Portfolio Recovery Associates Reassessed
Board: Portfolio Recovery Associates

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By UCLAgrdstnt
July 26, 2007

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I had a chance to listen to the conference call again without distraction (I wonder why they had the call in the middle of the day) and I do have a modified take on the quarter which is more complete and accurate.

The quarter met but did not exceed earnings estimates of .80 cents per share. It was actually a very solid though not outstanding quarter. The words "weakness" and "decline" etc. were used on multiple occasions throughout the call and there was not the congratulations sometimes given by analysts for the "great quarter". You have to remember that this call was done during the middle of the trading day and there is a lot of jargon and subtleties in the business. Given these factors the instinct for many was to sell. The call did not feel positive upon first listen.

However, when looking further the quarter was just fine, even good, though not spectacular.

Major points:

Cash collection on debt from "customers" (not fee for service businesses) was 9% year over year. This was lower than analyst's estimates according to the call. The fee for service businesses grew quite a bit, making up for the lower cash collections. This sounds bad at first... why were debt collections below growth estimates? But upon closer examination it turns out this was due to lower cash collections on bankrupt debt. Much of this was purchased in 2005 and it had grown a lot as the most lucrative debts were collected last year.

As part of the normal debt cycle the growth has started to plateau (the debt is harder to collect from this big purchase). They will need new bankrupt debt to get the more lucrative debts again... and they purchased a whole bunch. So this is really just a normal phenomenon in the business... not a sign of slowing.

Operating fees increased. Another potential concern. The concern: maybe it is harder to get good people to collect so you have to pay them more? No... it turns out the large costs are due not due to higher costs in paying debt collectors but in paying managers and in IT costs to build the business over time. This is investment in long term growth of the company: pay now and hopefully be rewarded later.

Amortization rates declined. This was brought up several times. I am not familiar with the term "amortization rates" as it pertains to this business. For individuals amortization describes paying the principle on a loan. I do know that on several occasions the amortization rate was described more as an accounting issue than as a sign of underlying weakness. All I can offer on that.

The areas that might be a concern include: the Tennessee office is much less productive right now then the established ones yet most of the growth in the upcoming years depends on it since the other offices are at capacity (except for the Kansas office which is to expand later) and their productivity, while high, is barely growing. This may depress growth. However, it turns out that the new center had been running without an optimal manager. He was just hired so this may improve a lot in the next quarters. This is something to watch for sure... can this office improve its productivity? This is really, really important because the value of PRAA largely depends on its ability to grow. It is clear now that new centers cannot immediately be expected to produce like established ones. It's not like opening up a new Taco Bell or McDonald's in a different city. How long will it take for this growth to happen and how much will it effect growth of the company overall? Or will only the core offices be really productive and expansion offices never be able to grow at the rate that the core ones have in the past years? If you're long on PRAA as I am this is really something to watch in the next quarters.

Some other points:

Positives: productivity increased overall y/oy though slowly, percent of debt collected on settlements increased in line with previous trends, and buying was heavy... boding well for future cash collection as long as they bought at reasonable prices.

This sweet spot for buying, however, won't really manifest itself until actually collected in the future so the CEO pointed out it is unclear how sweet it is at this time. Still good that they bought a lot.

All this being said I personally plan to hold at these prices. At $65 dollars per share it was trading at 20 times 07 earnings which is at the upper end of the range for P/E over growth for PRAA if the 15% 5 year forecast is accurate)... I think this run-up was due to the great first quarter and an analyst upgrade. It is now at about 17 times FY07 earnings. I think given the Tennessee expansion questions that this price is more reasonable... I do not plan to buy more at these prices until I see what happens going forward. But that's just me.

I hope people find my post useful. Feel free to agree or disagree.

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