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Small Cap Recap: The Last on PRAA For a While

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as always, time and price will ultimately declare the winner between Hoofy and Boo

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On Friday afternoon, after the close, Portfolio Recovery Associates (PRAA) filed its 10-K. That has the information needed to complete the scorecard. When I last left PRAA, the score count was a 3-3 tie between the risks that persist and those that PRAA's Q4 report seems to have put to rest.

Risk No.5 - the trend in the quality of receivables - remained unanswered at the time, but we now know more. Cumulative collections for the 2002, 2003, and 2004 pools continue far weaker than prior pools, with 2004 being the lemon of the group. The 2005 pool, on the other hand, ranked in the upper end of performance for first year pools.

Some more nuggets on the risk factors previously discussed:

  • The October spurt in bankruptcy filings does not appear to have had a meaningful impact on Estimated Remaining Collections (ERC's); the company had said as much on its earnings call.

  • PRAA's initial stab at ERC's for the 2005 pool seems much lower than for prior first year pools. The cause appears to be the higher percentage of bankrupt paper acquired which drags down initial expectations. Whether the higher profitability of bankrupt receivables makes up for the lower cash collections remains to be seen.

  • ERC's for specific year pools are generally ratcheted up as PRAA gets more concrete feedback on actual collections. The rate of increases in ERC's for 2002, 2003, and 2004 pools seems to lag meaningfully the ERC's increases for older pools, reinforcing the quality risks discussed above.

  • On the same issue, a subtle but arguably important difference between this year and last year's 10-K: "Since inception, we have been able to collect at an average of 2.5 to 3.0 times our purchase price for defaulted consumer receivables portfolios, as measured over a five to eight year period, which has enabled us to generate increasing profits and positive cash flow." (2005 10-K). Compared to: "Since inception, we have been able to collect at an average of 2.5 to 3.0 times our purchase price for defaulted consumer receivables portfolios, as measured over a five to ten year period, which has enabled us to generate increasing profits and positive cash flow." (2006 10-K).

  • The company asserts that problems with employee turnover are behind them. The turnover rate for 2005 was 52% vs. 48% in 2004. We'll have to monitor from here. Also, monthly cash collections for employees with tenure greater of one year fell from $17,124 in '04 to $16,694 in '05. However, cash collections per hour paid increased from $117.59 to 133.29.

  • PRAA states that seasonality in collections so far has been masked by the company's fast rate of growth. That no longer appears to be the case. This is relevant, IMHO, because the cornerstone of my bearish argument is that PRAA is a growth company, trading a premium valuation, but with slowing growth.

  • Speaking of relative valuations, PRAA trades at a P/E of 22.5, versus 14.4 for Asset Acceptance (AACC); 14.1 for Encore Capital Group (ECPG); and 14.4 for Asta Funding (ASFI).

With that, I can safely say that PRAA has taken up perhaps more than its due share of my writing. Hopefully I've laid out for the Minyanship the blueprint to follow the risks I see in this company, and, as always, time and price will ultimately declare the winner between Hoofy and Boo.

position in PRAA

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