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Thanks Madtrader for your very comprehensive reply It is a...

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SteveSage

2,839 Posts.

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27/07/18

10:48

Post #: 34590370
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Originally posted by Madtrader ↑

Their accounting model for their PDL portfolio is amortised cost. The amortisation rate they refer to is the average rate at which they take the acquisition value through to the P&L. For example, if they say an amortisation rate of 50% for some debt they bought at 20cents in the dollar, that would imply they take 10cents in year 1.

As you state, if they are doing this as simply as that then they aren't doing what they should be doing. I expect they use this metric as something that is translatable to the average investor and CCP for example also talk about the same.

Amortised cost actually requires a profiling of expected cash collections along with their expected timing (thus actuarial modelling would be required) and then determining an effective interest rate (EIR). EIR is the discount rate that exactly discounts those cash flows to the fair value at initial recognition (or in other words the price paid for the debt, including any directly attributable transaction costs, likely small).

The problem with debts acquired at deep discount is that the cash flow profile is obviously a lot harder to determine than a prime debt (albeit actuarial models would be used for loss provisioning under an amortised cost model - for example banks would determine probabilities of default (%), loss given default (%) and exposures at default to determine loss provisions, usually on an aggregate credit risk grading system).

Given this the underlying cash flows used in the modelling won't align to the contractual ones at origination and also require re-estimation every balance sheet date. I have been sceptical of CLH for a few years now as I felt there was some robbing Peter to pay Paul and they have returned a poor compound rate of return over that time. I took positions in PNC and CCP as they appeared superior and returned superior returns (100%+) but no longer hold either due to cyclical rotation and I felt I'd exhausted what value I saw when comparing against other investments.

CLH, as far as I can see and I've gone back over years of financials in the past, has never had an impairment of a debt or sub-portfolio of debt. This would imply to me that to some extent they aren't that granular in their modelling or they have impairments of parts of their book that they hide in the revenue line with other portfolios that have performed better. When I look at the carrying value of the PDL portfolio compared to the cash flows they derive and break them down into vintage profiles I have had the feeling for a while that the asset value should have been lower (i.e. amortisation was too slow). Bear in mind that over the lifetime of one of these debts, revenue = cash flow received from debtor less acquisition price discounted. All the above leads into this change in amortisation rate, a tick up in the rate is a potential way to take the acquisition cost over the time to the P&L without any major write-down. Not saying that's what's happened, but that's the way to do it without a shock.

I would be worried if this continued to rise over time. They haven't been buying as much over recent times so if in fact they were robbing Peter to pay Paul (via not taking purchase price to P&L as quickly as they should) and the merrygoround stops without increasing cash collections, then that thesis would bite hard (say hello to negative EPS). It's for this reason I believe one should never ever value a company such as CLH, CCP, PNC etc. using EPS. It's much much too easy to manipulate. Cash flows can be manipulated, but it's harder and for shorter periods of time (e.g. channel stuffing....).

From my cash flow analysis I believe CLH has improved, but personally I don't see it as a bargain. A different perspective perhaps to challenge other's investment thesis, whether anyone agrees or like's it aside.

good luck and DYOR

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Thanks Madtrader for your very comprehensive reply

It is a mystery how they value their PDLs and how that valuation feeds through the P&L given the lack of write-downs, but perhaps that is not a requirement for such firms given all of this debt is doubtful to some extent (?).

I went back to their Feb investor presentation, and saw that for the first time that they have separated out
PDL collection from Amortisation of PDLs, so it does seem that they apply what they believe is the depletion (& degradation) of their PDL book using that standard amortisation rate and put that through P&L, and you hope that takes into account what you eventually manage to collect.

I suspect the amortisation rate had to be increased as the cashflow seems to be less than EBITDA historically (although arguably, interest & tax is a real cash outflow so once you include this, it's not too bad).

I guess the only way to get to the bottom of this is to ask the company

CLH Price at posting: $1.49 Sentiment: Hold Disclosure: Held
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0 Great analysis

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