Found! Great Investors at Work: Tom Brown and Compucredit

Tom Brown is CEO of Second Curve Capital, a hedge fund focused on undervalued stocks in the financial services sector. He also runs a great blog, bankstocks.com

Brown recently stated that he likes sub-prime lender Compucredit. And it appears to be a huge holding for his fund.

Compucredit (CCRT) is a consumer loan company with four key businesses: credit cards, acquisition and collection of other companies’ receivables portfolios, payday loans, and automobile finance. Insiders own more than half the company, a fact that encourages the proper alignment of managerial and shareholder interest.

When speaking with Barron’s, Brown noted Compucredit has about $750 million of excess liquidity. Brown also mentioned that he liked management’s ability to manage risk, and that a company’s skill in making (and by inference not making) loans was a more critical variable in appraising a sub-prime lender than industry-wide phenomena like economic cycles and interest rates. Brown also saw opportunity in his supposition that Compucredit’s earnings could be expected to grow at an annual rate of 20% over the next two years, while its price to earnings ratio was likely to be in single digits. Payday loans and auto financing are big growth opportunities for the company. And the company’s specialized skill in underwriting loans for the sub-prime market, according to Brown, are potentially valuable in making acquisitions of companies and loan portfolios.

While Palmerston offers no endorsement or recommendation of Compucredit as an investment, Brown’s comments about where he has put a lot of his fund’s money offers insight about how margin of safety investors evaluate opportunities.

The $750 million of excess liquidity on the balance sheet (market capitalization is around $2 billion) is especially crucial. It can give Compucredit a variety of options for creating value on behalf of their shareholders. If there is an industry downturn, Compucredit might find opportunities to pick up assets at bargain prices. The larger reserve gives them greater capacity to ride out a severe economic downturn (were it to occur) than many of their competitors. And if some of those competitors are forced to dispose of assets in a hurry, Compucredit has the cash if a bargain appears. And that extra cash could give them an opportunity to ramp up their lending when competitors are suffering, or to return cash to it shareholders in form of stock dividends and repurchases.

So at a moment when many in the market are extremely concerned about a housing slump and the ability of poorer people to pay back mortgages credit card bills and auto loans, Tom Brown is looking beyond “consensus” views and betting that the market is missing something in the particular case of Compucredit.