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):
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.
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:
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.
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:
- Whether or not Ocwen’s affiliations with Altisource and other parts of Erbey’s empire is hurting homeowners.
- 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.
- 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:
- Its ‘captive customers’ will likely raise capital and expand.
- Bill Erbey is a talented operator.
- 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.