LPS: Buying Opportunity or Smoke?

| About: Lender Processing (LPS)

There's a potential opportunity here - maybe.

I speak of (NYSE:LPS), Lender Processing Services, which has gotten pounded the last two days:

Here's the scoop. First, these guys had some bad things to say last quarter, and missed expectations, getting hammered a bit.

But the last two days appear to be related to media attention focused on their subsidiary "DOCX", which provided, among other things, documents and services related to "helping foreclosures along" (along with all the other things that go into mortgage servicing.)

There's a lot of murky water here. There was an apparent issue with people other than the actual signatory doing signings - but this was also claimed to be corrected some time ago. And the company has issued a press release, stating:

LPS has not executed affidavits containing substantive borrower information on behalf of its lender/servicer clients since September 2008. When LPS performed this service, affidavits were prepared and provided by the lenders' or servicers' attorneys. These affidavits were then executed by LPS consistent with industry practice, under corporate resolution. LPS had processes in place to ensure the information in the affidavits was validated and that the affidavits were signed properly.

In reference to assignments of mortgage, LPS has made previous statements regarding its document preparation subsidiary, Docx, LLC. This small subsidiary (less than one percent of LPS' revenue) prepared assignments of mortgage for two lenders/servicers between 2008 and 2009. Docx did not prepare or execute affidavits containing substantive borrower information and no longer provides document preparation services.

During its operation, when lenders/servicers or their attorneys requested that Docx prepare an assignment of mortgage, the lenders/servicers or their attorneys provided the necessary borrower information, which was downloaded by Docx employees into a pre-approved document template. The document was then printed and either signed by the lender/servicer or Docx, pursuant to corporate resolution. Docx did not determine whether these documents were then used in a court proceeding – those decisions were made solely by the lenders/servicers or their attorneys.

It's pretty hard to get in trouble for being paid to be a typist, which is basically what is being claimed here. On the other hand typists don't make much either. That's the yang to go with the ying.

So here's the question. If this is all there is, and it was rampant (and ultimately false) speculation that DOCX/LPS was somehow doing things on their own in some unauthorized capacity (whatever that might have been), while there is no business risk to their primary activities, then there's a hell of an opportunity here.

It's not every day you get to buy something at 15% discount in two days trading.

On a valuation basis, under 10x P/E(ttm), you might also think this looks damn good, although there's no dividend argument to be made with a yield around 1%.

So this leaves us with the question: are we dealing with speculation that took the stock down 15% in two days, or is there something more behind the move?

Let's dig into the price movements.

There's no particular pattern in the options chain that I can identify to point to someone "knowing something" today, but the sell-off came on very high volume - 400% normal daily volume - and on Friday someone put on a bunch of December $30 PUTs - some 8,000 of them traded, all after the noon hour - when the dive linked to the rest of the market had occurred.

That is, the PUT buys started before the second plunge occurred in the stock Friday - taking place around 12:05 Central.

Here's what I'm concerned about. Here's the stock at the time the big PUT buy went off:

That sell-off on the open roughly correlated with the SPX; here's the chart.

Looks normal to me up to that point. The entire market was selling off, so you'd expect LPS to get hit too, and it did. Nothing unusual there - so far.

Now here's the problem. The Dec 30s at this point had an open interest of 110 contracts. But look what happens here, while the market is generally rising and so is LPS:

"Someone" filled an order for 5,000 December $30 PUTs, and it was pretty-much all one order, against essentially NO open interest.

The S&P continued to trade broadly-stable the rest of the day. But LPS did not:

Hmmmm.... someone buys a bunch of PUTs - $625,000 worth of them - and less than two hours later, there's a big dive in the stock on big volume that continues on today. There were more PUTs transacted on the way down too, but those may have been reactionary - that's not particularly "smelly."

The buy in front of the big move, on the other hand, is quite smelly - like dead fish. Like, for example, that someone knew something in advance.

And most of those PUTs "stuck" - today dawned with 7,634 contracts open and we only traded 1229 contracts today, so they'll stick into tomorrow too.

You got earnings at the end of the month. The quarter is closed, so at this point it is what it is and management should know where numbers are going to come. If there's something materially bad, after this press release, they're going to get pounded (and with good cause) for saying there's no impact from this on their operational results.

A potential recovery of the former price would give you a 16% gain in about a month - an extraordinarily-nice profit on an annualized basis. I'll take 16% gains in a month all year long and laugh all the way to my new private island in a couple of years.

The danger is that there's something more behind the sell-off that we're not being told, but that someone knows. And here I'm suspicious, with most of my suspicion centered around that big options trade two hours in front of the dive, a trade that was not taken back off.

That is, whoever did it thinks that whatever is going on, the profit potential on the trade is not over, and worse, this trade implies that they knew whatever "it" is before the move initiated - two hours before.

The first notice I had on the DOCX/LPS document issues and the first written information I saw was on Saturday, October 2nd. Well, on Saturday the market is closed. But you can clearly see that there was a massive, high-volume sell-off on Friday, combined with a suspicious options trade associated with the move.

So why did the stock sell off Friday, before this story broke, and what's up with that options trade?

I don't know. It's possible it's the class-action RICO lawsuit filing - LPS/DOCX is named. That was, as I understand, filed a few days ago. If that's all it is, then you're evaluating that risk - and whether whatever was identified and drove someone to spend $650,000 on a big bet for a big boom will hold up until December (a trade which, incidentally, is a clean double as of the close today.)

Or is there something else, and something more?

Before I bought into the stock, I'd sure as hell want to figure this out, because someone is on the other side of that trade with $650,000 of their own money, and they don't think the price of the stock is going to recover.

I'm gonna pass on this one unless I can find clarity on that options trade.

Disclosure: No position.