Life Partners Holdings: The Stock That Burned Me

Worldwide Invest Better Day 9/25/2012

Every investor makes mistakes, even Warren Buffett. What turns an honest mistake into an incredibly stupid error isn’t so much the initial mistake -- it’s making it an even bigger problem by compounding it and making the same mistake again. I got burned by the siren song that is Life Partners Holdings (Nasdaq: LPHI  ) by not only investing once, but by also turning around and buying more, even as its business was clearly falling apart.

The story on the stock
When I first came across the company, it looked like an almost ideal investment. It had what looked like an incredibly strong balance sheet, with far more cash than total liabilities. It was raking in millions in profits, while competing in the rather macabre industry of selling life settlements, that likely scared away more squeamish investors. It paid a large dividend that had been growing at a rapid clip. And to top it all off, it had been recently featured as one of the fastest growing companies around.

Indeed, it almost seemed too good to be true. Small, rapidly growing companies rarely pay dividends, because they’re busy plowing whatever cash they generate into building the business. Networking kingpin Cisco Systems (Nasdaq: CSCO  ) , for instance, didn’t initiate its dividend until 2011, years after it had already grown large enough to dominate its industry. Yet there was Life Partners Holdings, handing out a large cash bounty that looked to the outside world as if it were based on  hard-earned income.

What went wrong
Not long after I initially invested, the Wall Street Journal came out with a hard-hitting article that called into question the very core of the company’s operations. In essence, the people whose insurance policies Life Partners was selling weren’t dying nearly as quickly as the company’s life expectancy estimates anticipated they would.

That’s a problem, because the entire investing thesis for those buying life settlements from Life Partners was based on how long the insured people behind those policies would live. Longer life expectancies meant smaller payouts and returns on investment, making the company’s entire business model significantly less profitable.

Where I went wrong, though, was in presuming the company would want to immediately fix that very glaring problem. My thought process was that the business could still be profitable -- but with smaller margins and slower growth -- by using more reasonable life expectancies. Yes, it would be expensive, but it would be survivable for the company. By that (incorrect) logic, the stock seemed cheap enough for me to buy more shares. That error is what truly got me burned by the stock.

In reality, things didn’t turn out nearly that well. The Wall Street Journal piece was published in late 2010. By early 2012, things remained so incredibly broken, that the U.S. Securities and Exchange Commission filed suit against the company and its top executives for alleged fraud and insider trading.

This is a big deal. Keep in mind, not long before filing that suit, the SEC had offered to settle with Citigroup (NYSE: C  ) for what amounted to a ‘slap on the wrist' for that bank’s role in the subprime mortgage meltdown. That disparate treatment suggests to me that either the SEC was playing politics rather than protecting investors -- or that it really thinks it has a strong case against Life Partners. Either way, the one inescapable conclusion should have been "stay away." Instead, I made a bad situation worse by buying more stock after the issues became public.

The lessons                        
The most important lesson I learned from this debacle is that, when investing in the anticipation of a turnaround, look for signs that the company is actually trying to turn its business around. As a successful turnaround, General Electric (NYSE: GE  ) refocused on its industrial operations when an over-reliance on its capital business proved nearly fatal. Life Partners, on the other hand, still apparently prefers to follow the strategy of 'business as usual,' in spite of the very real issues facing the company.

The other key lesson I learned -- or rather, re-learned -- is that every investment should be made on the actual merits of the company under consideration, not based on what might happen if all the stars align. Making the initial investment in Life Partners Holdings seemed justifiable at the time based on what I could see. Making the follow up investment based on the mere potential of a turnaround -- after reality reared its ugly head -- was clearly not justifiable.

They’re expensive lessons -- but ones that are certainly worthwhile -- if truly learned and acted upon.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric, Cisco Systems, and Life Partners Holdings, though he’s not sure why he’s still holding the Life Partners shares. Click here to see his holdings and a short bio.

The Motley Fool owns shares of Citigroup and Cisco Systems. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (6) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On September 15, 2012, at 2:48 PM, thenoffya wrote:

    Good lesson. I almost made this mistake with UNG, before I ever learned what contango was.

  • Report this Comment On September 19, 2012, at 12:43 AM, einzling44 wrote:

    I bought a couple of LPHI at around 1.64. As I see it they may either make or break. Not a big part of my portfolio.

    Since their CFO quit and a lawsuit closed in their favor I came to think some more bottomfishers may join the ranks of LPHI shareholders. Hopefully LPHI get acquired or somehow manage to comply with listing standards.

  • Report this Comment On September 19, 2012, at 10:01 AM, slvrserfr wrote:

    Aside from the lawsuit, their business model isn't broken, plus they're paying a high dividend just to hold on to the stock and their fundamentals have improved. Oh, and they just partnered with Bristol Myers, which they wouldn't do if they were concerned about the company's prospects. I'm confident that this company will pull through these obstacles. Not to mention its a low float stock, which wouldn't take much for the company's stock to retrace higher.

  • Report this Comment On September 19, 2012, at 10:57 AM, Wormwin wrote:

    You made several errors:

    1) The CEO's previous company had accounting fraud issues with the SEC (ASK Corp.).

    2) The entire premise of the fraudulent earnings was the bogus life expectancy estimates. No firm can have double or greater industry margins unless they either have superior technology or are committing fraud.

    3) You do not read. This entire scheme was laid out for years in Seeking Alpha and in Citron Research (Andrew Left).

    4) You did not read the financials, that published the number of policies beyond the LE. There was an obvious need for restatements in the financials.

    5) You did not see the two changes in auditors within two years as THE serious red flag.

    6) When you knew the LEs were off, you never asked, "What is the exit strategy?". If you did ask the question you would have realized that the idea was to overinflated profits and then sell the company. It never happened so the scheme had to continue.

    7) The SEC under Obama is different, and will not stop at getting the fraudsters. You did not run after the Wells notice and subsequent SEC complaint.

  • Report this Comment On September 19, 2012, at 11:09 AM, Wormwin wrote:

    Slvsfer is wrong. There is not one lawsuit, but a plethora of current civil suits. Currently the TSSB is trying to shut them down claiming a $300mm shortfall based upon the bogus LEs.

    The fundamentals have not improved, but continue to deteriorate. Operating cash flow is still a negative $1.8 million per quarter. The one time rise in earnings came from selling off assets to raise cash and from the curious prepayment of taxes. The company is operating heavily in the red. The Attorney general asked the court to immediately cease any financial dispositions from the company and not to destroy any records. Some people think having any dividend is simply a way to strip assets out of the company since over half go to the CEO's family offshore trust.

    I have seen no 8-K regarding the Bristol Meyers rumor someone posted above. That is humorous.

  • Report this Comment On September 19, 2012, at 11:22 AM, Wormwin wrote:

    Einzling44,

    No recent lawsuit turned in their favor. The 1996 SEC v. Life Partners, Inc. & Brian D Pardo was the big one that kept the investments from being "securities" and requiring both registration and full disclosure. The current suits are for fraud, insider trading, stock fraud, RICO and breach of fiduciary duty.

    The CFO quitting is a red flag if there ever was one, because it was unexpected. They hired a new CFO and then fired him ten days later! So there is no one to sign any current financials as CFO. Would you want to sign off on any financials for a firm having all those lawsuits? LPHI may have problems finding another CFO.

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