In the debt collection business, size is a necessary requirement to offset the poor credit quality of its asset base and the costs of complying with increased government regulations. The industry is overseen by the federal government through the Fair Debt Collection Practices Act (FDCPA), as well as being subject to the new Consumer Financial Protection Bureau (CFPB) that was created in 2010. Despite having an oft-maligned image, the industry is consistently profitable and is fertile ground for investment opportunities. So, which players are worth a look?
Founded in 1998, Encore is one of the largest buyers of defaulted consumer debt, focusing on the credit card receivables segment. Its assets include one of the industry’s largest distressed consumer databases, which allows Encore to analyze consumer behavior and to better predict repayment patterns. The company also participates in the tax lien business through its Propel subsidiary, the largest tax lien resolution provider in Texas.
Encore has more than doubled its revenues over the past four fiscal years, as consumers’ financial positions have improved and the company’s collection efforts have become more efficient. In FY2012, the company continued to produce solid financial results, with increases in revenues and operating income of 23.9% and 28.3%, respectively, versus the prior year. Encore Capital Group, Inc. (NASDAQ: ECPG)’s operating margin improved to the highest level of the past five years, as collections exceeded expectations and the company relied less on third party collection agencies.
Looking ahead, the company has been in growth mode lately, with a 45% increase in acquired receivables during 2012. Encore is also utilizing the merger channel with its recent offer to acquire smaller competitor Asset Acceptance Capital (NASDAQ:AACC) for $200 million. Asset Acceptance focuses on the secondary receivables market, consisting of defaulted consumer debt that has already been through the collection process once or twice.
Asset Acceptance has rebounded from operating losses during the financial crisis, but its operating margin still trails its larger competitors by a wide margin. However, the company did post marginal growth in FY2012, with increases in revenues and operating profit of 4.1% and 5.7%, respectively, compared to the prior year. Asset Acceptance similarly benefited from improved collection trends, as well as its decision to reduce the size of its office network. Encore Capital Group, Inc. (NASDAQ: ECPG) should be able to further enhance the profitability of Asset Acceptance’s portfolio through cost savings from the integration of the two companies’ collection workforce.
Portfolio Recovery Associates, Inc. (NASDAQ: PRAA)
Founded in 1996, Portfolio Recovery has quickly become one of the most profitable players in the industry, with a diversified portfolio of services that includes debt collection, claims management, and collateral recovery for both commercial and municipal customers. Over the past ten years, the company has grown revenues by 26.7% annually through an adherence to a code of ethics and a conservative management of its balance sheet. In 2012, Portfolio Recovery finally took its business model into international waters with the acquisition of Mackenzie Hall, a U.K.-based debt recovery company.
In contrast to Encore, Portfolio Recovery Associates, Inc. (NASDAQ: PRAA) focuses more on the bankruptcy market segment, which accounted for almost half of its portfolio acquisitions during 2012. While bankruptcy-related receivables have a higher purchase price compared to defaulted consumer debt, they require less manpower through the resolution process, leading to a higher profit margin. As a result, Portfolio Recovery generated a 36.5% operating margin in 2012 versus a 27.7% operating margin for Encore.
Portfolio Recovery also enjoyed strong overall results in FY2012, with increases in revenues and operating income of 29.2% and 21.4%, respectively, compared to the prior year. Despite a slight decline in its operating profitability, the company benefited from strong productivity from its workforce, as well as better collection results from its portfolio. While prices for receivables have been rising across all asset segments, Portfolio Recovery Associates, Inc. (NASDAQ: PRAA) is still finding value in certain areas and the company expects further growth to its portfolio in 2013.
The bottom line
Tracking down deadbeat debtors can be a potentially time-consuming and costly process for small companies. However, the large firms have the resources to scientifically calculate the odds of repayment and leverage their expertise with the legal system. Given continued growth in consumer credit and the predictability of human behavior, the industry should have ample growth opportunities in the future. Encore and Portfolio Recovery have shown an ability to successfully manage the industry’s risks and they deserve a spot on investors’ watchlist.
The article Finding Value in Debt … Collection originally appeared on Fool.com and is written by Robert Hanley.
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