PSA Likely to be Sold...Then Out of Business? - Part 2

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Posted By: Eric B

A couple months a go I started a thread giving my opinion about the future viability of PSA in conjunction with its parent company Collectors Universe (NASDAQ: CLCT). Most of that thread was off-topic, so Ill provide an update here and include another prediction. These are opinions only!

Earlier this month, CLCT issued its 2nd Quarter results (they are on a June fiscal year) for December 2008. They were not good. Several items stick out.

First, cash used during the quarter was over $3 million. At that rate they will run out within 2 years. And this occurred during a period where they were reducing expenses in order to conserve cash. They had already suspended dividends. While a correct move, it is one of the first signs that a company is in trouble. How many companies have eliminated dividends and not gone bankrupt? Im sure it happens, but it is infrequent. They also converted notes to cash. Again, good move, but they have run out of these easy transfers. Income loss for the quarter was $10 million. Ignoring impairment, it was still a loss of $2 million.

Second, they set up a full valuation allowance to their Deferred Tax Assets. That is really bad it is an admission that the company will more likely than not fail to make a profit in the near future (3-5 years) to use the deferred tax assets. These are Accounting terms, not mine.

Quick explanation of what this means via an example. Company makes $5 million. Taxes are $2 million which they pay. Therefore profit is $3 million. Next year, company loses $10 million. Taxes are negative $4 million. They dont get this back but rather record this $4 million as a Deferred Tax Asset to use later (technically they can apply to prior year, but ignore this since CLCT has already done this). Third year, company makes $15 million. Taxes are $6 million. They only need to pay $2 million since they can use the $4 million Deferred Tax Asset from the prior year.

So when a company sets up a full valuation allowance, they are saying that they will more likely than not fail to make a profit in future periods to utilize the Deferred Tax Asset. This is a sign that a company is going under.

So how does this affect PSA? Results for the quarter for the PSA division were down. Operating income was just $258K. This is before the Presidents salary, Accountants, sales staff, office rent, etc. If you apply these total CLCT overheads based on revenue, total income for PSA is negative, i.e. they are not profitable. PSA units sold were down 8% from the prior quarter and lower than last year. Presumably these cards were submitted in the August-October timeframe before the economic mess started gaining visibility. So results may be much worse next quarter. If interested, read the latest 10Q for CLCT on www.sec.gov.

The grading business model has the law of diminishing returns. When a card is graded, it doesnt need to be graded again. Yes, some of you resubmit, so lets say that when 100 cards are graded, 80 do not need to be graded again. So the population is constantly decreasing. Constant growth was always unsustainable. Plus the outside forces of fake holders, lack of grading integrity, scams, etc. are hurting the industry and will get worse, not better. The half-point scale was initiated based on need and is losing traction.

So I feel a sale of PSA is inevitable. CLCT already sold off the Currency Division, so anythings possible. Plus the owners are coin people that would be the last to go. I mentioned last time that a sale would cause PSAs demise within 5 years since they would get sold to a company that would squeeze revenue out for a short time before credibility is lost and the company cannot make any more profits. But thats assuming the company could be sold. Hard to sell if they are losing money.

So heres a new prediction the PSA SET REGISTRY WILL CEASE TO EXIST within 2 years. Why? Because its not making PSA much incremental revenue. Yes, a 1-of-1 PSA 8 T206 generates buzz and brings high sales. But PSA earned just $100 or so from the grading, same as a similar PSA 6. They dont all get resubmitted. But more importantly, the cost to transfer and setup the Set Registry Hardware and Software along with its maintenance makes a sale more prohibitive. A buyer would ignore that piece. Sticking with the population report held on an Access database would be much cheaper.

Im not anti-grading. But I feel the SGC model without the inefficiencies and costs of being a public company is the business model for long-term success. Beckett too. I would rather stick with them than the alternative. Think VHS vs. Betamax. Even then, eventually you transfer to DVDs.

Could these predictions fail to occur? Absolutely. The stock price has seen a slight resurgence recently. This signals to me that someone may make a play for the company. But they also instilled certain poison-pills to keep this from happening. So maybe the stock price is based on a sum of the parts and remaining cash. Regardless, the rate at which they are losing cash and the certain slowing of the economy will require them to do something. Layoffs?