Altisource recap

This is just my opinion, but I think that Altisource is pretty cheap despite being one of the fastest growing stocks around.  Here are the company’s historical earnings per share (diluted):

2008: $0.38
2009: $1.07
2010: $1.88
2011: $2.77
2012: $4.43
2013: $5.19
Trailing twelve months: $6.69

Despite this incredible growth, the current TTM P/E is 12.8.

Amortization of intangible assets

In the past 2 quarters, amortization of intangible assets was $19.573M.  I believe that this non-cash expense hides Altisource’s true profitability.  Buffett discusses this issue in his 1983 shareholder’s letter.

Annualized, I believe this expense is somewhere around $1.61/share.  Adjusted P/E would be around 10.44.

*The intangible assets come from Altisource’s purchase of software companies (e.g. Equator) and from fee-based businesses carved out of servicing platforms that Ocwen acquired (Rescap, Homeward).  Perhaps you could argue that the amortization of intangibles related to the fee-based businesses make sense.

Future growth

Spinoff structure

HLSS OCN and RESI were spun-off (and IPOed) so that the spinoffs would contain businesses with lower returns on capital.  The spinoff companies are essentially Altisource’s ‘captive customers’.  They have long-term contracts that obligate them to use Altisource’s services and products.  (HLSS indirectly helps Altisource via Ocwen.)

The spinoff companies will likely continue to sell shares in secondary offerings and to lever up the new equity with debt.  The capital that they raise benefits Altisource as the capital is invested in growing the lower-return businesses.  This ultimately results in more fees for Altisource.

Full impact of Ocwen’s growth

There is a lag between when Ocwen acquires a portfolio of mortgage servicing rights and when Altisource sees increased fees from Ocwen.  If Ocwen were to remain the same size, Altisource’s EPS will go up slightly as Ocwen fully boards its loans onto Altisource’s REALServicing platform.

The latest quarter’s earnings grew year-over-year from $1.25/share (diluted) to $2.24/share, or +79%.

Altisource’s industry will rapidly grow

A report by O’Neil Equity research (PDF) provides the following table illustrating the shift towards specialty servicing:

oneil-shift-toward-specialty-servicing

Note that all of the large US banks are reducing their MSR portfolios ahead of Basel III capital requirements.  (Basel III requires the banks to use less leverage in buying MSR portfolios, making the return on equity unattractive.)  Even Wells Fargo is trying to sell MSRs to Ocwen.

The other industry tailwind is the rising cost of complying with regulations.  Thanks to increased scrutiny from the CFPB and Benjamin Lawsky of the NY DFS, the cost of mortgage servicing is rising.  This makes outsourcing mortgage servicing more attractive for smaller players who do not have the scale needed to spread compliance costs over a large number of mortgages.

It seems likely that specialty servicing will see huge growth.

Will Altisource grow?

I think that Altisource will gain market share given that Bill Erbey is one of the best operators in the business.  His publicly-traded empire (OCN, ASPS, HLSS, RESI, and AAMC) has a better track record than Altisource’s competitors.  Ocwen’s share price (including the performance of spinoffs) has performed better than Walter and Nationstar.

I believe Ocwen is currently the largest non-bank mortgage servicer.  From the latest 10-Qs, Ocwen services residential mortgages with an unpaid principal balance of $450B while Nationstar services $350B.

Benjamin Lawsky

Currently, it seems the biggest fear hanging over Altisource is that Ocwen (the affiliated company that is responsible for 59% of Altisource’s revenues) may get into trouble with Benjamin Lawsky of the New York Department of Financial Services.  At the request of the NY DFS, Ocwen has halted its intended purchase of MSRs from Wells Fargo.  This was supposedly done over concerns that Ocwen is growing too fast and will not be able to properly service the acquired mortgages.  Logically, at worst this would slow down Ocwen’s growth (and therefore Altisource’s growth).

Subsequently, Lawsky has expanded his investigation into Ocwen.  He is probing:

  1. Whether or not Ocwen’s affiliations with Altisource and other parts of Erbey’s empire is hurting homeowners.
  2. Whether or not Altisource is charging Ocwen inflated fees for Hubzu, which Ocwen uses to sell REO properties.  If true, this would hurt (New York-based) investors of mortgage-backed securities being serviced by Ocwen.  It is a little strange that Lawsky is pursuing this angle given that there are much more obvious ways that he could protect institutional investors.
  3. Whether or not Ocwen or Altisource is taking kickbacks on force-placed insurance (see my previous post on the topic).

In my opinion, it seems that Lawsky has found very little wrongdoing at Ocwen.  His publicly-released letters to Ocwen (see the NY DFS’s press room) have ended with requests for information, suggesting that he does not yet have the evidence that he is looking for.  It seems to me that he is on a witch hunt.  His February 12, 2014 remarks practically gave Ocwen a guilty verdict before he had any substantial evidence.  The “evidence” presented in his remarks was weak.  His argument was that Ocwen is so low-cost that it must be cutting corners:

At the same time as it touted its growth potential, the company also asserted that it can service those distressed loans at much lower cost – 70 percent lower, in fact – than the rest of the industry.

That’s not a typo. They said they could service those loans at a 70 percent discount.

Now – if someone told you they could get you a 70 percent discount on something like a cell phone or a car – your first thought might be, “That’s probably too good to be true.” And you may have a few follow up questions. Like whether the car has an engine.

So when it comes to something as important as a family’s home, those kinds of cost-saving claims bear special scrutiny. Regulators have to ask whether the purported “efficiencies” at non-bank mortgage servicers are too good to be true.

My previous research on Ocwen/Altisource found that Ocwen was consistently rated average or above average in servicing quality.  The problem with Lawsky’s investigation is that the premise is flawed.  Specialty servicers are part of the solution.  Unfortunately Lawsky’s goals are political.  He is trying to make himself (and Andrew Cuomo) look good in the eyes of the public.  Presumably he wants Ocwen to agree to a large settlement to make Lawsky look like a hero for protecting consumers who irresponsibly or stupidly took on mortgages they could not afford.

So far, Lawsky’s actions have caused Ocwen (and Altisource) to lose a lot of money.  The freeze of all MSR purchases by Ocwen (thanks to Lawsky) represents a huge opportunity cost.  On top of that, there is the cost of dealing with the monitors installed by the NY DFS and the CFPB.  The cost of the monitors may be somewhere around $40M/year (see Kenneth Bruce’s question in Ocwen’s conference call transcript for Q2 2014 for a more nuanced take on the true costs).  But eventually the monitors will leave.

While Ocwen is facing short-term pain, its problems aren’t that awful.  It continues to be profitable.  Eventually its Benjamin Lawsky problem will go away.  In the long run, regulations are good for specialty servicers as it increases demand for specialty servicing.  Regulation also improves the economics of the biggest specialty servicers.  Ocwen is currently the largest non-bank servicer based on UPB.

The bottom line

Altisource has a low P/E.  I think that Altisource will likely grow its earnings dramatically given:

  1. Its ‘captive customers’ will likely raise capital and expand.
  2. Bill Erbey is a talented operator.
  3. The specialty servicing industry will likely grow as banks shed their MSRs.

The company is also buying back shares with debt.  I think that Altisource is very attractive right now.

*Disclosure:  Long ASPS common shares.  No options.  I may be a little biased because Altisource is currently my largest common stock position.  I also have a smaller long position in OCN.

Links

To view my previous posts on Altisource, see all posts tagged altisource ASPS.  Start with the July 2013 updated writeup and ignore the 4-part series before it.

Advertisements

29 thoughts on “Altisource recap

  1. The current “crisis” looks indeed like it is a blessing in disguise.

    I have to admit though that I’ve been slightly bothered by the quality of servicing at OCN since wherever I look they are criticized as being worst along with few others like Nationstar and there seems to be a lot of mishandling done by these servicers. Then again I believe it’s common for are a lot of people who have made stupid financial decisions to try to avoid responsibility whatever it takes.

    Another thing: is there any kind of risk with the conflict of interest concerning Erbey and the relationships between Erbeys companies? I think that Lawsky is on a thin ground with his accusations, but I’m not familiar at all with the regulation in US and if there’s something that could essentially put stop, for example, to OCN/ASPS contract.

    As I see it, the market is implying the possibility of it with the big sell-off.

    With common sense you could think that OCN can do business with whoever it wants and however it wants, but being a resident in the nordic I’m not stranger to retarded regulation. The contract is probably solified through the tightly woven, most likely extremely interdependent relationship so it most likely wouldn’t make sense for OCN/ASPS to part ways.

    In any case, Lawsky would have probably already striked with whatever he could against Erbey and OCN if there’d be something instead of just asking questions and trying to dig some dirt. Everything shows that Erbey is extremely smart individual, judging from various articles and this interview https://www.youtube.com/watch?v=Z34XVKjue_M so I would find it out of character for him to do something that would risk the business – especially when he knows that the regulators are looking really closely.

    As for the valuation, it really does look laughably cheap. I don’t know whether it was intentional on your part leaving out even a conservative adjusted forward P/E and it really makes one wonder what the investors are thinking (and whether people know something that I don’t..).

    It also makes me wonder how the company is flying so well under radar. Maybe because it’s a bit hard to understand what they really do, making value investors put it in “too hard pile”.

    However, if history repeats itself, the most plausible answer is that the market fails to see past this Lawsky uncertainty.

    Anyways, thanks for the article – really enjoying your blog.

    • Thanks for the comment!

      Ocwen and Altisource have a contract in place that requires Ocwen to use Altisource’s services at a particular rate. That contract has since been amended and extended when Ocwen purchased mortgage servicing platforms (Rescap, Homeward).

      I believe the original contract was approved by shareholders in conjunction with the spinoff.

  2. One thing I’m still trying to decipher on ASPS is how much stock they’re allowed to repurchase under Luxembourg laws. Is their a ceiling on how much cash they can utilize here? The huge ROIC and free cash generation would allow them borrow quite a bit of money initiate Malone’s levered equity return strategy, unless they are capped in this regard. Any opinion or insight on this? Thanks!

  3. I think you made a mistake, Ocwen services 450 billion, not million.

    Also forward FCF multiple is more like 8x, with a 200% return on capital. If you put it like that, I think a lot of people would look more closely 😀 . A pretty big discount for what will most likely be a slightly increased cost base. And yeah agree with everything you said. I wish I didnt make it a full position right away though.

    FInally note how Lawsky removed his first letter to Ocwen. That really says how weak he is here.

    I think he is trying to save face here honestly. He has to find a flaw or else he looks like a overzealous regulator who sees ghosts everywhere. It would damage his reputation.

    • I don’t get anything from those ads. However, the ads do support the development of the WordPress software (which in my opinion is a worthy cause as many people use WordPress blogs; not all of them are hosted on wordpress.com).

  4. thanks Glen. 1/3 is more than I would have thought. I certainly won’t do that, but am looking to initiate a position in ASPS. Thanks for all your work. Excellent as usual.

  5. How do you see ASPS operating FCF if there is a prolonged period of time between OCN’s growing its MSR portfolio? Noticed they are increasing debt levels to increase buyback by $200MM. Any worries there? They seem to be adding a lot of staffing on their rental mgmt business and trying to diversify their income stream. Do you like those peripheral businesses?

    • I think eventually the Lawsky situation will resolve and OCN will start buying MSRs again.

      When Altisource expands into adjacent businesses, it should see a higher return than buying back shares. When it comes to excellent businesses, you’d probably rather see them reinvest capital rather than buy back shares.

      Levering up the business seems reasonable now given the valuation. Though they should also do quite well without debt.

  6. Do you know track record or have any letters of Luxor Capital? They filed yesterday that they now own 10.9% of ASPS. That is signficant.

  7. Do you have a sense of the % of float that is outside of insiders, Cooperman, Luxor, White Elm Capital? Would be interesting to know….

  8. Thanks for the great write-ups on ASPS. Based on what you wrote and my due diligence over the last 3 weeks, I took a position…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s