I wrote a few articles about Asta in Dec 2009 – Jan 2010 on my previous blog here, here, and here.

Since that time, it has traded as low as $6.00 and as high as $10.03, overall trailing the return of the S&P 500 as shown below.

Today I think it presents a compelling investment opportunity.

To be sure, the company has faced headwinds in the past few years.

Its business depends on collecting receivables from individuals with poor credit, often through wage garnishments or property attachments. But with high unemployment hitting these consumers hard and falling housing prices exasperating overextended, low credit consumers, the great recession has dried up these collection channels.

A key challenge to investing in Asta is that cash flows from these pools of distressed receivables are difficult to predict, and therefore hard to value.

GAAP accounting for these pools requires a host of assumptions to determine what is a return ON investment versus a return OF investment. The assumptions are so numerous it makes relying on reported book values and income difficult.

Still, at $6.70 per share, Asta seems cheap by almost any yardstick.

Here’s What You Get Per Share of Asta Funding:

According to a press release, they had a cash balance on May 10, 2011 of approximately $97 Million ($6.63 per share outstanding). The company is cash flow positive and pays a small dividend of $0.08 per share.

For sake of this analysis, I will divide Asta’s portfolio of receivables into 3 buckets, as shown in the chart above:

1. The Palisades Portfolio Pool
2. The Other Receivables Pool
3. The Fully Amortized Pool

Bucket 1: The Palisades Portfolio Pool

Historically Asta Funding purchased smaller portfolios of receivables – up to approximately $15 million. Then in March 2007, they paid $300 million to acquire one large portfolio. I will refer to it as the “Palisades Portfolio,” but if you are reading their SEC filings it is also sometimes referred to as the “Great Seneca Portfolio,” “The Portfolio Purchase,” and a few other names. The portfolio has not performed well, falling behind expectations almost immediately.

To purchase the portfolio, Asta formed a wholly-owned subsidiary, “Palisades XVI.” The $300 million was financed with a $227 million loan from Bank of Montreal, and $75 million from the parent company’s line of credit.

The portfolio has performed poorly, Asta has impaired the portfolio a total of $97.2 MM on its books, and the Bank of Montreal debt note has been repeatedly modified.

The current loan modification requires that all cash flows from the portfolio go to pay interest and principal to BMO with minimum monthly principal payments of $750,000.

While none of this is good news, the key is that the Bank of Montreal debt is in a bankruptcy remote subsidiary. Even if cash collections from the portfolio are insufficient, the parent company is not obligated to cover the debt.

There is also some optionality value to the extent future collections ultimately surpass the required debt payments.

Buckets 2 & 3:

Bucket 2 consists of other pools of receivables.

As I noted above, GAAP accounting for these assets requires many assumptions to determine when cash collected is recognized as a return ON investment versus a return OF investment. The accounting for most of this pool follows guidance from the American Institute of Certified Public Accountants (AICPA) Statement of Position 03-3.

The cash flows in this bucket have been declining in large part due to the company not purchasing new portfolios of assets as discussed below under “Aggressive Deleveraging and Cash Conservation.”

Because of all the accounting assumptions, pools from bucket 2 can outlive their projections and continue to cash flow after the principal balance has been fully amortized on the books. At this point, all cash flows are recorded as income.

It is these cash flows that I am referring to as bucket 3. The company does not provide guidance on the cash flows to be expected, but a historical analysis shows a good degree of persistence.

And it makes sense that these pools would exhibit a degree of persistence. The pools are made up of thousands of individual receivables and much of the collections come from wage garnishments.

The graphic below shows total cash collections from the fully amortized pool (bucket 3) and the total cash flows from pools that are on the interest method of accounting (as governed by AICPA SOP 03-3). This 2nd group represents approximately 90% of the total cash flows for bucket 2. (The buckets are my own analytical distinction, the company does not report on these buckets, making it hard to track them exactly. Nevertheless, the ~90% gives a conservative view and doesn’t take away from the analysis).

Aggressive Deleveraging and Cash Conservation

For the past three years, Asta has been on a campaign of aggressive deleveraging and cash conservation.

It has scaled back dramatically on new purchases of distressed receivable pools as shown below:

This has led to an overall decline in assets and the decline in cash flows (described above) as the older pools continue to be repaid by the underlying debtors.

But in the short term it has also freed up cash flow to deleverage.

Below is the total debt outstanding for the last 4 fiscal years (excluding the non-recourse Bank of Montreal debt).

Excluding the Bank of Montreal note, the debt is now all paid off (remaining balance from FY end 2010 has subsequently been repaid), and with the added help of a $52.7 MM tax refund, Asta has accumulated cash as shown below:

Despite their decline, with no interest payments the cash flows from the fully amortized and interest method pools (again ~90% of bucket 2 and all of bucket 3) seem more than sufficient to cover operating expenses, as the graph below suggests:

Ultimately Asta will need to decide what to do with all the cash. But whatever it decides, at $6.70 per share, the cash balance and positive cash flows provides an investor with good downside protection in this company.

Update: Asta Funding was recently deleted from the Russell 3000 index, an index of the largest companies by market cap. This will likely provide selling pressure in the short term as index funds sell indiscriminately to rebalance but, in my opinion, may provide a good buying opportunity for long-term investors.

Author Disclosure: Author has a long position in Asta Funding at the time of writing.

In it I discussed my concerns regarding certain SEC filings of L&L Energy (LLEN).

I had originally intended to post several follow up articles focusing on other aspects of the company, but in light of today’s events I no longer plan to continue this story.

I am also a contributing author for SeekingAlpha.com, and in connection with this am required to disclose if I have a position in any securities that I write about. My disclosure for the L&L article was that I had plans to enter either a short position or purchase put options.

For the record, I do not, and never have had any position in L&L Energy. To my knowledge, none of my friends, family, or associates have or have ever had a position in L&L Energy. I also no longer plan to enter any positions in the foreseeable future.

Simply put, I am not and never was positioned to profit in any way from the publishing of my article.

I write about investments as a hobby. I write about stories that I find interesting and always look forward to sparking a good debate. I firmly believe that a healthy market allows all market participants to discuss their views openly and that differing opinions contribute greatly to the efficiency and integrity of the markets.

I want to make one point very clear:

I am proud of the article I wrote, and I believe it to be 100% factually correct.

It accurately reflects my current opinion of the company, but at the end of the day, it is only my opinion.

Others will disagree but that is what makes a market.

Sincerely,

Aaron Stackhouse

L&L Energy, Inc, (NASDAQ: LLEN) is in the business of coal mining, washing, coking, and wholesaling. Although its operations are conducted in China, the company is headquartered in Seattle, WA. As of 5/20/11, the company had a market cap of $200 MM.

The stock has been volatile, and although off significantly from its 2010 highs, the stock is still up over 200% from its 2009 debut.

The company claims an impressive growth record.

It also has questionable accounting, puzzling acquisitions, and checkered senior management.

Today in part 1 of this series I am going to discuss the accounting irregularities I have found.

Accounting Irregularities

L&L’s SEC filings are riddled with accounting red flags, which is even more alarming as the CEO is a CPA, and the filings claim their business strategy is to “assign our US trained management team, including CPAs from the Seattle office to monitor and control the coal operations.”

Below is the actual balance sheet as reported on the 2010 10-K. Notice how the title omits the year, and 2009 is formatted as 2,009. The latter happens to me all the time… when I am creating a spreadsheet from scratch and excel assumes 2009 is the number 2,009 instead of the year.

Below is a portion of the statement of cash flows, as presented in the 2010 10-K:

Notice the “beginning of period” cash balances provided for 2009 and 2008, and compare them to the figures on the Balance Sheet as reported in the 2008 10-K:

To be fair, L&L did restate their 2008 results, but there was no mention of the cash restatement. The full disclosure in the 2009 10-K is as follows:

Subsequent to the issuance of the Company’s financial statements for the year ended April 30, 2008, the management of the Company determined that certain transactions and presentation in the financial statements for the year ended April 30, 2008 had not been accounted for properly.

Management became aware that there was more VAT tax payable in addition to what was recorded and reflected in the financial statements as of April 30, 2008. VAT tax payable was understated by $590,817 as of April 30, 2008. In addition, Management also determined that certain items in balance sheets of the Company as on April 30, 2008 were not properly classified in accordance with the US GAAP, specifically the allowance for bad debts.

The Company has restated its financial statements by recording the accrual for VAT taxes and bad debt allowance expenses, and reclassification as of April 30, 2008.

The effect of the correction of presentation is as follows:

The above constitutes the entire disclosure in the 2009 10-K.

No mention that the CASH at year end 2008 and 2007 was restated 28% and 93% lower than originally reported, respectively.

No disclosure that 2008 REVENUES were revised down by 27%, or that 2008 NET INCOME was revised down by 30%.

Note also that the restated balance sheet lists previously stated “total current assets” at $25,393,791, while the actual balance sheet as reported in 2008 (shown below) lists total current assets as $20,725,183.

Also notice that the restated “statement of operations” incorrectly calls it a statement for the year ended April 30, 2009 instead of 2008.

But most troubling is the cash discrepancy.

The 2008 10-K provided the following cash detail:

And the 2009 10-K provided the following (which are the restated balances):

Notice again the restatement of the 2008 cash balance, which was quietly ignored in the restatement disclosure. Note that the restatement even includes a restatement of the cash balance LLEN claims as “cash in banks.”

Also notice that the 2009 cash balance of over $5 MM includes a surge to $4.5 MM of “cash on hand,” as distinguished from “cash in banks.” I guess this means they have suitcases full of cash.

I hope the auditor brought a money counter…

Auditing

Speaking of the auditor, don’t count of them to verify the books.

The company is audited by Kabani & Company, Inc of Los Angeles. In a July 2010 inspection, the Public Company Accounting Oversight Board (PCAOB) reviewed Kabani’s audit of 8 different issuers. According to the report, the PCAOB “identified in 5 of the audits reviewed [sic], deficiencies of such significance that it appeared to the inspection team that the Firm did not obtain sufficient competent evidential matter to support its opinion on the issuer’s financial statements.”

These deficiencies included failures to properly address:

• in 2 of the 8 audits, departures from GAAP related to the treatment of minority interest
• the reporting of a disposal group held for sale and discontinued operations
• in 2 of the 8 audits, revenue testing
• the functional currency of a consolidated subsidiary
• valuation of acquired patents
• failure to test whether advance payments represented probable future economic benefits

Summary

Alarming as this is, it is far from the only reason to have concerns about L&L Energy. I’ll be back soon to discuss the other giant red flags at this company.

Author Disclosure: Author has plans to enter a short position and/or purchase put options in L&L Energy at the time of writing.

On the short side we have David Einhorn’s Greenlight Capital. Mr. Einhorn is a highly respected manager who’s fund has returned annualized returns of 22% since inception in May 1996 (through 2009) compared to approximately 4% for the S&P 500.

Einhorn has been publicly short since 2007 and on 10/13/10 he made public an updated analysis of the company. His presentation, which can be found here on his website, centers on his thesis that much of the land is not worth what the company says it is.

There is a LOT to say about this investment so this will be the first of a few articles over the next several weeks – this article will examine just one small piece of the puzzle…

The company owns approximately 574,000 acres of land, primarily in the Florida panhandle. The majority of this is undeveloped land managed as timberlands, but approximately 38,200 acres have entitlements for residential or commercial development.

St Joe owns 71,000 acres surrounding the new Northwest Florida Beaches International Airport in the West Bay Sector of Panama City Beach. 41,000 of these acres are dedicated to preservation in the sector plan, and the value of the remaining 30,000+ acres has been subject of much debate around this company.

So how much is this land worth?

Well, the airport relocated from its former location which was approximately 10 miles southeast in Panama City. In conjunction with the move, the airport authority sold the land at this previous location to Leucadia, who has plans to redevelop the site as a mixed-used project, for $80,000 per acre. Some bullish analysts have pointed to this 2007 sale as a comp for the value of St. Joe’s land surrounding the new airport site.

The argument is that if you apply all of St Joe’s enterprise value of ~$2.2B to this land around the airport, the market is valuing the land at $60,000 per acre and investors are getting the rest of the company “for free.” (The enterprise value has gone up a bit since Broyhill’s report, but this the basic argument.)

This argument seems to have gathered some momentum as David Einhorn noted in his presentation.

But at a closer look, this comp doesn’t even pass the smell test.

In fact, I’m pretty sure the only reason it was ever considered a comp at all is that both parcels are usually referenced in the same sentence as the word “airport.”

Let’s review… Leucadia purchased a FORMER airport, to be redeveloped as a residential site. The land consists of 708 acres situated along the water in Panama City. The demographics are dense – with 73,000 people in a 5 mile radius. It is one of the last available tracts of land of this type in Panama City, and notably, it is NOT next to an airport. What’s more, Leucadia purchased the property in 2007 near the top of the RE bubble.

St Joe’s land on the other hand is next to a new airport (not the most attractive feature last time I checked). It has much lighter demos – only 427 people within a 5 mile radius – and almost none of the developable land is on the water. (The land shown in green above is dedicated to preservation – and the yellow waterfront land at the northwest corner of the bay is actually part of a separate St Joe development, River Camps on Crooked Creek, which is a nice development but carried elsewhere on the balance sheet). St Joe’s airport land needs to be evaluated at today’s levels and shouldn’t be appraised at 2007 peak values, and notably, this land will require significant capital investments in site work, roadways, utilities etc.

Demographic data from SiteReports

The problem with this comp is the Anchoring & Adjustment Heuristic. Once $80,000 per acre is suggested, there is a tendency to revise estimates relative to this anchor, regardless of whether $80,000 is a reasonable starting point. Once someone points to $80,000, $60,000 suddenly becomes “conservative.”

I’ll be back soon to discuss some more realistic estimates for what this land is worth (but first, forget the $80,000 figure) and other aspects of this exciting investment debate!

Author Disclosure: Author is considering a short investment at the time of writing and is likely to enter a short position in the next few days.

Just a quick update…

On July 17, 2009, I ran a Yahoo Finance stock screen for stocks trading at a low P/B and relatively high cash per share. I then looked at the individual balance sheet of every stock and compiled the list below of all stocks from the screen that were trading at less than 1.1 times their net-net working capital.

I have been following their performance and below is an update (original post here):

(1 – NUHC was acquired at $7.00 per share by Arrow Electronics during the study period)

As you can see, the S&P 500 increased 40.7% between 7-17-09 and 3-2-11 (23.3% annualized) while on average, the NNWC stocks increased 81.3% (44.1% annualized) over the same period.

Of the 37 NNWC stocks, 12 underperformed and 25 outperformed the S&P 500 during this period.

DISCLOSURE: Author has no positions in any of the stocks mentioned in this article