PRAA - Portfolio Recovery Associates

[Liberty]

I've only recently started taking a closer look at this one. I don't yet have an opinion on it, but it sounds like a business that could interest Glenn, considering the other things that he's been writing about lately.

 

Curious to know if you've had a chance to look at it, Glenn?

[gym97]

I have read up on Encore and PRAA as well as Asta.

 

The industry has been consolidating with 3 or 4 players now making up most of the buying volumes. Barriers to entry have gotten higher and will only get higher with new regulations likely coming. That being said, the industry seems to have moved from a buy and outsource with low fixed cost to a buy and insource with high fixed cost model and this change combined with less supply (regulation, deleveraging, etc) might lead to companies might make it a lot harder to get attractive returns.

 

 

[ItsAValueTrap]

Thanks for putting this company on my radar.

 

1- Steven D. Fredrickson is a co-founder and continues to be the CEO.  Over time, he has really sold down his ownership in the company???

 

Before IPO - 9.1%

After IPO - 6.9%

2003 DEF 14A - 6.8%

2014 DEF 14A - 0.4%

 

2- To Frederickson's credit, the company has used a very conservative level of debt.  However, some of the things in the shareholder letter don't make that much sense.

 

The letter talks about return on equity.  This is kind of silly because investors should really be focused on return on capital.  It's more useful to know how well the company is doing without leverage distorting things.  I think Frederickson knows this because he used very little leverage.  He definitely didn't try to inflate ROE.  At the same time, it seems like he is trying to BS shareholders?  He knows what he is doing but he is a little promotional.

 

3- In the 10-K, take a look at "Total Estimated Collections to Purchase Price".

 

Entire Domestic Portfolio

Year        Total Estimated Collections to Purchase Price

 

1996 332%

 

1997 333%

 

1998 339%

 

1999 370%

 

2000 474%

 

2001 533%

 

2002 480%

 

2003 444%

 

2004 348%

 

2005 226%

 

2006 205%

 

2007 204%

 

2008 190%

 

2009 318%

 

2010 287%

 

2011 254%

 

2012 193%

 

2013 182%

 

Total 241%

 

"Total Estimated Collections to Purchase Price" is a rough proxy for the attractiveness of the portfolio.  It bottoms out in 2008 and 2013.  I don't have any insight into how much lower it will go.  Will profitability in the future be dramatically lower than it was in the past?  I don't understand this industry well enough to definitely say no.

[BargainValueHunter]

I owned this company years ago.

 

I made a great profit when I sold it.

 

I shouldn't have sold it.  :-[

 

Great business.

[Liberty]

Thanks for putting this company on my radar.

 

1- Steven D. Fredrickson is a co-founder and continues to be the CEO.  Over time, he has really sold down his ownership in the company???

 

Before IPO - 9.1%

After IPO - 6.9%

2003 DEF 14A - 6.8%

2014 DEF 14A - 0.4%

 

I don't know what's going on there. Haven't looked into him much yet. It certainly doesn't look very good.

 

2- To Frederickson's credit, the company has used a very conservative level of debt.  However, some of the things in the shareholder letter don't make that much sense.

 

The letter talks about return on equity.  This is kind of silly because investors should really be focused on return on capital.  It's more useful to know how well the company is doing without leverage distorting things.  I think Frederickson knows this because he used very little leverage.  He definitely didn't try to inflate ROE.  At the same time, it seems like he is trying to BS shareholders?  He knows what he is doing but he is a little promotional.

 

Isn't shareholder return over the long-term going to approximate ROE more, though? It's not like it's a useless BS metric, though it would be nice to have ROA/ROIC too.

 

3- In the 10-K, take a look at "Total Estimated Collections to Purchase Price".

 

Entire Domestic Portfolio

Year        Total Estimated Collections to Purchase Price

 

1996 332%

 

1997 333%

 

1998 339%

 

1999 370%

 

2000 474%

 

2001 533%

 

2002 480%

 

2003 444%

 

2004 348%

 

2005 226%

 

2006 205%

 

2007 204%

 

2008 190%

 

2009 318%

 

2010 287%

 

2011 254%

 

2012 193%

 

2013 182%

 

Total 241%

 

"Total Estimated Collections to Purchase Price" is a rough proxy for the attractiveness of the portfolio.  It bottoms out in 2008 and 2013.  I don't have any insight into how much lower it will go.  Will profitability in the future be dramatically lower than it was in the past?  I don't understand this industry well enough to definitely say no.

 

I was looking at that, and my understanding is that if your goal is to make the biggest absolute dollar profit, that will naturally go down over time, but it's not necessarily a bad sign. By that I mean that as a young capital-constrained company, you can be very picky and get huge returns, but as you get more access to capital, you then optimize for absolute $ profit rather than just % return.

 

ie. It's better to have 180% on 1 billion than 300% on 300 million.

[topofeaturellc]

or there is more capital in the industry and they've competed returns down.

 

It looks like they decided to change their operating model in '07-'08 and started to use some moderate leverage in their book.  Clearly part of that was about maintaining ROE as the trend in ROIC appears to be downward sloping while ROE is flat. Its also interesting that he chose to lever the business when the discount on the receivables was smallest. I'd wonder why that is.  You'd think you'd want to lever when returns are highest.

 

 

[thepupil]

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/102107

 

you all may want to look at the short thesis on VIC if you haven't already

[topofeaturellc]

requires a log-in. Is there a two sentence summary?  (this doesn't seem too interesting to me as an idea, but always interested to hear both sides of the table)

[thepupil]

writeup is a year old, just use the 90 day delay option.

 

sentence thesis is that gaap earnings are reflective of economics on 2008 and 2009 purchases and that returns going forward are likely to be much lower and not justify the high P/B.

[Liberty]

or there is more capital in the industry and they've competed returns down.

 

It looks like they decided to change their operating model in '07-'08 and started to use some moderate leverage in their book.  Clearly part of that was about maintaining ROE as the trend in ROIC appears to be downward sloping while ROE is flat. Its also interesting that he chose to lever the business when the discount on the receivables was smallest. I'd wonder why that is.  You'd think you'd want to lever when returns are highest.

 

My understanding is that the best debt is bought at times likes the financial crisis, so levering up a bit to get more of it makes sense. Then as the economy recovers, you have more trouble getting as big a discount on what you buy, but what you do own starts paying better so that kinds of compensate.

 

But as I said, it's not a business I know well, I'm just looking at it because it's been recommended elsewhere and it made me curious.

[topofeaturellc]

That makes sense - the short thesis. I was wondering how long the collection time is.

 

Yeah - it makes sense to lever up when the receivables at the biggest discount are available to you - but look what the discounts were at the time he added leverage compared to when he chose not to.  He was levering in '07 and '08 when discounts were at a local minima and he's levering now when discounts are at a local minima.

 

 

[Liberty]

That makes sense - the short thesis. I was wondering how long the collection time is.

 

Yeah - it makes sense to lever up when the receivables at the biggest discount are available to you - but look what the discounts were at the time he added leverage compared to when he chose not to.  He was levering in '07 and '08 when discounts were at a local minima and he's levering now when discounts are at a local minima.

 

They just made a big acquisition in Europe. I think that's what the recent leverage is for.

[topofeaturellc]

The CF statement makes it sound like it was just a pool of receivables in '13, not a platform for the collections. Maybe they did that deal in '12? Still added leverage in '13.

 

I'm being lazy and just looking the B/S and CF rather than the MD&A so you might be right.

[ItsAValueTrap]

So the estimated collections figures provided by management may be overly conservative.  Here's a table summarizing the original projections versus the current updated projections.

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/praa-portfolio-recovery-associates/?action=dlattach;attach=3456

 

The estimate for the 2008 vintage was overly conservative.  All the other vintages were overly conservative- sometimes significantly so.

 

2- Actual collections will likely be affected by the economic environment... e.g. how much unemployment and how many of the deadbeats declare bankruptcy.  When you buy a portfolio of credit card debt, it is practically impossible to accurately predict future unemployment.  So it's reasonable for PRAA's estimates to be wrong.

[gym97]

I've been interested in this space for a while. basically, PRA and Encore will likely be the only two buyers in the US and split the market. Smaller player's can no longer compete given the compliance costs. Finally, we supply of charged off debts should pick up as several major banks have stopped selling debt given uncertainty regarding CFPB regulation. I think Encore is a better relative value but both companies are significantly undervalued in my opinion.

[Edward]

Stock is down significantly while the business is doing very well in Q32015. Normalized earnings are up slightly (ex the provisions/reversals), and the yield adjustment was 139M$ in the quarter vs around 80M$ last year. Buying back shares. Any thoughts?

 

 

 

[gym97]

Very underrated businesses. Barriers to entry are huge. They benefit from recessions. Also, a significant portion of the market (BOA and Chase) were on the sidelines due to regulatory pressures and will return shortly. Wells Fargo was the third bank on the sideline but returned earlier this year. They have managed through the recent supply and regulatory issues and can now benefit from the return of two large issuers and a normalization of credit card charge offs. I think Encore Capital (ECPG) is better relative value. Comps in Europe trade at 15x to 17x multiples but benefit from more relaxed regulation and more avenue to deploy competition but a narrower moat. Since a few months ago, they have been fined a modest amount by the CFPB for what looks like very minor wrong-doings. The regulatory clouds seem to have been lifted. Recent share price drops don't make any sense.

[jouni1]

any news on friday? huge move days after earnings, just wondering if there's something i didn't find. thanks.

[valuedontlie]

This business sounds vaguely similar to oil exploration and production... These receivables are declining assets and the company needs to continually feed the beast. Hence the balance sheet expansion and higher debt load over time. What free cash is the company generating after making yearly purchases of new receivables?

 

The returns on the assets they've purchased have been good but I would imagine pricing is not static and that returns on purchases can fluctuate depending on where we are in the cycle.

 

Maybe I'm missing something but it seems fairly capital intensive with an unknown decline curve. Thoughts?

[gym97]

They have to "feed the beast" but charge offs are at all time lows and the three largest credit card issuers were not participating in the market over the last few years. Diversification into Europe / Latam provide more avenues for capital deployment. Also, unlike oil exploration, barriers to entry are extremely high in this business. I do not expect to see any new competitors enter the US market. In order to enter you would need extremely rigid compliance, dozens of years of historic data, a network of legal collection firms that you can trust or your own legal collection capabilities but most importantly, you will have to convince the banks (who have all been burned by compliance) to trust you. Most "CapEx on portfolios" is fully discretionary so theoretically if you had sound management, management could turn off the tap when prices were not good and turn it on again when prices are more attractive but it is yet to be seen if this is the case. Decline curves are an issue but the disclosures in my view on the decline rates have been fairly good in my view so I wouldn't call it unpredictable.

 

[feynmanresearch]

Here's our perspective on PRAA: http://seekingalpha.com/article/3745586-pra-group-is-an-overlooked-and-undervalued-company-that-offers-compelling-long-term-value

 

 

[HumbleInvestor]

Any reason to the price action in PRAA and ECPG?

AFAIK they have no oil exposure...

[bergman104]

Hey guys,

 

There seems to be some confusion on this board PRA Group and how they operate. I'll share my thoughts any would really appreciate any feedback.

 

The declining yield curve is a result of a couple different things. Recently, tightening supply has definitely impacted pricing but that doesn't tell the full story. Insolvency has lower overall expenses. So the prices paid, and thus the yield, on insolvency portfolios is lower. However, the actual net margin is exactly the same. In fact, the operating margins on insolvency portfolios is actually higher, but, again, net margins are roughly the same. This isn't a coincidence. PRA designs their models with this in mind. PRA started heavily buying Insolvency in 2011, but supply has been tight lately with the sellers still on the sidelines. This is one reason for the compression in yield curves, especially 2011-2014.

 

Another major impact has been a consistent increase in their efficiency. Their Call Centers now collect almost twice as much money per paid employee working hour compared to 2010. They have steadily increased this number since 2000 ($64/working hour in 2000 vs $341/working hour in 2015). This increase in efficiency decreases expenses and the number of employees needed. The decrease in expenses allows them to pay more for portfolios. This compresses the yield curve but, again, has little to no impact on margins.

 

So yes, the yield curve has been compressing but their profitability has been very consistent. Past 5-year margins have been 22%, 21%, 24%, 20%, and 18%. Additionally, net margin has ranged from 16%-24% over the last 12-13 years with the average margin being 21%. All of this means that PRA now has greater flexibility in what type of portfolios that it can buy, while maintaining consistency.

 

Also, PRA is NOT a capital intensive business. I cannot stress this enough. Capital intensive implies large capital expenditures and reinvestments in the business to remain competitive. PRA spends less than 10% of its net income on capital expenditures, in line with Moody's and Visa. Oil and Gas companies typically spend 75% or much much more of their net income on CapEx. I understand the analogy and why valuedontlie made it, but he missed the key point to PRA's business. PRA does not record revenue until they recoup their original investment. By that I mean that if PRA pays $100 for a portfolio, they do not record revenue (or pay taxes) until they collect more than $100. Let's say they collect $225 on the portfolio they originally paid $100. They record $125 in revenue ($225 collected - $100 purchase price) but they collect the full $225 in cash!!! When an oil company buys a drill bit, that money is spent and they eventually need to replace it. The oil company doesn't get its investment back, but PRA does get its investment back!

 

Also, a capital intensive business implies research and development. PRA has no R&D, which is a huge benefit. PRA is selling the same service that they always have and they will continue to provide that exact same service for the foreseeable future. This means that they can further refine and improve their business practice, improving efficiency. It also means that they do not have to constantly train their employees on their latest product (think a pharmaceutical company or car sales). That training is costly and time-consuming.

 

Lastly, the increase in leverage is due largely to acquisitions and share repurchases. They've spent $250 million on share repurchases in the last 3 years alone. They've got another $125 million repurchase program currently in place. But Aktiv acquisition was the big one. They paid $880 million for Aktiv's equity and took on $430 million of Aktiv's debt. Aktiv and share repurchases alone make up 1.55 billion of their current 1.725 billion in debt. It should NOT be viewed that PRA is suddenly buying portfolios on leverage. They are making acquisitions and buying back their stock.

 

Sorry for the mini novel, but I hope this clears up some of the questions I've seen over the last year or so. Hopefully, we can get a more robust PRA Group conversation, because it is a great company!

[Broeb22]

If you purchase an entire business with debt whose primary asset is their portfolio of insolvency and delinquency claims, how is that not the same as buying a portfolio of claims with leverage?

 

It's a little bit misleading to state that the company's accounting is conservative without noting that as a result of this policy 2015 earnings are really more reflective of the quality of 2012 and  2013 receivables, and not the more competitively purchased receivables from 2014-2015.

 

It seems like the only reason their ROE has held up so well over the last two years is they took on significant amounts of debt. If not for the debt, their ROE would be closer to 10%, not the 20% they've earned over time.

 

To be fair, this business has cycles and over the course of those cycles it seems to do very well. I don't really know how to assess the secular threat from established competitors who are being more aggressive, i.e. is this a case of PRAA earning above economic returns before and simply attracting competition that permanently reduces returns going forward...

 

I would want to do more research on their barriers to entry, as I think the financial crisis may actually be a tailwind for them and players like them. The consumer protection regulations force anyone that wants to do debt collection to invest in their compliance systems, so I see that as benefitting them against the little guys out there.

 

I kind of like the idea of this business almost as a portfolio hedge. Their business should be booming when the rest of the world is burning.

 

 

[bergman104]

You're correct. When I read your comment, I realized I was definitely wrong. To be fair (and to defend myself just a little  :P), Aktiv provided them with portfolio data (arguably the most important thing) and a platform that would have been much more difficult to generate on their own. Regulations, relationships with banks, ect would be way more difficult to navigate without Aktiv. But, again, they did use leverage to buy portfolios. I guess I wanted to differentiate between them losing their discipline in capital allocation vs making a strategic acquisition. I'm not saying the Aktiv purchase was good or bad. I think it is too early to tell. But according to PRA management, they have been looking to expand into Europe for some time. They said Aktiv was purchased because it fit their corporate structure/culture, and gave them a foothold in Europe. They also really like Aktiv's portfolio data and analytics. Your point on ROE is also accurate. But where are you getting your 10% calculation? I'm not saying it is wrong and I understand how ROE is boosted with debt. Just curious where you got the number. I wasn't able to tease out net income from Americas vs Europe.

 

But your second point isn't entirely accurate. In their 10k they state that they generated $97, $194, $253 and $117 million in 2015 from their 2012, 2013, 2014, and 2015 Core portfolios respectively. That's $291 million from 2012-2013 vs $370 million from 2014-2015. So 2014-2015 portfolios already impact their results more significantly than 2012-2013.

 

The next logical thought is maybe 2012-2013 are way more profitable? It's true that the current multiples on 2012 and 2013 are higher but that is the norm for PRA. Because such projections influence their future capital allocation strategy, they are almost always very conservative with their initial estimations of purchase price multiple and revise them as time goes on. For instance, 2012 core started at a purchase price multiple of 226% and then each subsequent year was revised to 248%, 279%, and 277%. The 2013 portfolio went 211%, 239%, and 268%. 2014 was 204% to 243%. For comparison, the second year revision for 2012, 2013, and 2014 were 248%, 239%, and 243% respectively. The 2014 portfolio is perfectly in line with 2012 and 2013 portfolios, at least so far. 2015 started 205%, also in line with 2013 and 2014 portfolios. As an aside, The 2009-2011 portfolios were truely spectacular 350%+ on average, but those contributed a combined 125 million, not enough to dramatically impact 1.5 billion collected. Also, the insolvency portfolios have a roughly the same 148% (2012-2013) vs ~130% (2014-2015), the multiple of which also seem to tick up 3-5% annual for the first couple of years. Lastly, it is a little too early to see how multiples in Europe will impact the bottom line. That being said, I'm told that they do not purchase their portfolios with multiples in mind, but rather net income margins. Because costs and taxes vary across different portfolio types, they use net margin as an equalizer to determine which available portfolios should demand the most capital. I think this is fairly logical. Furthermore, I don't see any reason why they can't be just as profitable in the future years, especially if supply comes back to market.

 

Also, PRA's competition is getting significantly less, not growing. Debt buyer have gone from ~40 companies 3-4 years ago to 4-5 now. This is due to the new regulation on the industry in the last couple of years. For instance, banks are now required to sell debt to companies that have a long track record of compliance. A new, unproven company can no longer call up a bank and buy debt, which was the norm of the past (especially with certain hedge funds or investment groups). Quoting PRA management from the most recent conference call "Regulation has put a moat around our business, which is both deep and permanent changing the competitive dynamics of our industry forever." Smaller players have simply given up because the cost of remaining compliant are too high. I find it some what ironic that one of the major head wind pushing PRA's price down is also making its competitve advantage significantly stronger.

 

Of the remaining 4-5 debt buyers PRA and Encore are the only major players that are public, and I believe PRA is the largest buyer in the US. From what I've seen PRA is also far and away the most profitable, and most conservatively financed. Encore, who I think is their largest competitor (someone please correct me if I'm wrong) is a 600 million market cap company, but it has 3.2 BILLION in long term debt. This is verse PRA, who is a 1.3 billion dollar company with 1.7 billion in debt. From what I can tell PRA significantly beats Encore on virtually every measurable metric, ROE, margins, ROIC, cash flow ect. Another competitor, SquareTwo, actually lost money last year. This is a very difficult industry. Why does PRA succeed? They are much much more efficient than their other competitors, most of which stems from their portfolio data and analytics. Put simply, they are excellent at figuring out who to collect from and who to ignore. Calling a customer who cannot pay PRA is a waste of time, money, and effort, not to mention strressful/agrevating to the client. PRA does their best to avoid this as much as possible.

 

I'm not saying PRA is perfect. There are definitley headwinds, such as regulation, tight supply, record-low charge off rates and higher debt. But at 8x earnings, a history of growth, and diminished competition, I don't have to be spot on with my analysis. I think it is a misunderstood company that presents significant upside to long-term investors willing to wait for a normalization in the environment. That's my 2 cents at least. I'd love to hear a bear case.