Debt turns into dollars for collection specialists
ONE person's garbage is another person's treasure - or, in corporate speak, businesses should focus on their core competency and outsource other functions to businesses with an expertise in those areas.
ONE person's garbage is another person's treasure - or, in corporate speak, businesses should focus on their core competency and outsource other functions to businesses with an expertise in those areas.Banks and other consumer lenders are geared up to sell lending products, manage clients who are servicing their loans and optimise their funding. They are not specialists at managing bad debts and arrears. Disclosures from the major banks show typically around 1 per cent of credit card debt is over 90 days in arrears. After 180 days of arrears, credit card debt is written off.Even if they are written off, there is value in these arrears. Some debtors may have hit hard times but are well-intentioned - and could repay in instalments or under other flexible arrangements. Others may have the funds but have been "lost" intentionally or unintentionally and with a little research can be located. There are of course those who have found themselves in situations that make it impossible to expect repayment.Listed companies Collection House and Credit Corp - along with New Zealand-based Baycorp (which is majority owned by ASX-listed Oceania Capital Partners) - lead a handful of experts in recovering value from these bad consumer debts. They possess a wealth of data and years of experience in managing the debts (Collection House recently celebrated its 20th anniversary) and possess analytical insight into which loans may still be serviced and which should be written off.They know that for a dollar face value of credit-card debt written off by the banks, a certain amount can be recovered, depending on the profile of a particular loan book (say 30?). And having insight into that likely recovery rate means they can put a price on the debts. Thus banks and other creditors maximise their returns and focus on their core operations by selling these written-off debts to collection specialists.By its nature this industry has counter-cyclical and defensive characteristics. A case for progressive earnings growth over the medium term can be envisioned, regardless of whether the domestic economy mounts a recovery or deteriorates further.Annual turnover in Australia's debt collection industry is estimated by industry researcher IBISWorld to be $1.8 billion, with a compound growth rate of 3.6 per cent from 2007 to 2012.The major players were all active in bidding for debt ledgers in the past financial year but expressed concerns over the level of competition. Credit Corp spent $92 million, slightly down on its spend in fiscal 2011. Collection House spent $61 million, up 24 per cent, and Baycorp spent $51 million, also up significantly.But in reporting on the year that was, concerns about competition were highlighted. Credit Corp said such competition may cause it to reduce debt ledger purchases in the short term. Baycorp said it had actually withdrawn from some sales processes.While IBISWorld expects growth to trend lower, thanks to more stringent regulations and more cautious consumer borrowing patterns, there are also trends playing into the hands of the leading and most reputable players.Regulation - and reputation - are creating opportunities for market-share gains. Unlisted competitor ACM Group, which has in the past reportedly collected debts that were owing to NAB, CBA, Westpac and Telstra, has faced adverse court rulings recently regarding its practices. CBA responded by stating in the press that it had stopped using ACM several years ago, while NAB said it no longer sold debt to ACM.Access to capital is another issue following the GFC. The listed players appear to be in a strong position. Credit Corp is ungeared, while Collection House has the long-standing support of a big bank and both have the flexibility of using their listed equity to help with funding.Baycorp does not look as well positioned, recently raising funds through the divestment of its 9 per cent stake in Collection House for just under $10 million, while listed parent Oceania has launched a $14.9 million rights issue.Collection House is trading on a multiple of just over seven times this analyst's earnings expectation for this financial year, which sits within the company's guidance for a rise in net profit to between $14 million and $14.5 million, up from $12.5 million in fiscal 2012. It appears to be the best value of the listed plays in the sector.Credit Corp is trading at a premium, on 11.5 times consensus earnings estimates.Martin Pretty is head of research at Investorfirst Securities.