Debt collection is risky business but pays off more for the financially astute
The pandemic struck debt collection companies hard. Their PDLs (purchase debt ledgers — the debt you bought from other companies and you wish to collect yourself) were greatly impaired (loss in value) because if people were out of work, how could they pay back their debt?
Despite this, at least one Australian debt collection company, Credit Corp, managed to survive well while its closest competitor, Collection House, sunk.
Financial Discipline
The biggest difference between Credit Corp’s and Collection House’s financial statements was the flow of cash. Both companies showed good profits on the income statement but the cash flow statement were different.
Credit Corp is a cash-making machine. It brings in cash and keeps it for further investment while Collection House had difficulty maintaining cash.
Even though Collection House had great profits, much of the money was used to pay off debt. Essentially, the company kept no cash it made.
The two screenshots below show how Credit Corp maintained strong free cash flow while Collection House had to sell of its PDLs just to pay off debt, thereby leaving the company with little cash left over.
Impairment Struck
Then COVID happened and both companies’ PDL portfolios were severely struck with impairment.
However, this is where things diverged. Credit Corp kept its PDL portfolio because it could afford to while Collection House couldn’t and had to sell it off.
With the 2 screenshots below, you can only assume that both companies correctly represented their PDL impairments.
Smelling an opportunity, Credit Corp scooped up Collection House’s PDL portfolio. This resulted in Credit Corp becoming the biggest debt collector in Australia. Its closest competitor could no longer compete.
Buying Out Your Competitor
The market didn’t like Collection House’s change in strategic direction. It wanted to stop collecting debt and instead offer its debt collection service to other companies.
In the context of the pandemic, this isn’t really a good turnaround strategy because frankly who needs to hire debt collectors when you’re struggling to pay your own staff?
Collection House’s share price shrunk to a few cents and smelling another opportunity, Credit Corp bought out Collection House for a few million.
Effectively, Credit Corp bought a workforce of debt collectors at a fraction of the price it would cost to train new ones.
Conclusions
This story isn’t about how good Credit Corp is as a company. Still, it’s more important to understand how a simple understanding of accounting and basic industry understanding can prevent you from buying dud companies.
I’ve learnt a lot from this. I admit I was tempted to buy Collection House at the low price but after reading its Cash Flow Statement, I realised the company wasn’t in the best state.
Finally, even if I bought shares, it’s not like Credit Corp bought Collection House at a premium. They bought it at a discount, so at most, I would’ve recovered what was invested.
