Analyst Finds Bottom Line Contrast Between Four Big Debt Purchasers

An analyst for William Blair & Co. has found a world of difference in the ways the four major publicly traded collection agencies have run their businesses in recent quarters. John Neff follows Asset Acceptance, Asta Funding, Encore Capital, and Portfolio Recovery Associates for Blair, a Chicago-based investment manager with a focus on quality growth companies. He has ratings on Portfolio Recovery and Asset Acceptance.

One difference is a firms’ approach to the debt portfolios that they buy.

Collection agencies that “flip” or sell a portfolio of debt they have bought for a quick gain may create impressive gains but the numbers are not indicative of the growth and operating efficiency of the company, writes Neff in his latest “Collection Disclosure Insight Quarterly.” A portfolio sale inflates current results at the expense of future gains, he writes, and that has been “particularly true in the rising price environment for portfolios” since 2004 “in which flipping to the greater fool has been that much easier.”

He notes that Asta (NASDAQ: ASFI) and Encore (NASDAQ: ECPG) have been active portfolio resellers in recent quarters. Neff estimates that portfolio sales accounted for 25 percent of Asta’s revenue and 36 percent of its net income for the two quarters ending on March 31^st. For Encore, during the first quarter alone, Neff estimates that portfolio sales accounted for 11 percent of its revenue and 76 percent of its net income.

Those sales may entice investors because they puff up a company’s earnings, but the numbers are temporary at best, because the earnings are nonrecurring, writes Neff.

In contrast, neither Asset Acceptance (NASDAQ: AACC) nor Portfolio Recovery (NASDAQ: PRAA) generated any revenue or net income from sales of debt portfolios during the first quarter of 2007, Neff found.

Neff also shines a spotlight on Asta for its practice of talking on debt to buy debt. In the fourth quarter of 2006, Asta net debt per share was $6.95. That skyrocketed to $25.12 of debt per share after it borrowed heavily and paid $300 million for a portfolio in the first quarter of 2007. In comparison, Portfolio Recovery recorded $1.68 of debt per share that quarter and Asset Acceptance had a 8 cents per share.

“There’s nothing wrong with going into a net debt position if there’s an opportunity to buy debt at attractive prices,” Neff tells insideARM.com. “But if that portfolio doesn’t work out, or there’s a change in the [business] environment, that debt leaves Asta with little wiggle room.” Neff noted that the portfolio was “heavily shopped” and Asta paid two to three times what some competitors bid for it.

Neff has an Outperform rating on Portfolio Recovery and a Market Perform rating on Asset Acceptance. He follows but doesn’t cover Asta and Encore.