Stocklemon Reports on Escala (Nasdaq:ESCL). Its Quality of Earnings and Business Model do not get our “stamp” of approval.

Ok, so here we go. You send me $10,000 for an investment in a stamp fund, yes a rare stamp fund, like the ones you used to collect when you were a kid. In return I will send you a photocopy of the stamps that you own ( as the real stamps are kept in a vault) and a postdated check for up to 10% interest on the money you will make in my guaranteed stamp fund…yes guaranteed.

http://www.tenerifeinsurance.biz/savings.htm

How long would this unregulated investment last in the US? Maybe 1 month before it gets shut down by some Attorney General. Well believe it or not, Spaniards have sunk some $6 billion into stamp investments for guaranteed rates of return as high as 10% a year easily surpassing the 3.5% they will earn in the bank. Much of this has gone to Afinsa who is the largest shareholder (over 70%) and business partner of Escala Group (ESCL), formerly known as Greg Manning Auctions.

First let’s peak into the financials of Escala and see how Afinsa affects its business.

In its last 10-Q, ESCL reported $558m of gross revenues.yet, just $40.1m of “related party sales” (7.1% of total revs) yielded an eye-popping 48.1% gross profit margin, while its other $514m revenues produced a scant .007% profit margin. Without those related party sales, instead of its “$15m profit”, Escala would have reported a $4.3m loss! It’s bizarre.

From 10-Q Sept 30, 2005 :

* All amounts in thousands

Is there any doubt that Afinsa is extending a sweetheart deal to plump up Escala’s profits…and as the largest shareholder by far on Escala, Afinsa reaps the benefit of the corresponding boost to Escala’stock . which happens to be Afinsa’s largest asset.

OK, so now we see that Escala is wholly dependent on Afinsa. Let’s assess how solid a business model Afinsa has.

The voices criticizing Afinsa’s business seem consistent no matter who the critic (smoke and fire). There seems to be widespread concern over the true value of the collectable assets being “sold” versus the perceived “guaranteed” value as established by Afinsa.Spanish consumer group Organizacion de Consumidores y Usuarios issued a warning about the danger of investing in stamps, citing its experience with Afinsa.

The consumer defense group says it was unable to find a buyer on the open market for a set of Afinsa stamps it acquired for Euros 600. “We were offered only 5 percent of the original purchase price if we wanted to sell Afinsa’s stamps on the open market,” OCU says in a special report on investing in collectables, which concludes that these investments are too risky for a non-specialist.”Motley Fool published an article stating that Lloyds of London, withdrew its insurance of the stamp portfolio with both houses over concerns about their actual value

http://www.fool.com/news/commentary/2005/commentary05112205.htm

But more disturbing, in a May Barron’s article the writer caught a top executive at Afinsa “Cold Busted”, as he sought a valuation on some stamps purchased from Afinsa, for which a documented valuation had been supplied (unknowingly) by the very same executive. This article is a must read for anyone who wants to see how Afinsa operates.

http://sl.stocklemon.com/ProdImages/escala barrons.doc

 While there has been a lot of flap in the press about Escala’s relationship to the “coingate” investment scandal in Ohio,

http://toledoblade.com/apps/pbcs.dll/article?AID=/20051129/NEWS24/511290375we think that is a sideshow. There’s only one real issue here: the quality of Escala’s earnings. It is the opinion of Stocklemon that Escala is a house of cards that is built on earnings created by a sweetheart deal which allows Escala to show a profit with a related party - its primary owner. This in turn increases the value of their stock. Meanwhile all business that is done without the related party is low margin and non profitable. In our opinion this is a double no-no. How their auditor lets this pass is a mystery to us.

This is a business model that can not sustain itself.

Cautious Investing To All