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Full name Ethan Daniel. Securities analyst based in Miami Beach, Florida. Employ both technical and fundamental analysis. Interested in diversification and avoiding correlation with markets.
  • PRAA: The Numbers Simply Don't Add Up 0 comments
    Jun 18, 2014 3:41 PM | about stocks: PRAA

    PRAA: The Numbers Simply Don't Add Up

    Portfolio Recovery Associates, Inc. (NASDAQ:PRAA) is a full-service provider of outsourced receivables management. Incorporated in 1996, PRAA went public in 2002, and has become a major player in the outsourced accounts receivable collection market. PRAA purchases, manages, and collects defaulted consumer receivables from credit originators, such as banks, credit unions, auto finance companies, retail merchants, and other service providers. The defaulted consumer receivables it collects are either purchased from a credit originator (owned receivables) or are collected on behalf of clients on a commission (contingency) basis. Below is a table listing PRAA's entire portfolio.

    PRAA is currently valued at a market capitalization of $2.95 Billion. It seems this number is a gross misrepresentation and overestimation of the true value of the company.

    Table 1.2 gives strong evidence that PRAA is overvalued. It is essentially a balance sheet listing all of PRAA's operating assets. When valuing PRAA, we must take into account what its expected future earnings are. According to the Portfolio Recovery Associates' website, the estimated total value of remaining collections is $2.68 B. This is expected to be collected over a number of years. There are a few important variables to discuss when evaluating PRAA's expected future performance. First, that PRAA collects 80% of the collectable debt purchased in a given year within roughly 4-5 years of purchase. Second, that PRAA estimates that administrative costs are 37 cents on every dollar of income from realized finance receivables. Third, that PRAA's profit margin on collection to purchase price shows a heavily negative trend line, indicating that debt is now more expensive (Table 1.1). More expensive debt means more leveraging and less earnings.

    Table 1.1

    In the company's most recent quarter it estimated that collections would be only 164% of purchase price, while in 2009 that number was 324% and in 2001 it was 534%. The total price of purchased debt in Q1 2014 is 144,889,000. The estimated total collections is 238,052,000 and thus administrative expenses are estimated at .37 x 238,052,000 = 88,079,240. This leaves the expected profit from Q1 2014 purchases at 238,052,000 - 88,079,240 - 144,889,000 = 5,083,760 (only 2% return on investment!). At the current price of debt, profit seems to be almost unattainable. However, this issue is not reflected in PRAA's current earnings because they are still collecting a majority of their income from the cheaper debt purchased in 2009-2011. As the economy improves, PRAA will likely find itself unable to operate with such a diminishing profit margin, as most other firms in the industry have already experienced. A decline in future earnings is practically guaranteed with the purchase of expensive debt in the past two years. With this in mind, PRAA's value is principally determined from its assets below, the cash receivables that they already own. The total estimated remaining collections from PRAA's portfolio after collection expense is .63*2,680,285,000 = 1,688,579,550. Without discounting, that is, if all of this money were to be collected today, PRAA's accounts would be matured and shareholders would be paid the $1.7 billion (this figure also ignores the company's liabilities). PRAA's current Market Cap is $2.95 billion while their portfolio is worth at most $1.7 billion. In the case of finance receivables the numbers should add up because the assets are strictly cash. To reach a full (and lenient) valuation of the company, take the undiscounted $1.7 billion, subtract its $730 million in liabilities, and add the $191 million that the company has in cash. This takes us to $1.16 billion. With 50.06 million shares outstanding, this brings us to roughly $23.17 per share. The stock currently trades at $59, an unjustified price.

    To summarize, PRAA is overvalued for these reasons:

    -The debt it is purchasing is becoming more expensive and squeezing its profit margins

    -The economy is improving and debt will become even more expensive

    -The current earnings do not reflect the more expensive debt because the majority of the earnings are from prior years purchases (much like oil companies developing more expensive replacement reserves)

    -Decline in earnings in future years is guaranteed by the expensive debt they have already purchased

    -Without discount the expected net realization of their portfolio is $1.6 billion

    -The company is trading at a $2.95 billion market capitalization

    -Total undiscounted expected earnings - debt + cash = $1.06 billion, placing share value at around $20

    We recommend: SELL.

    For a full Q1 earnings report click here-- PRA Reports First Quarter 2014 Results.

    Table 1.2- Summary Portfolio Data at March 31, 2014, Entire Domestic Portfolio

    ($ in thousands)

         
        

    Actual Cash

      
      

    Total

    Net Finance

    Collections

    Estimated

    Total Estimated

    Purchase

    Purchase

    Estimated

    Receivables

    Including Cash

    Remaining

    Collections to

    Period

    Price

    Collections

    Balance

    Sales

    Collections

    Purchase Price

    1996

    $ 3,080

    $ 10,227

    $ --

    $ 10,211

    $ 16

    332%

    1997

    7,685

    25,600

    --

    25,521

    79

    333%

    1998

    11,089

    37,581

    --

    37,384

    197

    339%

    1999

    18,898

    69,836

    --

    69,433

    403

    370%

    2000

    25,020

    118,678

    --

    116,918

    1,760

    474%

    2001

    33,481

    178,936

    --

    176,364

    2,572

    534%

    2002

    42,325

    203,979

    --

    199,228

    4,751

    482%

    2003

    61,447

    273,719

    --

    266,348

    7,371

    445%

    2004

    59,176

    206,294

    --

    199,213

    7,081

    349%

    2005

    143,167

    328,076

    5,725

    313,029

    15,047

    229%

    2006

    107,667

    222,758

    5,878

    210,205

    12,553

    207%

    2007

    258,367

    526,977

    19,091

    484,621

    42,356

    204%

    2008

    275,121

    533,621

    24,564

    480,864

    52,757

    194%

    2009

    281,333

    912,530

    22,742

    776,617

    135,913

    324%

    2010

    357,810

    1,048,010

    68,117

    786,876

    261,134

    293%

    2011

    392,929

    1,018,831

    142,431

    606,679

    412,152

    259%

    2012

    508,683

    1,018,297

    299,429

    419,298

    598,999

    200%

    2013

    627,917

    1,133,180

    508,564

    235,921

    897,259

    180%

    2014

    144,899

    238,052

    138,336

    10,167

    227,885

    164%

    Total

    $ 3,360,094

    $ 8,105,182

    $ 1,234,877

    $ 5,424,897

    $ 2,680,285

    241%

    Disclosure: The author is short PRAA.

    Themes: Financial Services Stocks: PRAA
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