Altisource Portfolio Solutions: Deeply Undervalued, High Free Cash Flow, Melting Ice Cube Or Rough Diamond?

| About: Altisource Portfolio (ASPS)

Summary

High margin business generating high free cash flow.

Balanced free cash flow allocation in stock and debt repurchases and investment in new businesses.

Deep under-valuation despite current business risks.

Introduction

Altisource Portfolio Solutions' (NASDAQ:ASPS) 2015 10-K describes its businesses as:

"Altisource® is a premier marketplace and transaction solutions provider for the real estate, mortgage and consumer debt industries. Altisource's proprietary business processes, vendor and electronic payment management software and behavioral science-based analytics improve outcomes for marketplace participants."

The 10-K lists Altisource's three reportable segments as mortgage services, financial services, and technology services. This segmentation was useful when Altisource predominantly served Ocwen Financial (NYSE:OCN), its previous parent company. Altisource was spun-off from Ocwen in August, 2009.

Now as Altisource has been aggressively developing non-Ocwen related customers and new businesses, management has offered, what I believe, a better way to look at its businesses in its quarterly earnings call supplementary presentation slides pg. 13. Instead of segmenting by the type of services (mortgage, financial, technology) it provides, management now focuses on the types of customers it does business with: servicers, originations, consumer real estate, and real estate investors.

Approximate breakdown of business by service revenue:

(millions)

2015 FY

% of Total Service Revenue

2016 Q1-Q3

% of Total Service Revenue

Servicer Solutions

$796

85%

$568

79%

From Ocwen loan servicing portfolio

$743

79%

$531

74%

From customers other than Ocwen

$53

6%

$37

5%

Origination Solutions

$42

4%

$38

5%

Consumer Real Estate Solutions

$2

0%

$1

0%

Real Estate Investor Solutions

$45

5%

$69

10%

Other Service Revenue

$54

6%

$41

6%

Total Service Revenue

$941

100%

$715

100%

Service Revenue Unrelated to Ocwen

$193

21%

$183

26%

Click to enlarge

Bullish Points

  1. High margin on revenue and high free cash flow with low capital expenditure requirement.
  • As of September 30, 2016, diluted shares outstanding were about 19.5 million shares. As of November 29, 2016, each share traded around $27. Market capitalization was ~$500 million.
  • I calculate LTM adj. EBITDA after CapEx at about $172.6 million or $8.85 per share. I calculate LTM adj. EBITDA after CapEx, interest expense, and income tax provision (or free cash flow) at about $134.3 million or $6.89 per share.

ASPS Revenue Margin and EBITDA (in millions)

2011

2012

2013

2014

2015

2016 LTM

Revenue

$‎424.0

$‎568.0

$‎768.0

$‎1,079.0

$‎1,051.0

$‎1,029.0

GAAP Operating Income (Loss)

$‎85.7

$‎127.4

$‎162.1

$‎170.5

$‎79.1

$‎39.8

Add: Depreciation and amortization

$‎8.4

$‎12.8

$‎19.1

$‎29.0

$‎36.5

$‎36.4

Add: Intangible amortization expense

$‎5.3

$‎5.0

$‎28.2

$‎37.7

$‎41.1

$‎49.6

Add: Impairment loss

$‎0.0

$‎0.0

$‎0.0

$‎37.5

$‎71.8

$‎71.8

Less: Gain on Equator earn out liability

$‎0.0

$‎0.0

$‎0.0

$‎(37.9)

$‎(7.6)

$‎0.0

Adjusted EBITDA

$‎99.4

$‎145.2

$‎209.4

$‎236.8

$‎220.9

$‎197.6

Less: Additions to premises and equipment

$‎16.0

$‎36.0

$‎34.0

$‎65.0

$‎36.0

$‎25.0

Adjusted EBITDA after CapEx

$‎83.4

$‎109.2

$‎175.4

$‎171.8

$‎184.9

$‎172.6

Less: Interest expense

$‎(0.1)

$‎(1.2)

$‎(20.3)

$‎(23.4)

$‎(28.2)

$‎(25.3)

Less: Income tax

$‎(7.9)

$‎(8.7)

$‎(8.5)

$‎(10.2)

$‎(8.3)

$‎(13.0)

Free Cash Flow

$‎75.4

$‎99.3

$‎146.6

$‎138.2

$‎148.4

$‎134.3

Adj. EBITDA to Revenue %

23%

26%

27%

22%

21%

19%

Adj. EBITDA after CapEx to Revenue %

20%

19%

23%

16%

18%

17%

Click to enlarge
  1. Conservative balance sheet. As of September 30, 2016:
  • Cash and cash equivalents were $135 million. Available for sale securities were $45 million. Rest of current assets of $133 million offsets all of current liabilities.
  • Altisource has only one type of debt: its senior secured term loan. The outstanding amount is $480 million. It requires equal consecutive quarterly principal installments of $1.5 million or $6 million per annum, with the balance due at maturity on December, 2020. Interest rate was 4.5%.
  • Net debt less cash and securities was $300 million, which is <2x of LTM adj. EBITDA after CapEx (calculated in point 1 above). Altisource CEO Bill Shepro has mentioned in a couple of earnings calls in 2016 that this would be a net debt level that he would be comfortable with. Thus, I believe future debt repurchase would be minimal.
  1. Balanced approach in free cash flow allocation.
  • Altisource management has been executing a balanced free cash flow allocation in stock repurchases, debt repurchases, and investment in new businesses.
  • During 2015Q1 to 2016Q3:
    • Stock repurchases total $94 million or 3.4 million shares. Note: Authorized share repurchase program has 4 million shares capacity remaining going forward.
    • Debt repurchases total $100 million (face amount) for $89 million.
    • Acquisitions of bolt-on businesses total $50 million (NASDAQ:CASH)

ASPS free cash flow allocation (in millions)

# Shares

$ Avg/Share

$ Stock

$ Debt Actual

$ Debt Face

Total $ Stock + Debt

Other Usage

2015

2.14

27.58

59

45

49

104

40.3

Q1

0.17

23.44

4

0

0

4

HLSS: 30

Q2

1.40

28.57

40

15

16

55

HLSS: -30

Q3

0.19

26.32

5

10

11

15

Castle Line: 22.8

Q4

0.38

26.23

10

20

22

30

Golden Gator: 17.5

2016

1.27

27.56

35

44

51

79

57.8

Q1

0.46

26.09

12

0

0

12

RESI: 29.4

Q2

0.30

26.67

8

44

51

52

RESI: 18.8

Q3

0.51

28.63

15

0

0

15

Granite: 9.6

Click to enlarge
  1. Deep under-valuation among peer companies.

Peer companies' enterprise value to LTM adj. EBITDA ratio: (These are approximate calculations as different companies have different EBITDA definitions, but serve as reasonable benchmarks.)

  • Black Knight Financial Services (NYSE:BKFS) publicly trades at 17x
  • Nationstar's (NYSE:NSM) Xome (privately valued at $1bn*) at 10x
  • Altisource publicly trades at 5x

*Source: Nationstar CEO Jay Bray's comments during 2015Q3 earnings conference call:

"Yes and I think from a valuation standpoint, the feedback that we have gotten from investors is definitely consistent with what we thought going in, at $1 billion or slightly more or slightly less. I think we're extremely pleased with the reaction around valuation."

2016Q1 earnings conference call:

Matthew Howlett (Analyst): "Do you still think it's worth a billion, I know you have made some comments on that in the past."

Jay Bray: "Absolutely, yeah."

Black Knight Financial does have a much more dominant and recurring revenue mortgage-industry technology and data services business. That's why it is trading at such a rich valuation.

Nationstar's Xome is the closest comparable to Altisource. Nationstar Mortgage Holdings is a direct and close competitor to Ocwen in mortgage servicing. Xome (a business segment within Nationstar) is similar to what Altisource was before spun-off by Ocwen.

  • Xome's revenue was $425 million and $437 million in LTM 2016Q3 and 2015FY, respectively. Xome's pre-tax income plus depreciation and amortization was $76.5 million and $92 million in LTM 2016Q3 and 2015FY, respectively.
  • Jay Bray: "I think long term I mean Xome is a $500 million revenue business that is going to make $100 million plus which is pretty darn attractive."
  • Assuming Xome is valued at $1 billion and would be making $100 million, Xome is valued at 10x by private market investors.

This is where Altisource would trade if it's valued close to Xome (10x):

Current:

5x => ASPS share ~$25

Potential:

6x => ASPS share ~$37

7x => ASPS share ~$46

8x => ASPS share ~$55

9x => ASPS share ~$64

10x => ASPS share ~$73

  1. Substantial insider share ownership.
  • Diluted shares outstanding ~19.5 million shares (as of September 30, 2016)
  • Bill Erbey, founder and ex-Chairman ~6 million shares
  • David Glancy, Putnam Investments ~3 million shares (I estimate its cost basis ~$60 per share)
  • Leon Cooperman, Omega Advisors ~2 million shares (I estimate its cost basis ~$45 per share)
  • Approximately ~11 million shares or 56% considered committed shareholders
  • Short interest ~5 million shares (as of November 15, 2016)

Bearish Points

  1. Business concentration risk.
  • On the surface, 74% of 2016Q1-Q3 service revenue is derived from Ocwen-serviced loans. Digging deeper, note that the majority of this revenue is not earned directly from Ocwen, i.e. Ocwen's expenses paid to Altisource that would show up in Ocwen's financial statements. Instead, Altisource earns the majority of this revenue by providing numerous property-related services on the loans serviced by Ocwen when Ocwen designates Altisource as the service provider, or when a party other than Ocwen selects Altisource as the service provider.
  • Altisource earned revenue from Ocwen (both directly and Ocwen designated) of $422.2 million in 2016Q1-Q3. Altisource earned revenue of $146 million in 2016Q1-Q3 related to the portfolios serviced by Ocwen when a party other than Ocwen selects Altisource as the service provider. As a result, after taking out revenue earned on Ocwen loans designated by non-Ocwen parties, service revenue directly earned from Ocwen or designated by Ocwen is 59% of total service revenue in 2016Q1-Q3.
  • Altisource no longer breaks out revenue directly earned from Ocwen as it's no longer a related company for financial reporting purpose. For 2014FY and 2013FY, the last time this data is reported, revenue directly earned from Ocwen is <10% of Altisource's total revenue.
  • Altisource has been aggressively diversifying to non-Ocwen customers in mortgage servicing and new businesses in originations, consumer real-estate, and real-estate investor solutions.
  1. Melting ice cube.
  • Mostly due to regulatory issues, Ocwen's serviced loan portfolio is in natural run-off. Ocwen's serviced loan portfolio is Altisource's largest revenue and profit source (point 1 above). On the surface, Altisource's major revenue and profit source is a "melting ice cube"
  • Digging deeper, Altisource generates most of its profits from default-related services ("mortgage services") provided to Ocwen-serviced loans. And this revenue stream has NOT shown any sign of decline from 2014Q3 to 2016Q3. During that period, while average number of delinquent loans serviced by Ocwen has declined by 39%, Altisource's service revenue per delinquent loan has increased by 65%. These two changes offset each other and result in a stable default-related revenue.

  • Furthermore, Ocwen has recently gotten past most of the regulatory issues and is aggressively trying to end the California DBO monitor and requesting New York DFS to lift its ban on Ocwen acquiring mortgage servicing rights on loan portfolios.

Conclusion

  1. Deep under-valuation.
  • The market is pricing Altisource as a melting ice cube, at 5x enterprise value to LTM adj. EBITDA after CapEx; half of what Altisource's closest but smaller competitor was valued in the private market.
  • Altisource's LTM adj. EBITDA after CapEx is $8.85 per share vs. market price at ~$27.
  1. Melting ice cube or Rough Diamond?
  • Altisource is going through a transition period, diversifying its revenue source to non-Ocwen customers and new businesses, making good progress but not as quickly as Wall Street would like.
  • Despite this transition period, Altisource's primary revenue and profit source has remained stable from 2014Q3 to 2016Q3; high margin business still generating high free cash flow
  1. Potential strategic catalyst.
  • Altisource's situation seems to be a great case to go private: stable and high free cash flow, low net debt, low market cap, but going through a transition period
  • Altisource's substantial insider share ownership could easily facilitate a go-private transaction, as was suggested by Leon Cooperman in Altisource's 2015Q4 earnings call.

Disclosure: I am/we are long ASPS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.