Asta Funding: Going Private Offer

Asta Funding (ASFI) is an old familiar name in the value investing community (I owned it for a stretch), it was once primarily a buyer of defaulted consumer debt for pennies on the dollar that would then go out and sue debtors in order to garnish their wages and recoup their investment, fun stuff.  Following the financial crisis, Asta took a writedown of most of the value in one of their large consumer receivables portfolios but it ended up still cash flowing and looked cheap with this potentially large zero basis asset.  They used those cash flows to diversify into similarly unsavory financial services businesses without much logic such as social security disability advocacy, personal injury claims and structured settlements.  This is a family controlled business and they have treated it that way in the past, they had a dust-up with Mangrove Partners which Asta ultimately ended up paying what looked like greenmail with a large tender offer, followed by a special dividend for most of the market capitalization pushing it further into microcap terriority, then had to restate years of financials, all of which led the shares to be completely ignored by the market.  For a while there it was trading below cash, a clear error of omission on my part not jumping on it then as I've always kept ASFI on my watchlist.

But on November 1, Gary Stern, Asta's Chairman and CEO offered to purchase the remaining outstanding public float (the Stern family owns ~60% of the company) for $10.75 per share conditioned upon acceptance by a special committee of independent directors and a majority of the minority shareholders vote for its approval.  Given the premium to where shares had been trading, I would expect both to be relatively easy to obtain.  Book value is about $13.50 with more than half that being cash, maybe there's a tiny chance of a bump.  But the board is only 5 members, one of which is Gary Stern, two of them have been on the board since the mid-2000s and have let this situation play out to-date, the other two are relatively new but likely friendly with the Stern family given the controlled status.  Even without a bump, financing should be a breeze considering the Sterns can dividend out the cash to themselves when in full control making this a low risk idea.

It's about a 6% gross spread, not fantastic, but I'm familiar with the company and its management, I see this as their opportunity to return to a family company and operating in the dark without pesky minority shareholders or exchange listing requirements (about half their press releases in recent years are NASDAQ de-listing notices).  Plus I have some dry powder and have been stashing cash in more small special situations like this until I find more mainstream ideas.

Disclosure: I own shares of ASFI

Year End 2013 Portfolio Review

One of my main goals of this blog is to keep myself accountable for my investing decisions because I am a loose believer in the Efficient Market Theory and think most people should invest in low-cost index funds.  All of my retirement accounts and a good chunk of my taxable account are invested in low-cost Vanguard funds (I'm sort of a Boglehead in that sense), but I do believe there are some opportunities for the smallish investor to exploit the market if you have the right temperament and the time/energy to devote to the process.

Strategy Overview
Below is a quick visual of the broad investment themes where I concentrate my time and believe where investors can generate above market returns, the more themes an particular investment hits the better.

I work in the banking/financial services industry, so my background knowledge and circle of competence skews towards investments in asset based businesses.  My goal over the long term (10+ years, multiple market cycles) is to generate an IRR of 20%, which will be difficult, but if I'm going to spend the time and effort, I want to make sure its worth my while over an index fund, otherwise I could be using this time on other income generating activities.

Year End Results and Current Portfolio

I started my active taxable account at the beginning of 2011 (but have been investing since 2004), below are my result from my first three years, a time period where I've admittedly had the wind at my back with only a few short and shallow corrections.  A couple clarifying points, my returns are an annual IRR for each particular year which produces slightly different results based on when I added cash to the portfolio (I haven't made any withdrawals), the 2013 returns are "pure" as I didn't make any additions to the account during the year.  The S&P 500 returns are not based on IRR, so its not quite an apples to apples comparison, and additionally one could argue the S&P 500 is not a proper benchmark given my lean towards small cap value stocks.

At this point, I'm pleased with my overall results, but also realize that I could be just lucky given the short time frame.

I also thought it might be beneficial to post my portfolio on a quarterly basis, so readers can relate and Monday Morning Quarterback my decisions, plus it will force me to only invest in high conviction ideas.  The below is my taxable brokerage account which follows the ideas that I post on this blog, as a full disclosure it's only a smallish portion of my net worth so the appearance of concentration or margin debt is not particularly significant for me, at this point its more of a hobby account.

As of 12/31/13

As I learn and gain experience, I will probably gradually transition some of my retirement accounts and other taxable accounts to a similar strategy, and at that point I'd probably also diversify further to 20-30 positions.  So take the above performance figures and holdings with a little grain of salt.

Year End Quick Thoughts on a few Portfolio Positions

Asta Funding

Asta is quickly turning into my lowest conviction holding and could be on the chopping block if I find a significantly better opportunity, I've started to lose faith in management.  On the latest conference call,  Robby Tennenbaum of Alta Fundamental summed it up perfectly with the following question (via Seeking Alpha)

This question is for Gary. So it looks like the personal injury business is growing nicely, and I'm sure there's good potential in the disability benefits business. But with your stock around $8.50 and a book value in excess of $13, and that's excluding the value of the zero basis portfolio, it's kind of hard to imagine how anything could have a better return on invested capital than buying back your stock. I mean, said differently, the market appears to be valuing all of your noncash assets at about $17 million. So I was hoping you could shed some light on how you think about the trade-off between maintaining the high cash balance for potential investments, especially in this challenging pricing environment, versus buying back your stock.

CEO Gary Stern then punts the question (which he has in the previous couple of conference calls as well) by talking about the private market transaction they did with an activist shareholder (PMCM) in June 2012 - they've also allowed their share repurchase program to expire last March.  First, management purchased shares back from PMCM at $9.40 a share, a premium to the then market price.  Why didn't management do a tender offer so that all shareholders could have benefited?  Probably because they wanted to reduce the activist stake and reduce the pressure on themselves.  Second, Robby Tennenbaum is exactly right, there's almost no investment that Asta could make that would be more accretive to shareholders than to buyback shares.  I just have a hard time selling at these prices, and when I invest in a deep value stock like this, I go in with an intended holding period of 3 years which should give management or the market enough time to realize a firm's intrinsic value.

American International Group

One of my larger positions has been in AIG, and it has contributed significantly to my portfolio's success this year.  I believe that large financials in the US are one of the few places to find significant value.  AIG still trades at a meaningful discount to book value, despite it's great turnaround in both operational metrics and capital allocation.  The company remains overcapitalized and will have significant opportunities to return cash to shareholders, hopefully in the form of share repurchases if its market price remains below book value.  Increasing interest rates should also benefit AIG as their low yield fixed income holdings roll over generating a higher ROE and EPS.

Early in 2014, I plan augmented my position (with fresh cash) in the AIG common stock with the TARP warrants that were issued in 2011 with a strike price of $45 and a maturity date of 1/19/2021.  I probably should have bought the warrants initially, but despite the run up in 2013, they still represent a great risk/reward profile and one of the few opportunities to earn a high IRR for 7+ years (also potentially valuable tax deferral).  The warrants come with a few anti-dilution adjustments to protect holders from dividend payments (above $0.16875 per quarter, the current dividend is $0.10 per quarter), stock dividends, rights offerings, and above market tender offers.  With the ILFC sale approaching a resolution, AIG remains one of my highest conviction holdings and should be setup for another good year in 2014.

2013 was a great year for the markets, I'm pleased to have out-performed over the broad market, and eked out a small gain over many diversified mid/small cap value funds.  Thank you for reading during the past 12 months and Happy New Year.

Asta and BMO Revised the Great Seneca Portfolio

It's been years since Asta Funding has been actively buying distressed consumer debt portfolios, their core business, and while they returned to that market this past quarter with a $3.3 million purchase of $53 million in face value of receivables, I think the much more important transaction is the renegotiation of the Great Seneca portfolio debt with BMO.  In the past I have treated the Great Seneca portfolio as a free option, and assumed it was worthless and the non-recourse debt would be written off as well.

During the quarter, Asta wrote down the value of the Great Seneca portfolio by $10.2 million to $46.3 million which they identify as the net realizable value.  Then below is the explanation for the transaction they completed with BMO:

"On August 7, 2013, in consideration for a $15 million prepayment funded by the Company, BMO has agreed to reduce minimum monthly collection requirements and the interest rate significantly. After BMO receives the next $15 million of net collections from the Great Seneca portfolio, offset by credits of approximately $3 million for payments made to BMO prior to the consummation of the agreement, the Company is entitled to recover, out of future net collections from the Great Seneca portfolio, the $15 million prepayment that it funded. In exchange for possible future debt forgiveness, BMO has the right to receive 30% of future net collections, after the Company has recovered its $15 million prepayment"

Although the 6/30/13 financials show $105 million in cash and securities, Asta paid BMO $15 million this past week as part of the revised agreement and now has $94 million in cash/securities (presumably after $4 million in cash inflows).  In essence Asta is reinvesting in this portfolio, while it might not be counted as a new portfolio purchase, its almost the same thing.

Going forward the first $12 million (net of $3 million in previous payments) will go to BMO, following that Asta will get the next $15 million and recover the prepayment, then the remaining revenue will go 70/30 to Asta/BMO.  So given the Great Seneca's net realizable value is $46.3 million, the first $27 million is allocated to BMO first, then Asta, leaving the remaining $19.3 million to be split 70/30, or $13.5 million to Asta Funding.  Asta's accounting is generally conservative (still making $9.75MM this quarter in zero basis assets), I think the $13.5 million number is likely an appropriate value for the end recovery value of the Great Seneca portfolio and may end up being a bit low.

Asta currently receives about $3 million a quarter on the Great Seneca portfolio, if this continues, BMO will be paid off in one year, and Asta will recover its $15 million prepayment in about 9 quarters.  If the $3 million quarters continue from there its about another 8 quarters (or 4 years from now) before the net realized value would be recovered in the 2nd quarter of 2017.  While it might initially feel generous to assume the $3 million can continue that far into the future, I've been pleasantly surprised the zero basis portfolios have continued to produce consistent cash flow for the past several years, and show little evidence of slowing down.  So assuming a $3 million a quarter run rate, Asta would earn about a 33% IRR on it's initial $15 million investment over the next 4 years, or an NPV of just over $7.1 million using a 20% discount rate.  The prepayment will make the balance sheet look a little weaker in the next few quarters, but I would say this is clearly a smart transaction for Asta.

Based on how I've previously valued Asta Funding, removing out the Great Seneca portfolio and adding in the NPV of the zero basis portfolio, I've made another attempt and included a line for the NPV of Great Seneca given the new arrangement.

As you can see, I roughly value Asta's book value at $16 per share, or 77% higher than it's current price of just over $9.  All the minority shareholders would probably prefer a big stock repurchase plan (which has expired and has not been renewed), but it appears Asta is finally using their excess cash and investing again in the core business which should be a net positive.

Disclosure: I own shares of ASFI

Checking in on Asta Funding

Asta Funding announced their fiscal first quarter earnings today.  No big surprises as the company continues to accumulate cash, repurchase shares, receive cash flow from their zero-basis portfolio, and invest in their personal injury financing business over their traditional credit card receivable business.

The most interesting part of the conference call was the surprisingly robust Q&A session, a few takeaways:

• The divorce business (BP Case Management) is slow, Asta has put very little money into it, doesn't sound like they're committed to the business or just can't find the necessary scale to move the needle
• Asta still hasn't made a lot of progress on their share repurchase plan outside of the one off-market block trade with Peters MacGregor Capital Management
• The zero-basis portfolios total over $1 billion in face value which represents a large asset portfolio that is not on the balance sheet, Asta collected $8.1 million last quarter, and $35.9 million over the trailing twelve months
• The Great Seneca portfolio's loan matures in April 2014, Gary Stern anticipates an extension, but has had no direct discussions yet with BMO
• Asta is working on lowering overhead costs, but couldn't provide any further details
• One caller asked about Asta's purchasing criteria and how other publicly traded debt collectors have been actively purchasing credit card receivables, why hasn't Asta been able to?  But Asta is holding firm on not changing their purchasing criteria standards, they would like to purchase additional credit card paper, just haven't seen attractive pricing, specifically, earning 2.7x purchase amount over 84 months would not clear Asta's required return hurdle

Asta is still just treading water, waiting out the current pricing cycle, and that doesn't bother me as I don't want to see them stretch for a large portfolio again.  Where I would like to see more progress is on the share repurchasing front, any additional repurchases would be highly accretive to current shareholders, especially if management doesn't see credit card paper pricing improve in the near term (why earn 1% in CDs when you can buy the stock back?).  Even so, I peg the adjusted book value of the company at $15.25 after deducting the carrying values of the Great Seneca portfolio's assets and non-recourse debt, then adding back an estimate of the zero-basis portfolio's NPV.  Based on the current quote of $9.47, a nice wide margin of safety here.

Disclosure: I own shares of ASFI

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