Altisource (NYSE: ASPS) provides real estate and mortgage portfolio management, asset recovery, and customer relationship management services to US-based mortgage originators and servicers.
At year-end 2012, the company had 25 million fully diluted shares outstanding and net-debt of $93 million. Its current equity market cap is $1.7 billion and total enterprise value $1.8 billion.
As background, Altisource was spun-off by Ocwen Financial Corp (NYSE: OCN) in August 2009 in a 1-for-3 shares distribution. By October 2012, Altisource shares had appreciated an astounding 1670% compared to a 50% rise in the S&P 500, during the same period.
The remarkable stock performance until October 2012, in our view, can be explained by Altisource's historical earnings and free cash flow generation (see table below). It is important to note that this strong growth over the past six years was mainly organic and acquisitions played a minimal role.
|Op CF / Share||0.33||1.19||1.37||2.01||4.35||4.67|
|Free CF / Share||0.16||0.98||1.06||1.57||3.71||3.24|
Source: SEC filings and Company press releases; All figures are in $millions except per share data.
Since closing at an all-time high of $124 on October 12, 2012, the shares have retreated 43%, significantly underperforming the S&P 500, which gained 11% during the same period. This steep price drop, coupled with strong company fundamentals, has created an attractive investment opportunity. Here's why:
Ocwen's Deal-Flow Will Continue to Drive Growth: Under an agreement that expires in 2020, Ocwen is contractually obligated to purchase certain mortgage and technology services from Altisource. In 2012, Ocwen accounted for 60% of Altisource's revenues and has been its primary growth driver. Ocwen has grown its service-loan portfolio dramatically from 470K in Q1-2011 to 809K in Q4-2012.
On October 3, 2012, Ocwen completed the acquisition of Homeward Residential and on February 15, 2013, Ocwen acquired certain mortgage servicing and origination businesses from Residential Capital, LLC. As a result of these two transactions, Altisource is expected to board 2.1 million new loans. In order to accommodate this business, Altisource is in the process of hiring an additional 1,600 employees (it had 5,770 employees at the end of 2012). Furthermore, Ocwen sees a lot more opportunities to acquire loans - the point being that Altisource should continue to benefit from Ocwen's pipeline for the foreseeable future.
New Growth Platforms: In order to diversify from Ocwen and expand, Altisource has developed several new revenue sources.
Origination: In 2010, Altisource acquired the manager of the Lenders One mortgage cooperative. In 2012, the members of Lenders One originated approximately $183 billion of loans representing 10.5% of the US residential origination market. Altisource's service revenue from origination related services grew 72% in 2012 to $37.8 million due to membership growth, higher origination volume and an increased usage of Altisource's services by existing members.
Residential Spin-Off: On December 21, 2012, Altisource completed the spinoff of Altisource Residential (NYSE: RESI) and equitized it with $100 million. Residential is a REIT that will own and manage single-family rental homes (acquired via distressed loans). This is a very large addressable market and Altisource estimates to generate initial revenue of $1,625 per home acquired by RESI and a recurring revenue stream of $1,275 per home per year. The Company expects to generate 40%-50% margins from this new business.
Hubzu.com: Altisource re-launched its consumer real estate portal, Hubzu.com and has sold over 25K real estate owned (REO or distressed homes) assets during 2012. Hubzu-based 2012 revenue grew 67% to $53.2 million from $31.9 million in 2011. Management has indicated that over the medium-to-longer term (i.e. once this business gains critical mass), it will separate Hubzu as a stand-alone company and most likely, distribute it to shareholders.
Significant Insider-Ownership: This is the least important factor in our long thesis, because, frankly speaking, it can cut both ways - - Pending Dell and recently completed American Greetings take-private transactions come to mind.
That said, we prefer to be invested alongside management, all else being equal. William Erbey, Chairman of Altisource (as well as of Residential and Ocwen) owns 23% of ASPS shares. His record of growing businesses and creating shareholder value speaks for itself - just take a look at the long-term performance of OCN and ASPS.
What is the Stock Worth? Altisource's management does not provide earnings guidance. Consensus 2013 earnings estimate, according to Bloomberg, currently stands at $6.80 per share. With 50%+ earnings growth track record and strong future potential, should Altisource not trade at a premium to S&P 500 multiple of 13x forward earnings? For example, a 20% premium would value ASPS shares at $107 or 45% higher.
Risks to our long thesis:
There is a saying about investment managers which we are always mindful of:
"Often wrong, never in doubt"
So when we find a compelling investment opportunity 'lying out in the open', we have to ask the question - what could we be missing? It's just common sense that one can't get 20%, 30% or 40% returns in the current 'return-free risk' environment without taking a lot of risk.
Here are the key factors which we considered when making this investment:
- Customer concentration - For now, Ocwen and Altisource are joined at the hip.
- Distressed home environment, Ocwen's and Altisource's sweet-spot, won't remain distressed forever.
- Bll Erbey is the founder and the brains behind the OCN/ASPS/RESI story - if he gets 'hit by a truck', it would be very detrimental to our investment.