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Sunday, August 07, 2005

Credit Acceptance Corporation (CACC)

This company (website) is in the same business as one of my other investments, NICK, so I have some interest in understanding it. But I find it more difficult to understand than NICK. That's a red flag. They are way behind in financial statements with a zillion 8-Ks that I need to go through.

CACC started out doing financing for the founder's dealerships. This expanded to other dealerships. Rather than doing normal financing, the company sort of shares a specific part of the risk with dealerships. The company directly finances part of the car and sends that money to the dealership immediately along with the down payment. After the advance has been recovered, 80% of the customer payments go to the dealer. 20% goes to CACC, along with apparently other fees of some sort, including collection costs, some sort of "service contract programs", life insurance(?), and a patented (oh geez) "Credit Approval Processing System" (CAPS), car leases, lease termination fees, and fees charged to dealers when they enroll in the program (watch out for this last one). Only 71% of revenues come from finance charges. Leases have been winding down. "ancillary product income" has been ramping up (13.3% now).

Why involve the dealers in the financing? Why do dealers pay $9,850 to join the Company's program?

Number of dealers involved:
Those numbers look bad.

The company has responsibility for collections. Each loan has a sort of capital structure. At the top of the stack is CACC's collection costs. Next is CACC's servicing fee. Next is the repayment to CACC for the advance made to the dealership. Lastly, any remaining amount goes to the dealer (dealer holdback). I suppose this creates a strong incentive for dealers to not submit garbage loans. Any misrepresentation by the dealer allows CACC to force the dealer to buy out the loan for the remaining balance, less unearned finance charges due CACC plus $500 for-the-hell-of-it fee. The structure of deals is generally set up so the dealer recovers their own costs immediately and some additional profit. Their claims at the bottom of the capital stack are gravy, apparently. Based on watching NICK over the years, I know there's a surprisingly large amount of profit that is squeezed out of high-risk loans.

CACC can audit the dealer's records. CACC can terminate the agreement on a material change in ownership of the dealer. The dealer can simply stop submitting new loans to CACC, but if they terminate the agreement, it's pretty harsh.

They ventured into UK and Canada and admit that it's a mistake (I'm one to talk, I wasted the last 2.5 weeks on automation that, in the end did me no good, thanks to the bizarre reaction of the pink sheets website to block my IP address after downloading a bunch of stuff that absolutely pales compared to what others are doing at Yahoo, and I did spend a lot of worthless time on community banks... ok, back to business).

CAPS does the usual automated computations on risk and return. Dealers submit stuff and instantly see the terms. They can change parameters and see how that affects their advances and customer terms. Pretty standard stuff.

It looks like CACC creates static pools once a dealer reaches 100 loans. At that point, they can elect to take some of that holdback money immediately, based on the usual computations.

Principal due is "loan receivable" while fees due are "unearned finance charge" on the balance sheet.

Average loan sizes are about 50% larger than NICK ($12K vs $8K) and maturities are shorter (37mo vs 44mo). The average loan in 2003 was $12K with a $5.7K advance.

There were 916 dealers who submitted at least one loan during 2003.

CACC has the usual assortment of teams for the various phases of default, including repossession and legal action.

CACC has some deals with insurance companies on life and disability insurance. CACC gets some of the profits in exchange for taking some of the re-insurance risk.

There's some sort of service contract that I'm not sure I understand. Dealers can offer these contracts to customers. The price is added to the loan. A 3rd party then carries the risk. About $22 million in revenue is from insurance and service contracts, something like 15% of total revenues.

The company also provides a plan to finance dealer inventories at 12% to 18%. This was being phased out in 2003. There were other secured credit schemes.

CACC's business is in Michigan, Virginia, Maryland, NY, Tenn, and a huge amount (66%) in "all other states". 694 employees, 439 in collection and servicing.

4.2 million stock options outstanding, average strike of $7.31. Net income has been consistently $28 million up to 2003. Probably something like 60 cents a share in earnings after all stock dilution, present and future.

In 1999, CACC had to up it's provisions for losses on loans made in 1995-1997. They're typically bad at predicting collection rates when loans are growing a lot.

18+% net margins.

Free cash flow seems to have been around $1 per share (earnings are 60+ cents) and the stock is selling for around $13. I need to get more up to date on 2004 and 2005.

(more on the way, all sorts of interesting stuff after this)

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