Credit Acceptance Corporation (CACC) Update pt 2

In the month since I posted my rationale for trimming my position in CACC, the stock has fallen just shy of 20%, and I recently began adding back to my position at $192. At these prices, modest growth is part of the thesis, so I haven't added in a really big way yet. I'll add in phases on the way down assuming no other major changes to the situation.

Additional Valuation Thoughts

My prior posts on CACC contain more background (post 1, post 2), but I thought I would lay out some additional thinking on the current valuation below.

CACC has $2.8b of capital which currently earns 12.7% and costs 5% (weighted after tax, per their Q2 PR), which includes 2.65% for the $2b of debt after tax. If we assume they don't grow or shrink and just dividend out that 12.7% in perpetuity, that leaves $14.4 per share for the equity after tax ([12.7% *$2.8b - 2.65% * $2b] /21mm shares) which makes $200 13.9x earnings (7% yield).

This ignores changes to returns on capital, interest rates, growth (or shrinkage, e.g., from a hit to capital by regulators), or changes to their capital structure. 

• Regarding ROIC, this business is cyclical, and on average CACC has earned closer to 14% on capital over the last 10 years or so (more thoughts on this 14% are below). Using this ROIC and assuming an $150mm hit to capital from regulators (see post 2) brings the multiple to 13x. 
• How are CACC's earnings are impacted by rising rates? Given the loan rates are not really interest rate sensitive, but the liabilities are, rising rates is a negative. In 2006, when the 10y treasury yield was 4.7% (vs 2.1% now), their cost of debt after tax was 5.6%. Using the above math and assumptions ($150mm hit to capital, and 14% ROIC) with this cost of debt, results in $12.30 in earnings and a multiple of 16x. On the other side of the coin, a rise in rates could improve the competitive environment because folks can achieve more reasonable returns elsewhere without extending down the risk spectrum into subprime auto, drawing capital out of the market. I cannot quantify this impact though.
• Adding in modest growth assumptions makes the stock look quite reasonable in either of the interest rate scenarios above. For example, in the less favorable high rate environment above, 5% EPS growth and a 10% discount rate (along with the 14% ROIC, $150mm capital hit assumptions) gives $240/share value. I think this scenario is pretty conservative.

It is reasonable to be concerned that the business is becoming more commoditized, and therefore 14% ROICs are a thing of the past. I don't think this is the case. I think this is a niche product that is hard to sell well. Over the years many people have gone broke by skating on too thin of ice, and this will happen again causing capital to withdrawal. Moreover, CACC "packs a bigger punch" than many other lenders in the market. Most folks take a deal that was going to get done and sweeten it a little, whereas CACC takes a deal that wasn't going to get done and makes it happen. All this leads me to believe this is not a product where the lowest cost of capital (banks) wins, end of story. There's also the possibility that something exogenous to the auto market occurs (e.g., 2008 crisis, large interest rate increase) that causes capital to withdrawal and returns to increase.

As I mentioned in the beginning, modest growth is part of the thesis at these prices, so I haven't added in a really big way yet. I will add in phases on the way down (fingers crossed) assuming no other major changes to the situation.

Disclosure: Long CACC

Basket of Japanese Stocks

Continuing on with providing a description of my portfolio changes since last September (beginning of my hiatus from writing due to fairly limited activity) is a basket of small positions (~1-2% each) in Japanese stocks purchased in October/November of 2014. I was pleased to locate these ideas from an individual on the corner of Berkshire and Fairfax message board. Below is a brief description of the rationale for each purchase, as well as the current situation and performance to date.

• Joban Kaihatsu (Ticker: 1782): At the time I purchased it, Joban had compounded book value per share over the prior 5 years at close to 15%, and it traded at 61% of book, 0.7x EBITDA, and 1.7x the average of several years FCFE. Currently it is trading at 478 JPY, which is 80% of book, 2.4x EBITDA, and 5.2x FCFE (5Y average). The return to date has been 56% in USD, and 73% in JPY.
• Fujimak (5965): At the time I purchased it, Fujimak had compounded book value per share over the prior 6 years at 10%, and it traded at 41% of book, 1.3x EBITDA, and 7x the average of 5 years FCFE. Currently it is trading at 790 JPY, which is 41% of book, 1x EBITDA, and 7x FCFE. The return to date has been 2% in USD and 3% in JPY.
• Tokyo Radiator Mfg (7235): At the time I purchased it, Tokyo Radiator had compounded book value per share over the prior 5 years at 9.9%, and it traded at 45% of book, 0.7x EBITDA, and 9x the average of 5 years FCFE. Currently it is trading at 645 JPY, which is 50% of book, 1.2x EBITDA, and 6.7x FCFE. The return to date has been 14% in USD and JPY.
• Car Mate Mfg (7297): At the time I purchased it, Car Mate had compounded book value per share over the prior 5 years at 9.6%, and it traded at 45% of book, 4.8x the average of 5 years FCFE, and had a negative enterprise value. Currently it is trading at 645 JPY, which is 43% of book, 6.8x FCFE, and the enterprise value is still negative. Due to a spike in cost of goods sold, EBITDA turned negative over the trailing twelve months, which is concerning and warrants closer monitoring of this company's progress. The return to date has been -1% in USD and flat in JPY.
• Nansin (7399): At the time I purchased it, Nansin had compounded book value per share over the prior 5 years at 13%, and it traded at 40% of book, 2.3x EBITDA, and 2.6x the average of 5 years FCFE. Currently it is trading at 400 JPY, which is 36% of book, 2.1x EBITDA, and 2.9x FCFE. The return to date has been -11% in USD, and -1% in JPY. 

In aggregate the basket is up 10% in USD and 16% in JPY. This is versus -3% for SPY including dividends since 10/31/2014 (+5% from the bottom of the short sell off in mid October). So satisfactory results to date, although not stellar because the positive performance is really due to 2 of the 5 names. These stocks still appear quite cheap, so I do not have plans to sell yet.

I have gone back and forth, but I currently have left the JPY exposure unhedged. As shown above, this has cost me a material amount.  My main reason for remaining unhedged is that it is expensive to hedge (although it has turned out to be more expensive not to hedge to date).  Additionally, aside from very large cash on these companies' balance sheets, currency movements affect these businesses in fundamental ways that I don't think is exactly 1 for 1 with the current market cap of the company. Lastly all currencies decline, and I don't know which ones will decline faster or slower than others. I no doubt will continue to cogitate on this reasoning.

I will continue to hold each of these stocks as they remain quantitatively cheap.

Disclosure: Long 1782.JP, 5965. JP, 7235.JP, 7297.JP, 7399.JP

Credit Acceptance (CACC) Update

In the short period I have owned it, CACC's business has continued to perform remarkably, and I continue to be very impressed with management.

In the last few quarters CACC has experienced solid loan growth and performance with relatively minor spread concessions (due to modest term extensions). Importantly, they have also shown growth in loans per dealer (5.8% YoY in Q2 2015), which previously had been declining sharply. Management uses this metric to monitor industry competitiveness (increasing loans per dealer indicating declining competitiveness). A few other notes:

• Q2 2015 adjusted return on average capital: 12.7% (compared to peak of 18.7% in 2010, and last cycle trough of 11.2% in 2008)
• Q2 2015 spread on origination: 24.1% (compared to 2009 peak of 35.3%, and last cycle trough of 21.4% in 2007)
• Q1 and Q2 2015 YoY loan unit volume increase: 28.4%, 30.6% 
• Collection forecast variances continue to be positive
• After having the FTC complaint resolved without incident, no additional changes have occurred on the legal inquires (DOJ and Massachusetts AG)

In short, they are firing on all proverbial cylinders. 

The stock has risen quite a bit more rapidly than I would have expected. At $250, it currently trades at 18.4x management's adjusted earnings per share (Q2 2015 TTM).

At these levels, the market is pricing in a fair amount of growth and franchise value into the stock, which is probably reasonable. I still fear regulatory issues and the possibility that they could send the stock tumbling. As I've followed the industry more though, the fines that are coming out of the CFPB and DOJ seem manageable for CACC. I've seen fines ranging from $25mm at Honda to $100mm at Ally. If one assumes an $150mm (I assume higher than others in the industry to be conservative, not because I think CACC is "worse" than the others) hit to capital due to a regulatory fine, it trades at 19.8x (150mm fine at approximately 14% returns on capital and 21mm shares is $1 per share in earning power reduction).

All this considered, I sold a large percentage of my position at around $206 (average cost of $125). I still own a non-trivial position, but it is only in the 2-3% range. However, I have and will continue to consider adding to my position because it is rare that I find something I feel I understand reasonably well with a management team as strong as this one. Clearly to date, selling shares has been a mistake.

Disclosure: Long CACC

Berkshire Hathaway (BRK.B)

With U.S. markets continuing to rise, my activity has been fairly limited since my last post. However I have made some moves, and this will be the first in a series of posts summarizing changes to my portfolio since last September.

First up is Berkshire.

Berkshire has been a very large part of my portfolio since May 2011. While not dirt cheap today, it is certainly not expensive and I have added to it recently below $140. It currently represents a whopping 25% of my actively managed portfolio.

I won't go into any back story around Berkshire's history or current businesses here.  I'll focus on valuation. Buffett provides pretty good clues as to how he thinks about Berkshire's value. There's a huge amount of discussion in the investment community around valuing Berkshire, along with a great variety of approaches. Below I discuss one such approach that is simple and logical to me. It goes without saying, but any investor should come to terms with whatever valuation approach(s) they use and be comfortable with the valuation. Shares trade in the $144 range, and Buffett's buyback threshold is currently $119 (120% of BVPS).

Buffett has two key quantitatve valuation metrics, the first relating to the insurance companies, and a second related to its operating companies. The figures for 2014 YE:
(1) investments per B share: $93.42
(2) operating income per B share: $7.23

A simple, logical, and I believe a conservative approach to value Berkshire is to tack a multiple onto (2) (representing the approximate value of the non-insurance subsidiaries) and add (1) (the the approximate value of the insurance companies) to the resulting figure. Using a 10x multiple on the operating income results in a value estimate of $166 (see post publish edit below). The operating earnings are pre-tax, so a 10x multiple is around a 6.5% post-tax yield, which is reasonable regardless of interest rates, given Berkshire is also likely to grow, albeit at a much slower rate than in the past. I think this approach is fairly conservative because it ignores material adjustments to the upside such as superior capital allocation, long-term shareholder oriented and rational culture and, as I discuss below, this approach arguably understates the value of the insurance subsidiaries.

As it relates to the insurance companies, the obvious question is why does (1) represent the value approximation when it only considers the assets, ignoring the liabilities all together.  After all, the economic value of equity is market value of assets minus the fair value of liabilities. So shouldn't the liabilities financing the investments be subtracted from (1) to derive the net equity? Of course we should, but the key thing to note is that the fair value of the liabilities isn't even close to the GAAP value shown on the balance sheet. The reason is that Berkshire has a tremendous  group of insurance companies. Specifically they have generated an underwriting profit (before a dime of investment income is considered) for 12 years straight. And over the past 4 decades they have consistently delivered money ranging from extremely cheap (less than 30 year treasuries) to better than free (profitable underwriting). Importantly, this "float" is not only long enduring (i.e., it doesn't mature or amortize like a regular liability because it is constantly replenished), it has grown at rapid rates. Lastly Berkshire has a strong track record of reserving for its obligations.

Since Berkshire's liabilities have largely been better than free and long enduring, one could reasonably argue that they are not just overvalued at the GAAP amounts, but are literally on the wrong side of the balance sheet, or more conservatively are worth 0. And hence, getting back to market value of assets minus fair value of liabilities, the value of the insurance companies are worth at least the investments and cash (market value of assets minus 0). Here I ignore other net insurance assets (excluding goodwill), which are positive. This approach also ignores growth in float (i.e., the present value of additional free money to be received in the future). In his 2014 shareholder letter, Buffett stated that he does not expect significant growth in float in the future, so this seems like a reasonable assumption.

I have heard some argue against this math because the liquidation value of the liabilities is their face value shown on the balance sheet. This is totally wrong for the simple reason that if the liabilities are arguably sizeable assets on a going concern basis, why would any rational manager pursue a course of action that not only destroys the asset value, but converts them into huge liabilities?  More concretely, a manager could
(a) Unintelligently put the liabilities into runoff and pay someone to manage them. This would still convert an asset into a liability, which is irrational. But the liability would still be worth way less than face because it would be cheap money and payments would stretch years. Or
(b) More logically sell the business /transfer the liabilities at something close to fair value. If the liabilities are an asset to us as a going concern, why wouldn't they be for someone else?

I've heard other arguments such as the fact that the assets the liabilities fund must earn low returns to defease the liabilities, so therefore one cannot simply zero out the value of the liabilities. While I understand Berkshire must hold some capital to protect policy holders, which is a yield drag, I don't think the assets are at all relevant to the valuation of the liabilities. If someone wants to haircut the value of the assets separately based on one's own asset return hurdles, by all means. I would note though that my understanding is that Berkshire does not sell policies with unlimited liability, so Berkshire has chopped the tail of the loss distribution to where it knows it's worst case scenario. I think it may be for this reason that Buffett has stated minimum cash balances he will hold. Haircutting the value of this minimum cash could possibly be reasonable, but I currently don't make any adjustments myself because I think there's enough conservatism baked into zeroing out the liabilities (rather than adding additional value given the expectation of underwriting profit) that it probably more than washes.

Buffett and Munger

Investors in Berkshire must also be comfortable with Buffett and Munger's respective ages. Obviously their passing will be a huge blow. The stock will also most likely fall significantly, as it reasonably should given simple math, and the value they add. Overall from an investment standpoint, this is not a huge concern for me. For one thing, the valuation above does not consider any premium for superior capital allocation or other "Buffett premium", even though I think there should still be a a capital allocation premium absent Buffett and Munger. I think this because, Berkshire is uncommonly disciplined, rational and shareholder oriented. And they mean it, rather than pay lip service to it. Capital allocation aside, culture runs deep in organizations and all along Buffett has put good incentives in place for managers (and board members), so I expect that Berkshire will still manage to thrive after Buffett and Munger.

Conclusion

In conclusion, I think Berkshire, with a value of at least $153 (see post publish edit below) and price of $144, is an attractive investment right now. Particularly when compared to general market valuations today. Further, I think succession risk, while not to be dismissed, is minimal given Berkshire's culture and current valuation.

Post publish edit: Regarding valuation, I actually think it also makes sense to subtract around half of Berkshire's deferred tax liabilities. This comes to $13 per B share, bringing the estimate to around $153 ($166-$13). How did I come up with half? Very subjectively. Berkshire's DTL relates primarily to capital gains and accelerated depreciation in BNSF and the utility businesses. These are both liabilities where payments will stretch many many years. The capital gains are arguably worth close to zero because Buffett does not tend to sell core holdings.  In any event, treating them like a 30 year zero coupon bond, discounted at the 30 year treasury rate of 3.05% gives a present value of around 45% and I rounded to 50%.

Disclosure: Long BRK.B

LICT Corporation (LICT)

LICT is an integrated provider of broadband and voice services. On the voice side, LICT has traditionally operated as both a Rural Local Exchange Carrier (“RLEC”, an incumbent local telephone company serving a rural area) and a Competitive Local Exchange Carrier (“CLEC”, a local telecommunications provider which competes with the incumbent telephone company). It provides high speed broadband (Internet) access through the provision of copper-based digital subscriber lines (“DSL”), fiber optic facilities, fixed wireless, and cable modems. It also provides video services through both traditional cable television services and Internet Protocol television services; wireless communications; and several other related services.

Value investor Mario Gabelli is the CEO and chairman of the board. He directly owns 29.74% and indirectly another 9.27%. Gabelli has consistently stated that he believes shares are undervalued, and has backed it up by repurchasing shares.

On August 28, LICT received its second unsolicited offer (PR) of the year. The first was immediately rejected as inadequate. The board is currently considering the second. The price is not disclosed, but the press release states: "As with an earlier unsolicited proposal which LICT disclosed on February 19, 2014, the current proposal represents a significant premium to LICT’s recent trading price. In addition, the proposed price is closer to the prevailing financial and marketplace dynamics in LICT’s industry than the previous proposal."

Telecom transactions are heavily influenced by EBITDA multiples. EBITDA is used to control for different depreciation assumptions and capital structures. In LICT's Q2 earnings PR, they state their EBITDA guidance for the year, of around $41mm EBITDA before corporate expenses, and including DFT, a business they recently agreed to sell (expected to close in Q4). Adjusting to exclude DFT and corporate expenses (assuming $3.4mm based on the average of several recent years), LICT has around $34mm EBITDA. As illustrated below, LICT currently trades at 4.3x EBITDA.

Share price	4,800
Shares	0.022327
Mkt cap	107.2
EBITDA	34.4	Excluding DFT; 3.4mm Corp Exp
Net debt	41.5	Excluding DFT
EV/EBITDA	4.3

Below is a table with comparable companies and operating metrics and trading multiples. The LICT numbers exclude DFT.

Company	Rev	Mkt Cap	Net Debt	EBITDA	EBITDA Margin	Rev 6M 2014 vs 2013	Net Debt /EBITDA	EV/ EBITDA	LICT Implied Px
LICT	85	107	42	34	41%	6.4%	1.2	4.3x	4,800
FTR	4,667	6,763	7,112	2,040	44%	-3.9%	3.5	6.8x	8,633
CTL	18,136	23,815	20,778	5,793	32%	0.5%	3.6	7.7x	10,015
OTEL	76	5	112	28	37%	-8.3%	4.0	4.2x	4,582
LMOS	203	322	331	84	41%	-4.4%	3.9	7.8x	10,130
Scenario - DFT Implied								5.8x	7,031

LICT's basic operating metrics are strong relative to comparable companies. It has managed to stabilize revenues in the declining parts of its wireline business and is now increasing revenue year over year. Looking at the table, it is doubtful that Gabelli would accept less than 5.5x or so (around where he sold DFT), and 7x+ seem possible, though around 6-6.5x seems most likely. All of these prices are substantially above recent trading levels.

If the deal does not occur, which is quite possible, the price could fall. However given the operating facts, the cheap valuation, and association with Ganelli, I will be comfortable owning the stock for quite some time regardless of the outcome. Though not an important part of the thesis, given the M&A environment, I would not be surprised either if LICT receives additional offers.

LICT is not particulatly cyclical. One of the main risks in owning LICT as I see it is regulatory risk (ICC and USF changes being made by the FCC). I can say confidently that I know less about this than the market. The market though does not ascribe going out of business multiples to other regulated parts of telecom businesses, and I don't see anything special about LICT in this regard.

Conclusion
Though I didn't post much historical financial information in this post, LICT's business is moving along nicely, and the price remains quite cheap. As frustrating as it can be to pay double my original purchase price, I plan to increase my position in LICT, depending on availability of the stock.

Disclosure: Long LICT, and hopefully buying more soon

Hupsteel Limited (H73.SI)

Hupsteel is a provider of industrial hardware and infrastructure products. It derives it's revenue from sales of pipes and fittings, structural steel and general hardware to the Marine, Oil & Gas and construction industry in Singapore. It is based out of Singapore.

A link to a very interesting write up of the company that someone else put together can be found here. I don't have much to add to that write up.

The balance sheet is below:

	Book	Adjustment	Adjusted	Per Share	Comment on Adjustment
Cash & Equivalents	59,491	0	59,491	0.10
Receivables	41,499	-4,964	36,535	0.06	Additional bad debt reserve
Inventories	45,828	0	45,828	0.07
Securities	15,721	0	15,721	0.03
Other	313	0	313	0.00
Total Current Assets	162,852	-4,964	157,888	0.26
Properties	13,567	64,933	78,500	0.13	Market per AR
PPE, Net	24,934	-12,467	12,467	0.02	50% haircut
Non Current	38,501	52,466	90,967	0.15
All Liablities	8,808	0%	8,808	0.01
NCAV	154,044		149,080	0.24
NCAV + Non Current	192,545		240,047	0.39

A summary of the thesis is simple: Hupsteel is a profitable and cash flow positive net-net with substantial investment properties whose value does not appear to be reflected in the price. Hupsteel also operates in a cyclical industry that is currently experiencing very difficult conditions. When the cycle will turn is unclear but it will at some point, meanwhile the company remains profitable and cash flow positive. 

Disclosure: Long H73.SI

Credit Acceptance Corporation (CACC)

CACC is an indirect subprime auto lender operating since 1972. CACC offers automobile dealers financing programs that enable them to sell vehicles to consumers, regardless of their credit history. Their financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing.

CACC has a remarkable track record, as evidenced by the following:

	GAAP        EPS	% Change	Adjusted    EPS (1)	% Change	BVPS	% Change
2001	0.57		0.57		6.50
2002	0.69	21.1%	0.70	22.8%	7.29	12.1%
2003	0.57	-17.4%	0.55	-21.4%	7.91	8.5%
2004	1.40	145.6%	1.37	149.1%	7.34	-7.2%
2005	1.85	32.1%	1.74	27.0%	9.51	29.7%
2006	1.66	-10.3%	1.59	-8.6%	5.96	-37.3%
2007	1.76	6.0%	2.03	27.7%	8.52	42.9%
2008	2.16	22.7%	2.65	30.5%	10.86	27.4%
2009	4.62	113.9%	4.03	52.1%	15.73	44.9%
2010	5.67	22.7%	5.70	41.4%	15.82	0.6%
2011	7.07	24.7%	7.34	28.8%	20.30	28.3%
2012	8.58	21.4%	8.58	16.9%	24.29	19.7%
2013	10.54	22.8%	10.43	21.6%	31.24	28.6%
CAGR		27.5%		27.4%		14.0%
5 Year		37.3%		31.5%		23.5%
10 Year		33.9%		34.2%		14.7%

(1) See CACC's annual report for the meaning of this term. They adjust for asymmetries in US GAAP treatment of earnings and are adjustments that I agree with.

Business

CACC provides financing to dealers through two programs: (1) the Portfolio Program, and (2) the Purchase Program. In the Purchase Program, CACC buys loans originated by dealers directly. For 2013, the Portfolio Program accounted for 93.5% versus 6.5% for the Purchase Program. Under the Portfolio Program, as compensation for the loan, the dealers receives (a) an upfront "advance", and (b) payments that depend on the future performance of the loan ("dealer holdback"). Subsequently:

• Consumer sends CACC principal plus interest
• CACC is reimbursed collection expenses
• CACC takes 20% of remaining amount as a servicing fee
• CACC uses any remaining amount to reduce advance dollar for dollar (i.e., not according to some "advance" amortization schedule) until the advance balance is zero
• Any remaining amount is paid to the dealer

One can think of CACC owning an ABS with a 20% coupon where the dealer takes the first loss position. Dealers are incentivized to place more loans with CACC by providing that they be able to pool every 100 loans placed and receive accelerated dealer holdback payments related to these loans. 

CACC insists on a margin of safety in pricing the loans as illustrated by the following:

Consumer Loan Assignment Year	Forecasted Collection %	Advance       %	Spread       %
2004	73.0%	44.0%	29.0%
2005	73.7%	46.9%	26.8%
2006	70.0%	46.6%	23.4%
2007	67.9%	46.5%	21.4%
2008	70.1%	44.6%	25.5%
2009	79.2%	43.9%	35.3%
2010	77.0%	44.7%	32.3%
2011	74.1%	45.5%	28.6%
2012	73.5%	46.3%	27.2%
2013	73.3%	47.6%	25.7%

The spread is a very important metric to track. The trend of late has been downward which is a concern. This is a function of the competitive environment, which I discuss further below.

The forecasted collection percentages shown in the table above are based on a statistical model. Accurately forecasting collection rates is critical to their business, and the following illustrates their forecast performance:

	Forecast as Of			Variance from
Consumer   Loan Assignment  Year	Dec 2013	Dec 2012	Initial    Forecast	Dec 2012	Initial    Forecast
2004	73.0%	73.0%	73.0%	0.0%	0.0%
2005	73.7%	73.6%	74.0%	0.1%	-0.3%
2006	70.0%	69.9%	71.4%	0.1%	-1.4%
2007	67.9%	68.0%	70.7%	-0.1%	-2.8%
2008	70.1%	70.3%	69.7%	-0.2%	0.4%
2009	79.2%	79.5%	71.9%	-0.3%	7.3%
2010	77.0%	77.3%	73.6%	-0.3%	3.4%
2011	74.1%	74.1%	72.5%	0.0%	1.6%
2012	73.5%	72.2%	71.4%	1.3%	2.1%
2013	73.3%	--	72.0%	--	1.3%

On average, their forecasts have been conservative by 1.3%.

Discipline is critical for any lender. As Charlie Munger mentioned, "The first chance you have, to avoid a loss from a foolish loan is by refusing to make it; there is no second chance." I think the following table tells the story of a disciplined underwriter.

Year	Average Unit    Volume Per Dealer	% Change
2001	52.5
2002	59.1	13%
2003	64.7	9%
2004	61.2	-5%
2005	46.2	-25%
2006	41.3	-11%
2007	37.7	-9%
2008	37.2	-1%
2009	35.0	-6%
2010	42.7	22%
2011	44.5	4%
2012	35.7	-20%
2013	31.6	-11%

There's some noise in this table (e.g., 2008 and 2009 volumes per dealer decreased as a result of capital constraints rather than the willingness to write business), but it shows that CACC is more inclined to grow unit volume by adding dealers rather than by adjusting pricing to drive per dealer volume levels. Of course, all else equal, they would prefer to see per dealer unit volumes increasing.  But I think management behaves prudently.

The below table shows the total unit volume and active dealer growth through time.

	Unit Volume	% Change	Active Dealers	% Change
2001	61,928		1,180
2002	49,801	-19.6%	843	-28.6%
2003	61,445	23.4%	950	12.7%
2004	74,154	20.7%	1,212	27.6%
2005	81,184	9.5%	1,759	45.1%
2006	91,344	12.5%	2,214	25.9%
2007	106,693	16.8%	2,827	27.7%
2008	121,282	13.7%	3,264	15.5%
2009	111,029	-8.5%	3,168	-2.9%
2010	136,813	23.2%	3,206	1.2%
2011	178,074	30.2%	3,998	24.7%
2012	190,023	6.7%	5,319	33.0%
2013	202,250	6.4%	6,394	20.2%
CAGR	10.4%		15.1%
5 Year	10.8%		14.4%
10 year	12.7%		21.0%

Growth has been very strong, but has of late been slowing. This too is a function of the competitive environment which I discuss below.

Competitive Environment and Market

The competitive environment is characterized by (1) saturation - there are many competitors (NICK, SC, CPSS, commercial banks, savings banks, credit unions, WFC moving more into subprime space etc), and (2) reduced volumes due to trailing off of pent up demand during the crisis. This combination of forces is a concern. Are we at the top of the cycle with a slow motion crash ahead (rates decrease and losses rise slowly, but dramatically)? I'm not one to predict cycles, but I actually don't think this would be so bad for CACC because they strike me as very disciplined, and over time it would weed out weaker players and tighten supply. Anecdotal commentary I’ve read though indicates that (a) on the supply side, while loose historically, it is still tighter than 2006-2007, and (b) losses in subprime credits remain at historical lows.

Overall, while a very legitimate concern, I take comfort in the fact that management has navigated these cycles successfully in the past by sticking to their principles and staying disciplined on price. I also take comfort in the ‘skin in the game’ portfolio program approach CACC takes (rather than outright purchases). This significantly reduces credit risk relative to the alternative, and gives dealers an additional revenue source.

As Don Foss (the founder and chairman) mentioned, while there are not barrier to entries, there are plenty of barriers to making money. Operationally, CACC seems very well positioned relative to its competitors. Below is a table comparing return on assets (unlevered capital) achieved by CACC and it's 'pureplay' competitors.

ROA	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	Latest Qtr
CACC	7.47	11.99	8.72	6.59	6.45	12.63	13.5	12.12	11.29	11.08	10.05
NICK	5.39	7.21	7.81	7.18	5.33	2.43	5.28	7.34	8.88	7.65	6.91
SC	—	—	—	—	—	—	—	3.96	3.75	3.09	3.09
CPSS	-2.52	0.35	0.92	0.69	-1.33	-4.23	-3.74	-1.77	7.2	1.73	1.84

And below is a table comparing efficiency ratios.

	Operating Exp to Int Income
CACC	23%
NICK	35%
SC	18%
CPSS	33%

These two tables combined paint a picture of a company that is extremely well run as compared to it's competitors. While SC has a lower efficiency ratio than CACC, it operates with much higher leverage (which allows it to earn greater interest income; raising the denominator, lowering the ratio) to achieve this. Note their are many competitors that are not listed here (banks etc), but it is still worthwhile to compare figures against the "pureplay" competitors that the data is easy to obtain for.

CACC has a very small share of the market. There are approximately 40 million used cars sold annually, 60 million adults with sub-prime credit scores and 60,000 dealerships. In 2013, 6,168 dealerships originated 202,250 loans with CACC. The opportunities for CACC remain large.

Management

CACC management appears to be quite shareholder friendly, focused, and rational. Their communication and annual letters are clear and full of useful information. They also accumulate commonly asked investor questions and present the answers in writing on their website. From reading managements communication, three themes jumped out at me: focus, discipline, and rationality.

An interesting video with management being featured is here: http://youtu.be/wah9p824nYg. Some of this video seems quite scripted, but it does give a decent picture of the management style. 

Share Repurchases

The company is also a regular purchaser of it's own shares:

	Diluted         Shares
2001	43,150,804
2002	43,362,741
2003	43,409,007
2004	41,017,205
2005	39,207,680
2006	35,283,478
2007	31,153,688
2008	31,105,043
2009	31,668,895
2010	29,984,819
2011	26,600,855
2012	25,598,956
2013	24,009,593

Since year end, the company has purchased an additional 637,420 shares, and announced a tender for 915,750 shares. Repurchases have the effect of raising financial leverage.  Below is CACC's leverage as compared to competitors.

	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	Latest Qtr
CACC	2.0x	1.7x	3.5x	3.6x	3.4x	2.4x	2.8x	3.3x	3.4x	3.2x	3.6x
NICK	3.8x	2.6x	2.6x	2.5x	2.4x	2.3x	2.2x	2.1x	1.9x	2.1x	2.0x
SC	—	—	—	—	—	—	—	8.8x	8.5x	9.8x	9.9x
CPSS	11.0x	15.7x	15.5x	20.0x	18.2x	30.0x	163.1x	—	16.9x	14.8x	14.1x

None of these competitors have sticky deposits that would justify obviously higher ratios. So while CACC is quite leveraged, they appear to be on the more modest end of the spectrum.

Risks/Concerns

1. The main risk that CACC faces in my view is funding. They are highly dependent on the capital markets, which no question is not ideal. While I cannot dismiss this risk entirely, the 2008 credit crisis was a very good stress test of their business model, and they passed with flying colors. They grew adjusted earnings per share 30.5%, 52.1%, and 41.4% in 2008, 2009, and 2010 respectively. This is in spite of decreasing loan volume in 2009 due to capital constraints imposed by the crisis. 
2. As discussed, the competitive environment poses a persistent threat.
3. Collection forecasting accuracy is critical to their success. Competition threatens the accuracy of their forecasts by way of adverse selection. They regularly present backtests and have historically been conservative in their forecasts.
4. Specialty finance companies do not sell for premium earnings multiples. I'm not sure if this is due to some stigma, or just the fact that they're balance sheet lenders (commodity). Other than companies in trough/unusual earnings situations, only a couple companies currently trade at earnings multiples in the high teens (e.g., FCFS at 17x).
5. Don Foss (founder and chairman, age 69) is selling all of his shares. Mr. Foss owns roughly 4.4mm shares, and per disclosures in recent tender offers, he intends to sell 100% of these. I'm not exactly sure what to make of this, but I think it's doubtful that he is opportunistically selling based on his view that the price as currently high, and also doubtful that he thinks the company’s prospects long term are poor (after going for 41 years, through multiple cycles, and recent performance etc). Mr. Foss has been selling for a long time, somewhat consistently. I haven't gone through all the tenders, but he was tendering large quantities of shares both in October 2006 and July 2010 (two totally different points of the cycle).
6. Regulation - Dodd-Frank established the Consumer Finance Protection Bureau (CFPB). While the CFPB is a potential wildcard, at the moment it does not seem to be cause of much concern from CACC's perspective. To date their main focus seems to be fair lending practices (i.e., not discriminating based on race, religion etc). Something to keep a close eye on. 

Conclusion

I purchased CACC based on:

• Track record: Their track record is very strong. The last 5y/10y, they have compounded BVPS 23.5%/14.7%, adjusted EPS 31.5%/34.2%, and unit volumes 10.8%/12.7%.
• Management ethos: I am very impressed by management. They (a) strike me as very rational, focused, and disciplined; operate on margin of safety/value investing principles, (b) strong capital allocation; have also bought back a lot of stock (24%/42% of the stock the last 5y/10y), and (c) seem to be shareholder friendly; quite clear and transparent communication
• At 11.9x TTM NI (management’s “adjusted” earnings), the price seems reasonable, or at least not unreasonable. For context, historically CACC has sold for 13.5x-14x earnings on average the last decade; competitors currently trade in ranges of 9x (CPSS) to 15x (SC). My thinking is you're not paying a lot, if anything, for growth which they have delivered plenty of. 

For me, this is a company that I can say that were it to fall dramatically in price, all else equal (mainly management remaining in place, and access to funding), I would feel comfortable allocating a very large percentage of my net worth to.

Disclosure: Long CACC