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Hi, I posted this reply on the CAPS message board today and am posting it here as I'm interested in thoughts on my analysis of AACC's business.

I think AACC's business model is in trouble right now, thus the declining stock price. However, if they can make the right improvements in their operations and get things back on track, then the business could grow and an investment may be warranted. Right now, even with the low historical price, there is a lot of risk in this investment. Here are my thoughts...

A reason that the stock has declined so much recently may be because FCF as a percent of Revenue and Purchased Receivables Revenue as a percent of Cash Collections are both trending significantly downwards. For instance, in 2005 FCF was 35% of revenue, in 2006 it was 24% and in Q2 07 it was 18%. Purchased Receivables Revenue as a percentage of Cash Collections has gone from 80% in 2004 to 69% for the first 6 months of 2007. This has a big impact on the FCF returns that AACC delivers on the capital they invest in the bad-debt pools. Currently they are not able to generate returns on their bad-debt investments that can grow the business.

In the 2006 10K they estimate that their cash collections return 451% on the purchase price of the bad-debt they buy. The way I see it, if as an example, they invest $100 in bad-debt, they should on average collect $551 in cash. Currently they would realize about 69% of Revenue on that $551 Cash Collection, which would be $380, of which 18% would flow through to Free Cash, or $68. That's a -32% return of FCF on their $100 bad-debt investment.

Now in 2005 when they converted 80% of Cash Collections to Revenue and 35% of Revenue to FCF, that same $100 returned $136 in FCF, which is a very nice 36% ROI. This return allowed them to grow the business by purchasing larger quantities of bad-debt.

This probably explains why they needed to open the line of Credit with JP Morgan.

From Q2 07's earnings results I believe they're paying 3.4% of face value of the debt their purchasing, vs 3.59% in Q2 06, so it would appear that their margins, as they relate to the purchase price of the debt, are improving. It looks to me like it's the Operating Expenses, specifically the Collections Expense, and the Interest Expenses that's having the biggest impact on their margins.

Also, they talk a lot about the increased amortization rate on the Cash Collections, which is having the negative impact on their Cash Collections to Revenue conversion. I don't follow how they determine this exactly, but it's clear that it has a big impact on how much revenue they recognize.

I think they need to demonstrate the ability to generate positive FCF returns on the bad-debt investments, which could come from improvements in several areas:

1) Improved operating margins by lowering Collections Expenses/increasing the efficiency of the Collection process
2) Converting a higher percentage of Cash Collections to Revenue

Otherwise they will not be able grow the business as they will only be able to purchases smaller and smaller new bad-debt pools with cash from operations and will need to continually tap their credit facility to grow revenues. This will be a death spiral for the business.

The management team didn't explain it quite this way on the Q2 07 earnings call, but I sensed that there was an urgency about the improvements they're implementing because they know this business will not grow as it's currently performing.

I'm interested in any comments.
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