Fidelity National Financial Inc. (NYSE:FNF)
March 21, 2013 1:30 pm ET
George P. Scanlon - Chief Executive Officer
Brett G. Gibson - JP Morgan Chase & Co, Research Division
Brett G. Gibson - JP Morgan Chase & Co, Research Division
Okay. We're going to get started here. My name is Brett Gibson, fixed income researcher at JPMorgan. We are pleased to announce the final presentation in this room for the day, and that's Fidelity National Financial, the largest title insurance company in the United States. Representing Fidelity National is George Scanlon, the company's Chief Executive Officer, which he has served at since 2010. Prior to that, he served as the Chief Operating Officer of Fidelity National and prior to that, was Executive Vice President of Finance at FIS.
And with that, I will turn it to George and we thank him for being here.
George P. Scanlon
Thank you, Brett, and good afternoon, everybody, and thank you for being here today.
Starting off, obviously, with the forward-looking statements, so we've got presentations outside the room in case you didn't get the chance to pick one up. But you can read that at your leisure.
As Brett mentioned, we're the nation's largest title insurance company. We are the most profitable company in the industry as well by a significant margin. And we look at ourselves, while we're an insurance company and regulated, insurance represents a small part of our total expense base, and we look at us as a company that is a fairly sensible way to play the recovery in real estate, both Commercial and Residential.
We do diversify outside of Title insurance. As the largest player we're limited by, and I trust to expand and, frankly, with our national presence, there are no gaps in our markets. So there's not a reason to be that acquisitive on the Title side, but we do diversify and have a successful track record of going outside of Title insurance and generating above-average returns for our shareholders.
You can see by this slide that there are a lot of brands here. Above the blue line represents the various title company underwriters. We've chosen to maintain these brands in each of our markets, so typically in urban markets, these brands compete against one another, as well against -- as well as outside competition.
Below that American Blue Ribbon Holdings is the holding company for our casual restaurant brands and J. Alexander's is the holding company for our upscale brands. And then below that, we've got a series of investments on a smaller scale. Ceridian and Remy and Cascade are minority owned or partially-owned investments. And then Digital as a company, we acquired at the end of December.
On a revenue basis, you can see that in '12, we grew our revenues from just under $5 billion to $7.2 billion. That was principally driven by the consolidation of ABRH and Remy when we gained majority ownership of those. You can see our earnings more than doubled, our margins expanded by over 300 points and our EPS went up over $1 share to $2.68 a share. Cash flow grew dramatically to $620 million. And we're entering the phase in our cycle where our claims, payments are in a descending trend and our earnings are in an uptrend. And so our cash flow over the next few years should expand and be meaningful.
Our balance sheet, we've got over $5 billion in our investment portfolio. You can see we grew our book value per share over $4 to almost $21, and our reserve for claim losses is about $1.8 billion and we continue to provision about 7% of our Title Premiums and our trends have been in the 5.5% range over the last 4 years. But we're still paying down those big years '05, '06 and '07, which for the industry were the major claim years.
Our balance sheet is very healthy. We've got about a $1.3 billion in debt. About over $300 million of that is associated with our restaurant operations in Remy, which we consolidate but we do not guarantee or backstop any of that debt. So on the Title side, we're about $900 million to $950 million in debt.
Just organizationally, we get a lot of questions as we diversify into other businesses outside of Title as to whether that's a distraction or not. So we highlight this chart to emphasize the really independent nature of our different operations. You can see on the left side, Randy Quirk runs our Title business. He's been there 36 years.
Hazem runs our casual restaurant business. Lonnie runs our upscale business. Jay Pittas runs Remy and Stuart runs Ceridian. And these gentlemen don't even know each other. So from an operating perspective, there's really no synergy benefit among them. We prefer to maintain that independence so that when opportunities come to exit, it's a cleaner break for us and the acquiring company. And we found that, that separate governance and oversight allows us to succeed in our portfolio investments.
So we are the largest Title insurance company. These are brands you may or may not be familiar with. Most people don't know the Title insurance company that is protecting them. Our relationships tend to emanate from real estate brokers and lawyers, depending upon the markets you're in. And it does vary by state.
As a regulated company, our rates are either promulgated by the state or filed. Typically, there's no meaningful rate differentiation among the competition. And we like the idea of internal competition because as you'll see in a minute, the combined nature of our industry does limit the number of competitors. And competitively, we find that competing among each other helps us optimize our performance and retain our revenue base.
With regard to the national market, we've got about a 34% overall market share. You can see our nearest competitor First American is 26%. There are 2 other competitors which have another 25% or 26% of the market. And so roughly, about 87% of the market is controlled by 4 players. The business is sold 2 ways, 1 direct and 1 is through agents. And honestly depending upon what state you're in, will determine generally what happens.
Overall in the west, it tends to be more direct oriented, which means you'll come to one of our offices and do your real estate closing there. In the east, there's more of an emphasis on the agency side, which means you go to an attorney's office or a title company agency office and close there.
Roughly within the industry, about 60% of the total revenues go through agents. These are typical real estate attorneys or specialized title companies. And the 40% are through direct offices. You can see that we've got about a 40% market share on the direct side and about 30% on the agency side. We've got about 5,000 agents, there are about 20,000 total agents nationally. And the ability to grow our market share and revenue rapidly comes really through the agency side. And we made a conscious decision over the last 3 or 4 years to take our agency count down from about 11,000 to 5,000 and the reason is simply because we emphasize the bottom line, not the top line. And the agents effectively underwrite on your behalf and you provide the backstop insurance. And we found that agents that don't follow our prescribed controls, don't remit their premiums to us on time and have a high rate of claims, tend to be unprofitable relationships. And so we've taken that agency market share down, from probably close to 40 down to 30, and it's probably at a floor right now.
If you look nationally, state-by-state, we've got 1,100 offices. We're #1 in half the states, #2 in another 20. And most importantly, we're #1 in the 5 states that account for over 1/2 the real estate transactions that are done, and that will be California, Texas, Florida, New York and Illinois.
Our operating strategy is fairly simple. We don't spend a lot of time trying to predict what's going to happen in the market. We don't, outside of being a modeling exercise, run the business based on what MBA things or what Fannie Mae thinks, or what any expert thinks. We basically know that we've got about a 90-day backlog of orders. And so that represents our future revenue. And as the order trends move upward or downward, we adjust our headcount accordingly.
Our order trends moved up significantly last year. So we added about 1,500 positions. But as the orders ebb and flow with seasonality and obviously with the change in mix between refi and purchase, we'll make the headcount adjustments.
We target and normalize pretax margin of 15% to 20%. Nobody knows what normal means, we're not in the normal cycle now and probably won't be for several years. But we've been able to achieve mid-teen margins in what remains a pretty sluggish market.
If you break down our Title revenue, you can see that about 70% comes from Title premiums. The balance comes from fees that are associated with real estate services. So roughly about 30% comes from escrow and closing, as well as other services that we provide to large banks like JPMorgan, Wells and Citi where we provide different appraisal and default management services.
In the Title expense side, the sliver for Title claims is only 5%. So many times, we get lumped in to the insurance category. And again we are an insurance company, we are regulated. But unlike most insurers, the claims component represents a small portion of our cost. And in a perfect world, claims should be 0 because we do the title research work and our objective is obviously to ensure that the title is clean and there are no claims made on that property, both to protect the lender and the buyer.
Inevitably, circumstances arise where claims do occur, and about 1/3 of the time it's because we missed something. The balance really relates to fraud, which has been declining, as well as complexities that arise in commercial construction projects. The trend in claims has been favorable over the last 4 years. As I said earlier, we're running at about 5.5%. The worst years for the industry were '05, '06 and '07 and the claims experienced there was about 9%. So we're still going through because of the lag effect, the payout of those older claims.
If you look at our performance in, again, what's been a challenging market, the left side, our mortgage originations, and so somebody buys a home and they borrow money. This does not represent the entire market. Today, about 30% to 35% of the homes purchased nationally are purchased with cash. Now a lender will always require a title policy, it's at the buyer's option if there's no mortgage. We typically find that most buyers want title insurance protection. And so we issue policies on that market to those buyers as well.
But you can see actually '09 was the best year in the last 4 years in terms of originations at about $2 trillion. And by historical measures, not a great year. But you can see it came down 20% in '10, another 20% in '11 and then went up about 30% last year primarily because of growth in refinancing transactions.
If you look at our revenue it's to some degree follow that market, and what's interesting is if you look at '09 versus '12, you can see that our revenue spiked up modestly, less than 5%. But our profit margins more than doubled. So we ran at about 14% last year, 16% in the fourth quarter against about 6.5% just 3 years earlier. So we've done things on the cost side to position ourselves to benefit from the turn in the market, which is definitely happening.
If we look at ourselves relative to our peer group, we're the dark blue bar. You can see that throughout the last 13 years which really has represented every imaginable phase in the cycle, we've done significantly better than the public competition. If you look at last year, when we did 14%, the rest of the industry comprising that 87%, did less than 8%. The year before, we did almost 11% and they did about 3%.
So in good times, bad times, in transitional times, we continue to significantly outperform our competition. We really have no pricing advantage. Everybody generally gets the same premium.
Now with regard to the future, if you look at real estate sales, existing home sales, you can see, are projected in '13 to be about $4.9 million. If you look back to the beginning of the chart in 2000, they were at $5.2 million. So while things are getting better on a relative basis, they're still historically very low, and you're continuing to see positive news about housing. And if you look at this next chart, you can see that the issue in housing today is not on the demand side, it's on the supply side. And as a result, with the available inventory, you can see down to 4.2 months. And just a couple of years ago, it was over 12 months.
We are at a historically low level. And what that's doing is it's establishing price appreciation in most markets. The home builders are benefiting because of the absence of supply in the resell side. And I think that both buyers and sellers are gaining confidence. So I think this is a bullish sign as we enter the busy spring selling season. And I think the key indicators are is the supply-side going to come on in a more natural way because buyers today with the outlook for prices tending to appreciate rather than depreciate, why not take advantage of the low interest cost environment and get a home at these affordable rates.
Now what that means for our business is today we're running at about a 60/40 refi to resale relationship. And that's abnormal. Typically, we're more weighted toward the resale side. But because of the low rate environment and also because the resale environment has been lagging, we've been heavily weighted toward refinanced transactions.
We made twice as much on a purchase transaction as we do on a refinance transaction. So round numbers, $2,000 when you buy a home, about $1,000 when you refinance an existing loan. So as that mix changes for us and again the originations market doesn't have to change, but the mix -- as the mix changes and it will evolve to much more of a purchase bias, you can see that our fee per file because of that mix change, from 70/30 -- to 70/30 purchase actually grows about 31%. So while the originations market may appear to be flat, our revenue will actually grow as that mix changes.
Shifting now to restaurants. We've got almost $1.5 billion of revenue from restaurants. We've got into this 4 years ago in a series of distress acquisitions, out of bankruptcy. Our Chairman had experience in the restaurant industry in the 90s and so there was a familiarity with the industry. And we've successfully turned that around, bought 2 public companies last year. O'Charley's, which owned the Ninety Nine, Stoney River and O'Charley’s concepts and then J. Alexander's, which is an upscale restaurant primarily in the southeast.
So all in, we've got almost 700 restaurants. If you look at the next page, they're distributed pretty broadly among the different types. You can see O'Charley’s is the largest with about $500 million in revenue and 200 restaurants. That's really a turnaround story. It was a company that was public, struggling for years, generating margins about 1/3 of what we were generating and what the industry was generating. We bought it on a net basis, at about 2x EBITDA. The industry multiples were closer to 8%. And so it's one of those that we did a lot of research on and concluded that their strategies were not going to lead them to success. And we think we can do a better job. So the focus in that segment is on getting O'Charley’s better.
We decided to split our Upscale division from our Casual division for that reason. The management team on the Casual side is very focused on getting the margins better at O'Charley’s. We had a strong management team on the Upscale side. So we moved Stoney River into J. Alexander's and we see a lot of potential growth for the Upscale chain. That won't be distracted by the focus on margin fixing that's going on at O'Charley’s.
We're dual-pathing these, the end result probably next year at sometime we'll be either an IPO of some sort or a merger into a public company. But we're likely to have 2 public restaurant companies when the dust settles. That obviously gives investors an opportunity to evaluate our value, I guess, the investments we've got, as well as giving the change of currency for future growth.
The way we look at it, the way analysts evaluate the restaurant industry, is the businesses tend to trade at a multiple of EBITDA. Our expected EBITDA is about $100 million and that reflects some margin expansion at O'Charley's, and the realization of about $20 million of synergies, which are on track.
So we multiply that times 8, we get a valuation of $700 million, north of $700 million, less about $90 million in debt. We own 55% of this, we have a private equity partner that owns primarily the balance. And our investment is about $200 million. So we look at it today as we've doubled our money and with upside potential as we expand the margins.
Obviously, if you look at the valuation on an adjusted basis, factoring in those enhanced margins, we get close to $1 billion and obviously 55% of that is over $500 million or about $2.40 per share. So this is the way we think about it. We've got work to do to get those margins up, obviously.
We also own 51% of Remy International. It's a manufacturer of alternators, starters and hybrid motors. It's a company we bought, distressed debt, got them through a prepackaged bankruptcy and ended up with a minority position, which we added to, last summer, to cross the 50% line and therefore consolidate them.
You can see the revenue's about $1.1 billion, solidly profitable company at $165 million of -- or $155 million of EBITDA and been a great turnaround story. If you look at this next chart, you can see that roughly 60/40 split between OEM and aftermarket. The aftermarket is primarily through Pep Boys and the large-scale retailers, and there's been consolidation on the aftermarket side. And the OEM side is General Motors and Hyundai and people like that. The manufacturing for the most part is done outside the U.S. And if you look at the right side of the chart, the margin expansion has been driven by cost productivity. And one of the things we challenged them with is growth. And so we're looking at what can be done obviously organically and what on the M&A side might make sense. But you can see that the after-tax income has dramatically increased.
As part of the post-bankruptcy, financial engineering, we converted our preferred into common and that really facilitated more earnings available to the common shares and that enabled them to get the credit facility. And so there's self-sustaining investment and one that we've got a lot of hope for.
We've got a history of doing this, so those not familiar with our story, may question why we veer outside of title again, there's nobody in title we'd want to buy and there's no gap in coverage that we want to make. Our emphasis is on paying a solid dividend, buying shares back in the market, which we're doing, and then using that excess cash to put into growth opportunities.
So rolling the clock back 10 years, FNF bought a company called Alltell Information Services. Ultimately, after a series of transactions, that spawned 2 public companies, FIS, which is the largest bank technology company in the world, and Lender Processing Services, which is a large mortgage processing company. And so if you have been an investor in FNF and had participated in that ride, your original investment of $26 would be worth about $83 today. So we're pretty financially astute and we've got a great reputation in the capital markets. And so we've got access to capital and we're pretty smart about how we do things. And everything is for sale, I tell that, whether it's the Title business or Remy or Ceridian, or any of these others. Everything's for sale and we're unemotional about anything we own. The objective here is to create value for our shareholders.
Our Chairman who founded our Title business, is our fifth-largest shareholder. So there's clear alignment with investors. The management team is also heavily invested in the company and we're all about enhanced returns.
We invest in ancillary other things and again have a history of selling. So FIS, which we had effectively spun off several years earlier, was buying a company and needed an equity bridge, so we put $50 million into. 18 months later, they did a recapitalization. We basically got our $50 million back and we're still sitting with about $50 million worth of their stock, which is fully liquid.
Sedgwick is a claims processing company we bought and sold 4 years later, doubling our money again with a private equity partner. And we were in specialty insurance and we were in property casualty. And we had a flood insurance management business, which was a pretty good business. But we exited both of those in part because we want to manage our destiny. And on the Property & Casualty side, you're obviously subject to lots of things beyond your control and the variability in earnings was dramatic. And so we basically extracted over $300 million of capital from those businesses, some of which was redeployed into restaurants, which have a much more favorable opportunity for growth.
Ceridian is a business we bought about 5 years ago. Third largest payroll processor, about $1.5 billion in revenue, good solid margins. Frankly, overpaid for it and borrowed a lot of money. So it's carrying a significant debt burden. But there are 2 businesses there. There's a payments business under Comdata and there's the HR management business, which they're mostly known for. And our expectation is that over the next couple of years, there will be probably 2 transactions involving these businesses, possible IPO or sale. But they're trending very favorably and migrating the HR side to -- off a mainframe solution to a SaaS solution, which tends to get valued much more highly in the market.
Last acquisition we did was at the end of the year, we bought a company called Digital Insurance. They target the small and medium business market by providing health care consulting, a technology platform and brokerage services. $20 million EBITDA and a $70 million revenue base this year, it's a very fragmented market, we like things that have scalability. We think there's a lot of potential for this business.
And obviously the health care space, which we don't pretend to be an expert in, offers a lot of growth opportunity and it's going to go through a lot of changes, so very excited about this business. We've got advisors with us who are expert in health care who are helping us through this, but solid management team and we think an opportunity for significant growth.
So in summary then, diversified business, clearly a plan on the recovery in real estate. We participate in Residential and Commercial, in refi and in resale transactions. So we really cover the gamut. We're national, so we're not concentrated in one market. We don't have to speculate on where growth will be in the future and load our balance sheet up with dirt. We're a profitable and profit-driven company. And we've got upside potential in the portfolio of investments that we've got and a pretty good track record to expect realization of returns on that.
So with that, that wraps up the slides. And I'm happy to respond to any questions, or I've got Dan Murphy, our Treasurer and Head of IR; and Tony Parker, CFO, with me as well.
George I'll kick it off here. A quick one for me. Talking about your portfolio of businesses, apart from Title insurance, and understanding what you said that you have business heads that head each of those individually, they don't know each other, and your emphasis on selling them and unemotional contact. Still, I think, it's something that investors are concerned about and particularly on the fixed income side. Can you help us understand over time how that evolves, that strategy? That's number one. And then number two, how does your balance sheet factor in to how you finance these? And in the future, would you be opposed to using your balance sheet in terms of levering up to do a larger deal?
George P. Scanlon
Okay. So coming from the debt angle, protecting our rating is important to us as an insurance company and as an underwriter. So there is effectively a 35% ratio that we have to stay within. We're running at about 23% today, I think. And on a net basis to what we're actually on the hook for, it's about 19%. So there is a governor in terms of leverage that we will obviously respect. The investments that we've done, if you look at our aggregate investment position today, it's probably about what it was 3 years ago we just changed the mix. And it's interesting, when we got in the restaurant business, we ended up spending half our time talking about a business that we had a very small amount of our portfolio invested in. But the reality is everybody understands restaurants and very few people understand starters and alternators. And we've got just about invested -- the same amount invested in each business. So we cycled out of the Specialty Insurance business, and as I said, put some of that money back into the restaurant business. I think you'll see incremental capital going to restaurants but we're looking at deals all the time but the restaurant company and Remy both financed and have independent credit facilities without any back-stopper guarantee from FNF. So if they want to grow, they need to find the money to do it. So we're very conscious of the balance sheet, and we've got a great balance sheet. We got an $800 million credit facility with nothing drawn on it. We've got about $300 million in cash at corporate. So we've got a lot of liquidity and as I said, we're in the market buying shares back, and we raised our dividend 14% this year, after raising it 17% the year before. So providing a yield protection for the equity side and our debt doesn't mature until '17. So we've got a lot of runway and like I said, about $950 million, I think, in debt, that we're responsible for.
Do you have a firm set of criteria you use for these direct investments that you could share with us?
George P. Scanlon
We try to find things that are distressed, typically, that are not regulated and that's the common theme among all of our outside investments, that have scalability because they operate in fragmented markets and we try to buy right. So as I said with O'Charley's, we paid 2x EBITDA, every deal we spend on since then, most of which are done by private equity firms. So there's limited synergy opportunity, went closer to 9x. And they were not, by the way, outstanding properties, they were struggling in their own right. So I think historically we've done a good job of buying. I think if you looked at the track record of the investments we've made and then exited we've made gains in virtually every investment. And we've not been afraid to put incremental capital in to grow those businesses. Digital's a good example where they've done 19 acquisitions, the average investment is $3 million to $5 million in one of their -- typically, a family selling out of the business. And we're trying to get them to think a little bigger. They were owned by a fund for a long time, the fund needed a liquidity event, and we're not afraid to put more capital to work if we think we can get the return. And they've got a good track record of assimilating acquisitions, so, and that's a business that could be a $500 million business for us. But again if somebody knocks on our door and offers us a compelling price, we'll seriously consider it. And the one thing we're always sensitive to is tax leakage. So we try to find ways to minimize the cash cost of exiting a business when we can. Any other further questions? Great. Well thank you. Do you have a question, Brett?
Brett G. Gibson - JP Morgan Chase & Co, Research Division
I will. We do have 6 minutes left. So I guess turning to the meat of your company, the Title insurance business, can you help us understand where -- how much economic factors play into your expectations on where refinancing and purchase activity will go? And what are the economic factors that you look at beyond the obvious ones of housing starts and different things like that? Does unemployment factor in, in a big way to how you look at these GDP, et cetera? Can you just talk about how you think about those?
George P. Scanlon
Yes, I think there are obviously, I'd say, macro factors that we watch. Interest rates, clearly, has generally, historically been the primary metric to watch in terms of housing demand because of the Fed policy actions, rates are artificially low. And so home affordability has never been as good as it is today in virtually every market. We're in this abnormal cycle because we're coming off a binge that went bust. And now it's recovering but by any measure we're still at 20 year lows in terms of resale activity. So while MBA is projecting on a percentage basis, I think, 20% this year and 15% next year growth that would get us up to $700 billion in originations for resale. That's worse than '09 and MBA and Fannie are the ones that do their projections. And we look at those academically because we don't manage our business to what's inevitably going to be an incorrect projection. As an example, they both projected 2012 to be sub-trillion in originations, and we ended up almost twice that. So they were materially off. And we don't pretend to forecast any better. As I said earlier, we manage our business on a 90-day basis. So we capture the orders from around the country every Monday and we look at trends. And if orders are trending down, we're going to take headcount down. And we measure open orders per employee and that is the key metric that leads to obviously closed orders per employee when those orders close and our headcount will bounce up and down. We bring in a lot of temporary workers, we bring in a lot of people that we say, we've got a 90-day window here for you and after that we can't guarantee anything. We don't pay severance. So our exit costs are minimal. And as I showed in that chart, throughout the last 13 years, they were highlighted in that chart, we've managed to outperform the industry by a material amount. And so everyone asks us when is the refi market going to cliff, and we have no idea. Our orders are running strong. But inevitably, it will because everybody who has re-fied, probably won't do it again, so, but there's still a huge market out there who hasn't. And as prices firm up, as appraisals get better, it could open the market for refinancing to people who aren't eligible today. So it is what it is. The key thing for us is I want to see the resale market pick up because that is the sustainable metric for our business, that is the way we should be viewed into the future in a more 70% or 80% resale, refi mix versus the inverse that it has been. And that's when I think investors will not have anything to be concerned about. Right now, everybody's trying to figure out the timing of the cliff and nobody knows. I think what they have to trust is that we will adapt to whatever market is and maintain profitability.
Okay. Thank you very much.
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