Desktop Stock Ticker | Protection From High Debt

Protection From High Debt

Before delving into a full analysis, investors will often take a quick look at a company’s balance sheet to get an thought of its financial position. Armed with information about the nature of the company’s business, the shareholder can get a excellent thought of whether the company is “safe” from a solvency point of view. Since value investors value the protection of capital above all else, a company with a high debt level will often be immediately discarded from further analysis. Sometimes, though, a high debt load is not a threat to solvency at all!

Consider Asta Funding (ASFI), a firm that buys consumer receivables from companies that offer credit to their customers (e.g. credit card companies, telephone companies). For the quarter finished September 30th, the company shows consumer receivables of $208 million against senior debt of $123 million, for a difference of $85 million.

Note that this is not the same thing as an asset of $85 million against no debt, because of the uncertainty of the value of the asset and the magnification of this uncertainty that results from leverage. To illustrate with an example, if the value of the asset is overestimated by 20%, the levered book value drops by nearly 50% from $85 million to $43 million (208 * 0.8 – 123) whereas the value of the unlevered asset would only drop to $68 million ($85 million * 0.8).
In the case of Asta, the value of the assets is rather uncertain. The company buys its receivables for pennies on the dollar, as the companies selling the accounts have already tried and failed to collect from these customers. Adding to the uncertainty is the fact that high unemployment levels have made it more hard for Asta to collect on its receivables: the company has written down $184 million of its receivables in the last four quarters.
As such, an shareholder scanning only the balance sheet force take a look at these numbers and run. Though, Asta is a lot safer than it looks. The reason for this comes down to the fact that most of its debt is secured by one particular asset, and only one particular asset. Should that asset (currently carried at $121 million) not perform, the loan of approximately $100 million does not have to be paid from the company’s other assets! This is an fascinating situation which increases the safety of Asta significantly.
The company trades at just 2/3 of its book value despite the fact that most of the debt is non-recourse. Aaron Stackhouse discusses the company’s situation in further detail here, for those interested in further analyzing this company.
Looking at a company’s balance sheet can give an shareholder a excellent thought of the company’s debt level. Though, only with a careful reading of the notes to the financial statements can an shareholder reveal items that significantly alter an shareholder’s perception of how solvent a company may be.
Disclosure: None

This article was written by Saj Karsan of Barel Karsan. If you loved this article, please vote for it by clicking the Buzz Up! button below.

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