Bill Ackman Offers a Short-Selling Lesson
One of the market's best-performing stocks yesterday was a company called World Acceptance Corp., which makes small loans to people whose finances are in dreadful condition, many of whom can't even get a credit card. This is a lucrative business, as long as the cops don't clamp down too hard. And so far they haven't, notwithstanding the efforts of some hedge funds that have shorted World Acceptance's shares.
One of the timeless lessons of hedge-fund manager Bill Ackman's recent adventures with Herbalife Ltd., the nutritional-supplements distributor, is that if your reason for shorting a stock is the hope of some sort of future government crackdown, you may not have much of a catalyst. If a company is a pyramid scheme or another kind of scam, it can stay that way for a long time without the government doing anything about it, even if lots of people are begging regulators to act. As long as the scam is profitable, the company will keep making money, which is bad for anyone shorting it.
I'm not saying Herbalife or World Acceptance is a scam. Other people have said those things already. (Last May, ProPublica published a wonderful investigative report about World Acceptance that ran under the headline, "The 182 Percent Loan: How Installment Lenders Put Borrowers in a World of Hurt.") The point is that the business of shorting stocks and then calling up regulators, while defensible as a noble exercise in public service, has its drawbacks. The cops may prefer eating doughnuts or chasing other miscreants instead.
In World Acceptance's case, the stock rose 14 percent to about $100 yesterday after the company reported quarterly earnings that topped analysts' forecasts. The shares are up 27 percent in the past year, although the price isn't back to where it was three months ago when Bloomberg News ran an article that began with this sentence: "Hedge funds betting against shares of World Acceptance Corp. have been pressing the U.S. Consumer Financial Protection Bureau to investigate the installment-loan firm, according to people briefed on the discussions."
We're still waiting to see if anything comes of that one. Meanwhile, about 46 percent of the company's freely tradeable shares had been sold short by investors as of Jan. 15, according to data compiled by Bloomberg.
Net income was $23 million last quarter, up 11 percent from a year earlier, on $160.5 million of revenue. It's still a small company, but it has a valuation that would make any Wall Street executive salivate. At $1.1 billion, the Greenville, South Carolina-based company's stock-market value is 3.4 times its book value, or shareholder equity. For a financial-services provider, that is the sort of multiple you usually see only during a mergers-and-acquisitions frenzy.
It's especially remarkable when you consider the makeup of World Acceptance's balance sheet. The company has $947 million of total assets, 89 percent of which are loans. Basically, the market is telling you that a bunch of loans made by World Acceptance is worth a lot more money than a group of loans made by almost any other lender. This might seem nuts at first. But then wait until you see the company's income statement.
World Acceptance said it had about $142 million of income from interest and fees last quarter -- for a company that had a mere $842 million of loans as of Dec. 31. That's a huge amount of interest and fees for a very small loan book. It sure beats doing 30-year mortgages at 4.5 percent. To be sure, that loan figure is a net number. It showed gross loans of $1.26 billion, which excludes the company's loan-loss allowance along with unearned interest and fees. The downside to lending money to poor people is that a lot of them don't pay you back, which is why the company charges its customers so much.
It's easy to understand why some investors believe that lobbying the Consumer Financial Protection Bureau to complain about abusive lending practices is a potentially winning strategy. And perhaps they will be proved right. There's just no telling when that will be, if ever.
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