns on that investment vastly exceed the interest rate on the credit facility.

In addition, the unemployment situation in the U.S. is abysmal. More and more people are leaving the workforce. Many have debts. They will not be able to pay in full but, because they are on government assistance, they will be able to pay something. That means Portfolio Recovery’s business is partially being subsidized by the deepest pockets of all — the U.S. government.

The company is trading at 15x earnings while growing earnings at a rate of 52% YOY and a full-year estimates at a rate of 20%. Analyst five-year growth rate is 15%, but I frankly think that’s much too low.

In the end, this is a company I want to own. Well … actually … that I do own. So do me a favor. Don’t pay that credit card bill.

As of this writing, Lawrence Meyers was long PRAA.

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