Asta Funding

As Bruce Berkowitz of Fairholme Funds puts it, "investing is all about what you give versus what you get."  One way to go about looking for value is determining when GAAP accounting rules often result in a company's assets being carried at values far less than their intrinsic value. 

Asta Funding is such a company, their main business is as debt collector on defaulted loans, not exactly a popular or sexy business model.  Asta acquires portfolios of consumer receivables for pennies on the dollar and then it goes about the collection process to recover as much of the original loan as possible.  The collection of these receivables has typically been attempted by the originator and potentially several others, these are really aged and bad debts. 

Asta Funding is a family run business by the Stern family, who control 30% of the shares outstanding.  The company's founder is Arthur Stern, who at 90 is still a company director and "Chairman Emeritus".  His son, Gary Stern, is now the President and CEO and has been in the post for close to two decades.

Asta has $106,347,000 of cash and marketable securities as of 9/30/12, with virtually zero recourse debt, versus a market capitalization of $121 million.  A little history, in March 2007, Asta made a mistake in buying an incredibly large receivables portfolio at the top of the market, called the Great Seneca portfolio, a $6.9 billion portfolio for $300 million, by far the largest acquisition they had ever done.  They paid for the portfolio with $225 million in non-recourse loans and $75 million from their credit line.  The portfolio has been significantly written down and currently sits on the books for $65.4 million versus $61.5 million in non-recourse debt.  The company's business plan is in a bit uncertain going forward as they are not making any large receivable purchases since they believe the price is too high, a market condition also mentioned by other publicly traded competitors.

The potential value in Asta comes from how they account for their consumer receivables portfolios.  When the company can no longer determine the timing of cash flows from one of their portfolios, they switch from the interest method to the cost recovery method of accounting.  Under the cost recovery method, all cash flows from the portfolio go immediately towards a reduction in the principal amount of the portfolio.  Compare this to the interest method, where a portion of the cash flows is recorded as revenue and a portion as principal reductions.  Eventually, the entire portfolio is written off under the cost recovery method even if there are still cash flowing assets remaining in the portfolio.

The cost recovery method understates the true value of the consumer receivables as it reduces revenues in the near term as the company recognizes basically no revenue until the entire portfolio has been recovered, defers taxes as a result, and then eventually creates a "zero basis" asset that has no book value but produces cash flows.

Asta experiences considerable revenue from these zero basis portfolios, $36.4 million for the fiscal year ended 9/30/2012.  The revenue received on the zero basis portfolios is surprisingly consistent, clearly showing these assets have considerable value that is not being portrayed on the company's balance sheet.  Calculating the value of the zero basis portfolios is difficult, as the company does not provide much information in any of their filings.  In order to ballpark the amount, I took an quarterly average of the revenue for the last two years, ran that revenue off at 5% per quarter for 3 years (0 revenue after 3 years), took out 40.3% for taxes, and then discounted those cash flows back at a 16% discount rate to be extra conservative.  That comes out to an NPV of $37.4 million that is being carried at zero.

Since the Great Seneca portfolio's debt is non-recourse, let's just assume that the portfolio eventually ends up being put back to BMO, the lender.  Shedding this portfolio on both the asset and liability sides would result in an overall $3,937,000 write-down.  The net effect of these two adjustments (adding the zero basis assets and removing Great Seneca) adds additional $33.4 million to the assets making Asta's current market price look even cheaper when compared to book value.

What is the company doing to close the gap between the market value and instrinist value?  Asta has been repurchasing shares, $16 million worth in the last year most of which came in one block trade with Peters MacGregor Capital Management ($9.4 million, 1 million shares).  Expect Asta to pursue similar private market transactions as the limited trading volume of their stock limits their ability to repurchase shares in the open market legally.  They also announced a fairly insignificant special dividend of $0.08 today, speeding up the 2013 dividend ahead of what is anticipated to be higher taxes on dividends next year.

Additionally, Asta has also started investing in two related businesses, personal injury settlement financing and divorce funding financing:

• Pegasus Funding, LLC
• BP Case Management, LLC

Management is potentially reaching outside of their circle of competence in these recent new businesses, however both have joint venture partners who are doing the day-to-day managing and high hurdle rates before those partners receive additional returns, the incentives should be aligned for both to be profitable.  Currently they're only a small piece of Asta, accounting for $18.6 million (listed as other investments), or 8% of assets, but these could be potential growth areas if the traditional consumer receivable portfolio business continues to be uneconomic.

Asta Funding isn't an outstanding operator or a franchise company, but it's clearly cheap and the cash position provides a large margin of safety.

Disclosure: I own shares of ASFI