Insolvency companies look beyond the recession; but should investors?
If you think there's something inherently malodorous about making money from distressed consumers and businesses, you're not alone. Many Fools feel the same.
On our Dealing with Debt discussion board there have been forceful criticisms of personal insolvency companies over the years. While on the investment boards, putting forward a corporate insolvency company as a share idea is guaranteed to produce some strong attacks on the ethics and behaviour of practitioners in the sector.
Whatever your views about these businesses, though, you'll probably agree that they might be expected to prosper in harsh economic times. Yet, by and large, the latest recession hasn't been a great bonanza for listed insolvency companies and their shareholders.
Personal insolvency
For a spell in the mid-noughties it seemed like personal insolvency companies were listing on the stock exchange every other week. They promised -- and for a few years delivered -- sparkling earnings growth. And they traded on eye-poppingly high price-to-earnings ratios.
The goose laying the golden eggs was the Individual Voluntary Arrangement (IVA), a debt solution which allowed many people to write off a significant portion of their debt and pay the rest over a number of years.
The party came to an end for 'IVA factories' in 2007. Creditors, mainly banks, decided to get tough, exposing the shortcomings of the companies' expensive mass advertising-driven business models and reliance on big upfront fees. By the time the recession hit, their profits -- and share prices -- had largely collapsed and some were already on their way to going under.
Today, the few survivors huddle in the lower reaches of the AIM market. The biggest of them, Fairpoint Group (LSE: FRP), has a market cap of £31m, a shadow of its former size when it traded under the name Debt Free Direct. Ironically, just ahead of last month's announcement that the UK had finally crawled out of recession, Fairpoint Group released an upbeat trading statement exuding confidence for the future.
Corporate insolvency
Share prices in corporate insolvency companies have fallen across the board since 24 October 2008 -- the date we learnt that GDP growth had turned negative. RSM Tenon Group (LSE: TNO), is down 7%, while Begbies Traynor Group (LSE: BEG) and Vantis (LSE: VTS) have fallen 43% and 77% respectively.
Vantis's problems have been manifold: massive debt, a too-clever-by-half tax scheme that put it under investigation by HM Revenue & Customs, a dispute with its auditor ahead of its recent interim results -- which, when they were finally released, included hefty asset impairment charges and a going-concern warning from the auditor.
Begbies Traynor's latest interims came with a profits warning for the full year, which my colleague Malcolm Wheatley has reviewed. The company's core insolvency and recovery business, which is responsible for around 85% of group revenues, has been thriving, but its tax advisory division has struggled.
RSM Tenon Group, the largest of the three companies, sitting at the top end of AIM with a market cap of £152m, released a positive trading update last month. The company generated only about 30% of its revenue from insolvency and recovery in 2009, but has been agile enough, through acquisitions and reallocating resources within its business mix, to grow earnings per share in each of the past five years; a trend which analysts believe is set to continue.
The worst is yet to come
The recession may be over, but insolvency companies are still waiting for their high season. The thinking seems to be that an enormous wave of financial distress is building behind the temporary wall of low interest rates and quantitative easing, and that as in previous recessions insolvency numbers will continue to grow strongly for two to four years after GDP has turned positive.
However, the latest insolvency statistics give a mixed message, with personal insolvencies hitting a record high but corporate insolvencies showing an overall fall.
A further concern for corporate insolvency companies, and anyone considering investing in them, is that the Office of Fair Trading announced last November that it was launching an investigation into the corporate insolvency market.
If all this hasn't put you off, then Fairpoint, in the personal insolvency sector, may have some appeal as an IVA-survivor, and RSM Tenon Group, having managed to grow its earnings through the recession, unlike its corporate insolvency peers, is perhaps also not without attraction. Personally, I see stronger and less problematic opportunities in other areas of the market.
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