With the number of shoes starting to fall around Escala
Spanish authorities have charged nearly a dozen people affiliated with Afinsa with running a glorified Ponzi scheme, whereby the extraordinary rates of return it has been paying to investors in its stamps can only be repaid from the money of new investors it attracts. Additionally, charges of money laundering, embezzlement, and tax evasion are on the auction block, as investigators found some 10 million euro hidden behind a newly plastered wall in one of the homes they raided. Similar charges have been filed against Forum Filatelico, another Spanish auction house.
Escala's relationship with Afinsa is unique. In return for a 67% interest in the company, Afinsa guaranteed it would buy as much as $1 billion worth of stamps from Escala. The deal was sweet for both parties because Afinsa was able to feed the growing stamp investment mania sweeping Spain -- it's been estimated that more than 350,000 people participated in the scheme -- and Escala would receive a steady stream of revenue. So dependent is Escala on Afinsa for its profits, that 68% of the company's earnings for the first nine months of the fiscal year were derived from this relationship. The company also recently admitted that instead of the $16.6 million in operating income it reported in the first quarter, it instead had a $1.7 million loss.
The SEC probe into Escala will undoubtedly delve into how that relationship worked and how the company accounted for its inventory. Despite thinking that Afinsa would get a break by buying its stamps from its affiliate, Escala actually charges its parent company more than it would another buyer. Escala's profit margins are three times more on sales to Afinsa. Afinsa would then value the stocks based on prices listed in stamp catalogs -- its own catalogs -- and then use those prices to guarantee a rate of return to investors. The problem is that the prices listed in the catalog usually have no bearing on what the stamps actually sell for, which oftentimes is far less.
The question investors should have, and the ones regulators probably do have, is whether Escala was marking up the price of the stamps it sold to Afinsa simply to boost its own bottom line. And then, was Afinsa using these inflated values to tell investors in Spain that its stamps were more valuable than they really were? The conflicts and dangers of such an arrangement were more palpable to investors than the issue of whether Afinsa was operating a con game. That Escala's stock cratered when troubles arose at Afinsa should not have been surprising. Investors who continue to buy this stock where so much uncertainty remains are not investing at all, but rather gambling. And to this Fool, it looks like a loser's bet.
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
