Thesis
World Acceptance is a legal loan shark whose financials and business practices do not add up. Either the business is much less attractive (returns shown are being accomplished by hiding the commensurate risks), or it is preying on the weak and must be regulated away. Neither scenario paints a favorable outlook of WRLD's future. Current regulation provides an imminent catalyst, which I believe will play out over the next 12-18 months. I believe we will be able to "see the white's of their eyes" on this investment, and can scale into this accordingly as the regulatory pressure builds. I think this could be a potential zero or very close to it.
In the company's own words, the business model could be regulated away (10K):
"...proposed or pending legislative or regulatory changes have been introduced that would, if enacted, have a material adverse effect on, or possibly even eliminate, our ability to continue our current business. We can give no assurance that the laws and regulations that govern our business will remain unchanged or that any such future changes will not materially and adversely affect or in the worst case, eliminate, the Company's lending practices, operations, profitability or prospects."
Overview
WRLD was founded in 1962 and makes installment loans aka small dollar loans, unlike others in the payday or pawnshop space. They are the only public company operating in this niche. In FY2010, the company's average originated gross loan size was $1,067 and the average term was 11 months. The annual percentage rates on the loans range from 25% up to 204%. WRLD operates ~1,000 cheap small storefronts in 11 states in and around the south, as well as in Mexico. Growth is severely limited as the company operates n all states that legally allow their business model. WRLD's goal is to operate by the letter but not intent of the law by utilizing a series of loopholes. Up until recently, the regulatory pressure on small subprime lending has been focused on the very short term payday loan space.
Sources: Company reports
Analysts, however, are asleep at the wheel, having focused on Mexico and its potential for new growth. Mexico is a rounding error, accounting for 80 offices and 4.5% of the company's loan book while not turning a profit until the most recent quarter, in which it earned $279K pre-tax. It seems unclear if their business model works the same in Mexico (lack of social safety nets). Either way, the impact is minimal given it is starting from such a low base.
Sources: Company reports
Excess Returns
WRLD uses a method of precomputing the interest on the loans called the rule of 78s, a largely archaic loan method leftover from the era before computers. The effect of this is to penalize prepayments by frontloading the interest into the loan structure. WRLD states loans are prepayable at any time without penalty. WRLD further misleads customers by claiming they get a rebate if they prepay but this is much less than the normal savings for prepaying a loan due to the front loaded nature of the interest on the loan.
http://en.wikipedia.org/wiki/Rule_of_78s
The real insidious part of this loan structure is how it is used to juice returns and create a cycle of debt many customers get locked into (without any understanding). WRLD aggressively markets refinancing of loans before maturity. Once a customer has paid a few months of the loan (which was mostly interest), the customer is eligible for another loan. Due to the rule of 78s, the loan structure and new origination fees dramatically increase the effective APR well beyond what would have been if the loan was simply paid off in due time. Thus, the company is able to charge interest rates upwards of 204%.
From the 10K:
"As of March 31, 2010, the annual percentage rates on loans offered by the Company, which include interest, fees and other charges as calculated for the purposes of the requirements of the federal Truth in Lending Act, ranged from 25% to 204% depending the loan size, maturity and the state in which the loan is made."
Sources: Company reports
One might suspect that credit quality would tell a story of the aggressive growth and egregious business practices, but quite the opposite is true. Credit trends have remained impressively healthy over The Great Recession.