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By OnTheRivet
February 11, 2005

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As a true contrarian, I bought ASFI instead of PRAA. (But is it my first third?)

After two horrible days of trading I decided my due diligence wasn't enough. I spent most of last night and early this morning working up a report on Asta Funding but I will spare you my writing ineptitude.

However I will try to highlight what I think is pertinent or at least entertaining. I will appreciate all constructive criticism for both our sakes.

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*Lack of transparency

-> This company is really controlled by a family interest headed by Chairman Arthur Stern and his son and CEO Gary Stern. A niece controls a huge chunk of shares and the company reports that the Stern family basically controls the company. All in all I am guessing north of 25 and around 30% controlled by the family

-> This creates a situation where management isn't forced or needled to producing the transparency a small investor like us would like to see. It isn't necessarily horrible just not great. Furthermore not to justify it but put it in perspective they are more tight lipped like a traditional private business versus Portfolio Recovery Associates who basically knew they were going public from the get go.

-> I am beginning to believe that you can't hide the cash flows and regardless of what management wants you to see or not see, there is pertinent information in the traditional three financial statements. As they say cash is king.

*Management

-> Management has a long history of collecting receivables. However most of it is in motor vehicles and retail installment plans. They repo'd a lot of cars. Anyway their push into consumer receivables didn't start in earnest until 1999.

-> Management has made one strategic error costing them 2.5 million, regarding a failed business venture in 2000 with an ecommerce site (Small Business Resource Inc).

-> Their current strategy is seen in a couple of ways.
A) Building up a call center bought in 2002 (currently 66 employees working there)
B) Overhead is still low due to outsourcing debt collection to third parties
1) 115 employees vs. 798 employees for PRAA
C) Continue to focus on particular portfolio's with predictable cost recovery
1) Income Method vs. Cost Recovery Method which is less assured

-> Big management change at the CFO position when Herman Mitchell stepped down and Mitchell Cohen was hired in October 2004. No major reason given except HM wanted to pursue other passions. This is important because in this business, the CFO is important in the debt buying.

-> Compensation. I am a little weak on what is correct payment but ASFI looks in line with the founder/chairman making around 1.5 million and the CEO base salary of 500K. Those two didn't sell any meaningful amounts of stock in 2004. CEO Fredrickson from PRAA pulled in a base salary of 622K plus exercised another 13.5 million in Options. I might consider PRAA top brass being overpaid in options (just my opinion)

~~~~~~But what about the good stuff~~~~~~~~

So, the metric we as investors want to know is the recovery potential versus the debt actually paid. PRAA sets its standard at 2.5 to 3 times. So if I received $1 dollar in collections I attribute 33-40 cents to principal repayment and the rest as profit. That's a 60 - 67 percent profit on each dollar collected.

NOTE: ASFI's operating margin 73% and PRAA's om is 39.7%. Seems like ASFI is managing that but PRAA is not? Is this a flag -->> I don't know

PRAA also states that that is over a 5-7 year time period per purchased portfolio. Unfortunately ASFI began building their portfolio in 1999 so they just are reaching a 5 year time period. So ASFI potential is still to be seen in this light.

NOTE: ASFI comments that they see the majority of their cash flows in the first 18 months when purchasing a portfolio although the amortization length is over a 3-5 year period.

******Old school cash business vs. new school actuarial accounting business

-> I think that looking at cash flow is very instructive in these businesses relative to their carrying value of consumer receivable liquidation portfolios especially when you don't want to trust bubba's actuarial expertise.

-> PRAA recorded in their last 10-K interest income of 81.8 million. They did this on their portfolio on the books as 92.6 million. Furthermore they recorded 35.3 million in cash flows attributable to this portfolio. This doesn't look conservative to me. 81.8 million recorded income and received in actual payments 35.3 million in old school cash?

-> ASFI recorded in their last 10-K interest income of 51.2 million. They did this on their portfolio on the books as 146.2 million. Furthermore they recorded 62.9 million in cash flows attributable to this portfolio. This looks much more conservative to me. Their net income of 51.2 million is .81x cash flow versus 2.32 of PRAA

********** My interpretation.

>>First of all both PRAA and ASFI have recently funded their growth through secondary stock offerings. ASFI utilizes more debt than PRAA but still both funded large chunks with equity.

>>ASFI's cash flow is much healthier than PRAA's compared to net income. When comparing cash flow's to value of portfolio's ASFI is receiving anywhere from 58% (2001) to 309% (2000) and 76% (TTM) whereas PRAA's is receiving 38%, 39%, and 58% in 2003,2002,2001 respectively. Which also tells me that ASFI is getting back a larger chunk of its investment.

>>Caveat: ASFI doesn't breakout debt it sold versus principal collected however if trends are sustainable I am just as happy if ASFI is a shrewd broker of debt. This is definitely open to debate and discussed in the interview with Fredrickson CEO of PRAA.

>>ASFI uses leverage .3 Debt/Total Assets vs. PRAA which is like .02

********Valuation

-> Looking at relative values ASFI is priced at 13X earnings and 10X forward projected earnings. Analyst 5 year estimates are of 15.5% (vs. PRAA's 20%) which puts its PEG ratio at less than 1.

-> ASFI has grown their receivable collection from 16million in 1999 to 146 million in 2004. That's a 55% annual growth rate. Last Fiscal YOY Growth was 38% (more realistic) in receivables.

-> If ASFI continually collects 15% Net income to Liquidation Portfolio in 5 years the Portfolio Grows at 35% (t=0 146 -->> t=5 655) and collect 15% on it 655*.15=98.20 million. The problem is estimating growth in shares to fund this growth. With little track record and equity offerings being lumpy it's hard to guesstimate such growth.

-> At EPS Growth of 15.5% at t=0 EPS 1.66 t=5 3.41 EPS. At a Trailing PE multiple of 15 that's a share price of 51. At estimated ~ 90 million in net income to get 3.41 EPS that's 28 million shares or a doubling of current shares. So almost 4x net income growth on 2x share growth. I honestly don't know if this is a good way to look at the business or not.

-> This is a lumpy business. Debt purchasing is an art and requires patience. I don't believe that pure statistical models make a successful business. Shrewd business practices have to be in place. So management as a whole is critical. Measuring the cash flow collected and revenue recorded ASFI looks conservative. However clean valuations are difficult because some years should look better than others due to the uneven distribution of debt purchasing.

-> Macro level economics I think are in favor for this group of companies. There is more competition for debt but the overall debt is growing as well. ASFI quotes an industry newsletter (Nilson Report) saying that in 2005 there will be an estimated 72.9 billion in charge-offs, up from 18 billion in 1995. Also as Fredrickson (PRAA) states that the ARM's mortgages will put a crimp on consumers as rates rise and the revolving credit will be the first to get charged-off

~~~~~~~Bottom Line~~~~~~~~~

I think its an interesting business and priced low relative to its peers even though I believe it to be performing just as well. Future growth looks promising just at a question of how much share dilution to get there. However I am comfortable with some leverage because that lowers the share dilution and increases my return on equity.

Lack of some transparency and being family controlled will probably keep the relative valuation of this stock down.

I believe this will at least be a double using fundamentals and conservative multiples in 5 years and maybe better and maybe worse depending when you make your purchases. Being a volatile stock buying at the wrong time can cost you. Do your homework.

Matthew


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