Asta Funding: Last of the Net-Nets

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Hester submits:

Despite having a market cap of nearly $110 million, decent trading volume (for a net-net at least) and a very high historical ROE, ASFI sells below the price of its net current assets. It is also currently profitable, and almost completely unlevered, although you wouldn't know it by just looking at the balance sheet.

Asta Funding purchases and liquidates distressed consumer receivables. The consumer receivables are normal consumer debt, think credit card accounts, phone bills, television bills, some auto loans, some personal advances, etc., usually in bulk, buying mostly from banks and other credit grantors.

This provides a valuable service. Asta services and liquidates the accounts, takes risk off of the creditor's balance sheets, paying cash for typically severely distressed and non-performing receivables. The creditor, typically a bank, usually tries to collect on the accounts first and is unsuccessful, and just wants to get whatever cash it can for the accounts and get it off the books, selling the receivables typically through an auction or private negotiation.

As we all know, net-nets don't just happen, at least in today's market. Especially ones this big, and profitable. Something has to be wrong. Some hair of some sort.

Great Scott! Great Seneca

Asta's business is capital intensive. That's a problem for most in this space, since these aren't banks or insurance companies with huge amounts of long term, low cost capital. It takes money to make money. The receivables that are acquired are normally volatile and dependant on the health of the American consumer.

Add in some leverage, which most everybody in the space does eventually, then add in some more leverage, which most everybody in the space does eventually, then add even more leverage, which most everybody in the space does eventually. I think you get my point.

If not, I'll spell it out.

The institutional imperative is to add leverage when times are good and ROE/ROA's are high. This works until it doesn't, and when it doesn't it usually blows up pretty bad considering these assets are volatile, and riskier, and dependant on the economy. Asta had done a good job of avoiding this imperative, but in 2007, they joined the club.

In early 2007, ASFI decided to make a purchase of a portfolio sometimes known as, and I'll refer to as, Great Seneca, or GS. The deal was uncharacteristic for two reasons.

The first was the sheer size of it. The purchase price of $300 million was a very copious one for a smaller company like Asta, especially considering the average receivables purchase was/is sub $10 million, and its largest purchase was never much over $15 million. To finance this the company took out a $225 million non recourse loan from the Bank of Montreal, and drew about $75 million from the open line of credit.

The second was the valuation.

The portfolio amounted to about $6.9 billion in receivables, and was purchased for $300 million. This represents a purchase price of about 4.35 cents for every dollar of receivables. A typical purchase past and present excluding the GS portfolio is made at a price of about 3 cents on the dollar. The GS portfolio was a whopping 45% premium to the valuation of a typical receivable. ASFI has historically recovered around 160% of the purchase price, or 4.8 cents on the dollar, so the deal seemed like it should work out at the time.

But it didn't.

Almost from the start the purchase proved awful. The economy immediately collapsed, and the GS portfolio collapsed with it. It quickly became clear that ASFI would not collect what it paid. The company moved it from the interest method of accounting (carrying the debt at the value of the future discounted cash flows) to the cost method (carrying at cost minus any payments), and then started taking large impairments on it.

The stock price began a precipitous fall, from $44 per share in the beginning of 2007, when the company acquired GS, to $1 in early 2009, as the company teetered on insolvency.

But, things recovered. The stock quickly bounced back to about where it is now, the health of the consumer has recovered, and the company shored up its balance sheet into what we see today. It entered into several amendments with the bank of Montreal on the GS loan, but ultimately recourse mainly stayed limited to the GS receivables solely, and the company eliminated most other recourse debt.

Balance Sheet, No Love At First Sight

Perhaps one of the reasons for the undervaluation stems from the fact that merely looking at the current balance sheet today tells the wrong story.

ASSETS

Dec. 31, 2010 Sept. 31, 2010

Cash and cash equivalents

$ 81,058,000 $ 84,235,000

Restricted cash

1,202,000 1,304,000

Consumer receivables acquired for liquidation (at net realizable value)

139,579,000 147,031,000

Due from third party collection agencies and attorneys

2,425,000 3,528,000

Prepaid and income taxes receivable

- 196,000

Furniture and equipment, net

446,000 338,000

Deferred income taxes

18,307,000 18,762,000

Other assets

4,396,000 3,770,000

Total assets

$ 247,413,000 $ 259,164,000

LIABILITIES

Debt

$ 79,268,000 $ 90,483,000

Subordinated debt - related party

- 4,386,000

Other liabilities

1,314,000 2,105,000

Dividends payable

292,000 292,000

Income taxes payable

1,204,000 -

Total liabilities

82,078,000 97,266,000

This is the balance sheet from the most recent quarter. As you can see, it doesn't convey the debt free picture I painted. That's because the Bank of Montreal debt is recourse only to the Great Seneca portfolio of receivables, not the rest of the company's assets. Therefore, it only makes sense to separate the assets and debt on the GS receivables and treat them as a separate riskless call option, and use what's left of the balance sheet to estimate book value. Here's what the balance sheet looks like for valuation purposes after necessary adjustments are made:

ASSETS

Dec. 31, 2010 Sept. 31, 2010

Cash and cash equivalents

$ 81,058,000 $ 84,235,000
Non Great Seneca consumer receivables 51,879,000 55,231,000
Due from third party collection agencies and attorneys 2,425,000 3,528,000
Prepaid and income taxes receivable 0 196,000
Furniture and equipment, net 446,000 338,000
Deferred income taxes 18,307,000 18,762,000
Other assets 4,396,000 3,770,000
Total adjusted assets 158,511,000 160,060,000

Free Option Assets:

Restricted Cash (which is due to BOM)

1,202,000 259,164,000

Great Seneca receivables

87,700,000 91,800,000

LIABILITIES

Subordinated debt - related party

$ 0 $ 4,386,000
Other liabilities 1,314,000 2,105,000
Dividends payable 292,000 292,000
Income taxes payable 1,204,000 0
Total adjusted liabilities 2,810,000 6,703,000

Free Option liabilities:

Bank of Montreal debt

79,268,000 90,483,000

Shares outstanding: 14,827,767

Current adjusted tangible book value per share is $10.50 with an extra $.65 in book value per share for the GS call option. I wouldn't put much faith in the book value of the GS portfolio, as it has been heavily written down and is difficult to calculate. Current stock price is $7.45 per share.

As you can see adjusting for economic reality takes the balance sheet from a lot of encumbered, debt ridden assets to a substantially unlevered cash rich company. The balance sheet goes from a debt to equity ratio of nearly 50%, to less than 2%.

I think the recourse vs. non recourse debt issue has created some confusion in the market place. Some people don't separate the GS entity from the rest of the business and thus aren't looking at the situation correctly. There also may be some worry that the company will commit another mistake, since the last one is still fresh in memory. I think the odds are very low, in fact the incident has made management gun-shy and despite a very soft market in receivables currently, management has stayed very disciplined. Which brings me to my second reason for undervaluation, current low ROA's and ROE's.

Lack of Buying Opportunities

Buyers of receivables, including Asta, earned very good returns on capital in the years leading up to 2007. During those years, ASFI raised money and purchased receivables, by taking on debt and diluting equity. The company had good reason to do this, from 2001-2006 the worst ROA year yielded 16%, and the best yielded nearly 25%. Inevitably, these returns brought in competition, and Asta now has to bid against many more buyers of these securities, and struggle to find new debt that meets its criteria. If we annualize recent results, it is earning about a 6% ROA. During the past couple of years returns were very negative because of writedowns of GS and other receivables.

So current returns are low, especially considering the huge cash balance the company has that is not making much money in today's low rate environment.

Some people might interject that the low returns ASFI is currently making is good reason for the stock to sell at a discount of book. I take the view that as long as management is sane, the company is profitable, leverage is reasonable, and the assets are at least semi easy to value and liquid, then a discount to book value is unwarranted.

ASFI is swimming in cash, more than half of book value is composed of it. Furthermore, the receivables are of good quality, as they are performing well and are generally more conservatively accounted for than they have been historically at ASFI and currently by their competitors. There is a large market for the receivables and they are a higher quality non-cash asset, especially compared with most net-nets.

I'm not going to try to guess a price target or intrinsic value for ASFI. When it comes to valuation, the only thing I'm going to say is: Does it make any sense for ASFI to trade at such a discount to book, given all the factors working for it?

Disclosure: I am long ASFI .

See also Platinum to Gold Ratio Declines on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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