Seeking Alpha
Special situations, long/short equity, deep value
Profile| Send Message|
( followers)

By way of background, Altisource Residential (NYSE:RESI) was spun off on December 24, 2012, from Altisource Portfolio Solutions (NASDAQ:ASPS), itself a 2009 spin-off of Ocwen Financial Corp (NYSE:OCN), a mortgage loan servicing and asset management company.

Altisource Portfolio, with an equity market cap of $1.9 billion, provides real estate and mortgage portfolio management, asset recovery, and customer relationship management services to companies like Ocwen. In plain English, this means Altisource Portfolio does all that needs to be done from the point when a home loan goes into default until the ultimate sale of the good old "American Dream."

Before I turn back to Residential, I want to point out a common thread between these companies: Chairman and CEO of Ocwen, William Erbey.

Mr. Erbey has served as the Executive Chairman of Ocwen since 1996 and is a 13% owner -- that stock is up 500% since 1996 compared to a 100% gain for the S&P 500 during the same period.

Mr. Erbey is also the Chairman of the Board of Altisource, owns 23%, and that stock is up 400% since its spin-off in 2009 compared to a zero percent gain for the S&P 500 during the same period.

I have no problem admitting that I am a fan given this type of a track record of creating shareholder value. To paraphrase a friend of mine: "Erbey is pig Latin for making investors money."

So with this backdrop, now let me turn to Residential, one of the latest offspring of Altisource and the grandchild of Ocwen.

Residential was formed essentially as a "blank check" company by Altisource to exploit opportunities in the distressed single family home market. The newly spun-off company's stock was distributed to Altisource's shareholders in a taxable transaction a couple of months ago. At the time of the separation, Residential was equitized with $100 million in cash. It has 7.8 million shares outstanding and a tangible book value of $12.81 per share, just about all of it in cash.

So what's the game plan for Residential? Using a 50/50 debt and equity mix, Residential will acquire distressed loans (known as NPLs in sophisticated circles), eventually take ownership of the underlying properties (picture large sinewy repo dudes with menacing expressions) and convert them to rental homes. In other words, it will be a landlord REIT.

FYI, the only other publicly traded pure-play in this space is a company called Silver Bay (NYSE:SBY), spun off from Two Harbors (NYSE:TWO) via an IPO. Blackstone (NYSE:BX) is also a very significant player.

Its advantage, as Residential sees it, is in its relationship with Altisource and Ocwen. Through these close ties, Residential believes that it will get the "pick of the litter" in NPLs, whereas you and I would have to line up outside auction-houses to buy these same properties and then proceed to hire large sinewy dudes mentioned elsewhere in this note.

Accordimg to CEO Erbey (Altisource's Q3-12 Conf call dated October 27, 2012):

"Altisource Residential, which we refer to as Residential, will be an externally managed REIT in the single family rental market. We believe Residential will achieve above market returns by acquiring non-performing loans at a lower cost than directly acquiring OREO, and two, operating with a lower cost than its competitors.

Residential sourcing strategy for obtaining single-family rental assets, centers on acquiring non-performing loan portfolios. We believe residential can acquire non-performing loans at approximately 55% of the value of the underlying real estate collateral.

For loans in the portfolio where the borrower is willing and able, residential will modify the loan and subsequently work with the borrower to refinance the modified loan at approximately 95% of the value of the underlying real estate collateral, providing Residential an attractive return on investment.

For those loans where the borrower is not willing or able to reform or modify the loan, Residential will work to convert the loans to assets for the single-family rental business. By eliminating some of the costs of directly acquiring an REO and leveraging Ocwen's servicing expertise to timely resolve non-performing loans.

We believe residential will obtain single-family rental assets at a lower cost than directly buying REO. Altisource will provide property management, rehabilitation management and leasing brokerage services to residential. Leveraging our lower cost structure, we'll be able to provide these services to residential at a cost we believe is below market.

Additionally, through Residential's loan servicing agreement with Ocwen, Altisource will provide a suite of mortgage related services on non-performing loans."

On February 21, 2013, Residential announced that it had acquired a pool of NPLs from Ocwen with a UPB (means unpaid balance, in case you are wondering) of $121.2 million, and is in the process of acquiring another $235 million in UPBs from separate sellers.

Assuming the latter deal goes through, here is how I believe that math works out from refinancing a portion of these loans, based upon a February 28, 2013 presentation:

Total UPB Acquired$358 million
Price Paid to Acquire (Assume 56% of Face)$200 million
Gross Yield9.0%
Pretax Net Cash Flow from Refi$18 million
Pretax Net Cash Flow Per Share$2.30
Total Shares Outstanding7.8 million

So $2.30 per share in potential pretax net cash flow simply from refinancing -- this is before Residential gets to its main objective of converting homes into rental properties, which is likely a 12-15 month process.

I have come across a lot of healthy skepticism about Residential's prospects:

1. Too many folks are getting into this distress home-rental space -- which will pressure yields in the future.

2. Residential will be a perpetual equity-raiser, so why jump into the stock now?

3. Distressed home opportunity has a finite life -- it won't last forever.

I think these are all valid arguments. But I am still thinking about Mr. Erbey, who also owns 23% of Residential, and his extraordinary track record of creating shareholder value.

I am also thinking about the fact that Residential is a recent spin-off (and hence opaque) with only 7.8 million shares distributed (thereby unattractive for institutional investors, for the time being).

You will, of course, need to make up your own mind, assuming you find this idea interesting.

P.S. On March 15, 2013, Residential filed a form S-11 to register for a $100 million equity raise -- this validates, in my opinion, the notion that Residential has a healthy pipeline of NPL acquisitions in the near-term.

Disclosure: I am long RESI, ASPS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.