A Controversial Small Cap

By Sham Gad | January 13, 2010 AAA

The stock market is not without its share of companies that, for one reason or another, look destined for a prolonged period of difficult operations. As Buffett often quips, it's often better to leave these businesses alone, because it's easier to "walk over one-foot hurdles than jump over seven-footers." As always, there's great wisdom in Buffett's remark. The following small cap names have indeed dealt with years of difficult times, but for one reason or another, possess attributes that could create value.

IN PICTURES: Eight Ways To Survive A Market Downturn

See For Yourself
The first company, CompuCredit (Nasdaq:CCRT), may be one of most shunned stocks today, partly because it occupies a highly controversial industry: the underserved consumer credit market. In other words, CompuCredit helps those who are unable to obtain a traditional credit card gain access to credit. Whereas the big names like Bank of America (NYSE:BAC), JP Morgan (NYSE:JPM) and Capital One (NYSE:COF) focus on the traditional credit customer, CompuCredit squarely focuses on the severely underserved consumer who does not have the means to obtain credit from the traditional credit market.

Light at the End of the Tunnel
In exchange for these services, CompuCredit charges fees commensurate with the risk involved. Unfortunately, these practices have come under intense government scrutiny because the fees are believed to be unfair. Needless to say, with the economic downturn, this business model is not where you want to be today. But wait: CompuCredit is not some fly-by-night business run by undesirable individuals. In the fact, it's the exact opposite. Through thick and thin, insiders have maintained ownership of nearly 50% of the company with CEO David Hanna receiving only a $50,000 a year salary - even when the company's market cap was over $1 billion. So the wealth destruction created by the collapsing share price has hurt management just as deeply as it has shareholders. (For more, see Can Insiders Help You Make Better Trades?)

It's likely that the above side of the business will be in a tough time for a while to come. And it appears that management feels the same way. What is now intriguing about this company is a spin-off of the company's microcredit business into a separately traded public company, Purpose Financial Holdings. Purpose Financial will be primarily engaged in the business of marketing, servicing and/or originating small-balance, short-term loans through a network of 316 retail branch locations in Alabama, Colorado, Kentucky, Mississippi, Ohio, Oklahoma, South Carolina, Tennessee and Wisconsin and via the internet in both the U.S. and the U.K. The businesses had revenues of approximately $98.4 million and $107.2 million for the nine months ended September 30, 2009, and year ended December 31, 2008, respectively.

With a current share price of about $3.50 and a market cap of $165 million, this spin-off could be the next leg of growth for CompuCredit. Traditional micro loans are typically given to people who use them for business purposes, which suggests a high rate of payback but, more importantly, a much more acceptable business practice in the eyes of the public and the government. (For more, see Cashing In On Corporate Restructuring.)

Time Will Tell
While a lot of other variables exist, a successful spin-off along with a quality microloan business could be just what shareholders need from CompuCredit. It's doubtful that the subprime credit lending business will ever come back to what it was before the financial crisis. Getting shares in a separate entity focused on one specific business area could be the hidden gem in what otherwise seems a nearly impossible business outlook. (For related reading, check out Subprime Lending: Helping Hand Or Underhanded?)

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