Consumer debt purchaser Asta Funding (NASDAQ:ASFI) came a-callin' the Friday before last. No, it wasn't calling to collect on a non-performing car loan -- Asta outsources 95% of that sort of work to collection agencies. Instead, it was hosting an extra-special conference call for analysts and investors. (Yes, ordinary investors can and should tune in to these -- Yahoo! Finance provides handy links to many calls right here.)
So what was special about this particular call? In addition to presenting its robust quarterly earnings results, the company also wanted to provide a forum to discuss its recently closed purchase of a $6.9 billion (face value) portfolio of receivables for $300 million. Management called the deal "one of the larger purchases in the marketplace ever." For comparison's sake, Fool favorite Portfolio Recovery Associates (NASDAQ:PRAA) bought about this much delinquent consumer debt over the course of fiscal years 2005 and 2006 combined.
On the call, management identified several reasons why this pool of debt is not merely bigger, but also of higher quality than the average portfolio. First, the bulk of the portfolio is credit card debt, which is Asta's bread and butter. Witness the failure of Asset Acceptance Capital (NASDAQ:AACC) to properly model collection on defaulted wireless phone bills, and you will understand why it's important for a company to stick to the debt it knows best. Second, the geographic mix of the receivables is more favorable than normal -- fewer Texans (notoriously uncollectable), more New Yorkers (surprisingly collectable).
Finally, and perhaps most important, $1.1 billion of assets in the pool have gone through litigation, and judgments have already been awarded. That means essentially no legwork for Asta. Another "significant" portion of the receivables are what management calls "sue-able." The debt collection industry has its share of euphemisms, but this is not one of them. Due to its concentration of sue-ables, the portfolio generally fits into the company's strategy of collecting via the court system, and whatever portion doesn't fit will be outsourced or sold back into the market, presumably at a small premium.
For years, Asta's management has pointed to its outsourcing model as a competitive advantage. This mega-acquisition nicely demonstrates its argument: because the company doesn't need to invest in call centers, or worry about training and retaining collectors, its business model is much more easily scaled to meet the supply of consumer debt on the market. Contrast this to Portfolio Recovery, which recently bought a new facility to expand collection capacity, or Asset Acceptance, which has at times experienced severe staff turnover -- as high as 84.2% annualized(!) in the first quarter of 2005.
Even though it means the company is taking on 2:1 leverage to finance the acquisition, investors have cheered the landmark deal. Asta's stock is up 35.4% year-to-date, thanks to the big announcement of the purchase back on Feb. 9. I would be remiss if I failed to mention the massive short interest in the stock, which has just added fuel to this rocket. Nevertheless, I believe it would be foolish (small "f") to jump aboard at this point merely because of the possibility of a short squeeze. In a recent interview, Foolish fund manager Centaur Capital admitted that after several weeks of research, it had found the debt collection industry too murky to analyze conclusively. Very smart people have thrown up their hands, and others have taken the opposite side of the bet here in very large sums -- so do some serious sleuthing if you're thinking about scooping up shares.
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Fool contributor Toby Shute gets all charged up just thinking about the debt collection business model, but he doesn't own stock in any of the companies mentioned. Portfolio Recovery Associates is a Hidden Gems selection. The Motley Fool has a disclosure policy.
