ASPS - Altisource

[ItsAValueTrap]

Altisource is in the mortgage servicing business.  The mortgage industry is increasingly outsourcing mortgage servicing as it is expensive to comply with regulations and the specialized companies are just better at doing it.

 

Why I'm interested in ASPS:

#1- They seem to be the best operated mortgage servicer.  They did not do anything wrong with robosigning, unlike the big banks.  ASPS posts better profitability than its other publicly-traded peers.

#2- The valuation seems to be reasonable for such a quickly growing company.  P/E 18 at $80/share.  It has grown revenues at about 37%/year over the past few years.

Next year, their growth should be guaranteed as Ocwen boarded a huge number of new loans.  (Their revenues might grow even more than 37% next year.)

#3- Their capital allocation is probably above average.  ASPS recently started buying back its shares again (though in the future it has to amend its term loan due 2019).

 

I've written about Altisource here:

http://glennchan.wordpress.com/tag/altisource-asps/

 

Anybody have thoughts on this company?

[LC]

So from what I understand, ASPS is the property manager, RESI owns the loans, and AAMN/NewSource provide asset management/title services?

 

My question is why ASPS and not AAMC? AAMC's profitability is directly tied to RESI's dividend payments but lacks the downside of holding the loans themselves.

 

So if RESI prospers, NewSource prospers with it by providing title insurance. NewSource funnels these profits back to RESI via the dividend, but RESI then pays AAMC based on the level of dividend payments. Sounds like AAMC owns all the upside without the downside.

 

Also, where does ASPS fit into this picture?

[Olmsted]

My question is why ASPS and not AAMC? AAMC's profitability is directly tied to RESI's dividend payments but lacks the downside of holding the loans themselves.

 

So if RESI prospers, NewSource prospers with it by providing title insurance. NewSource funnels these profits back to RESI via the dividend, but RESI then pays AAMC based on the level of dividend payments. Sounds like AAMC owns all the upside without the downside.

 

You're right that the economics of AAMC are very, very attractive.  But its market cap is a little crazy.  For AAMC's stock price to be attractive you would have to assume either an absurdly high ROE on RESI's assets or a much, much larger asset base.  With other buy-to-rent residential REITs trading now trading just at or under book, and with companies like this one having absorbed much of the "shadow inventory" of foreclosures and NPLs, a much larger asset base seems unlikely.

[Olmsted]

If you check out the most-recent SBY investor presentation you can see why I don't think ROE to this business model is likely to be overly generous going forward.  They break down their acquisition costs for single-family homes.  Their first investments were cheap, not so much any more.  That means a nice bump in book value, but lower returns on any new capital they put to use.  Fix-up costs and ongoing expenses are also coming in higher than initially anticipated.  I think RESI's and AAMC's optimal time to exist was a couple years before it was actually brought public.

 

If I have time I'll dig up that presentation and post a link.

[LC]

I think this is the report you are referring to

 

http://investors.silverbayrealtytrustcorp.com/file.aspx?IID=4335231&FID=1500049868

 

I still need to do more research on the cash flows between RESI and AAMC. If AAMC receives payment based on title insurance proceeds remitted to RESI, what does the ROE of RESI's assets have to do with it?

[ItsAValueTrap]

Here's my updated writeup on ASPS:

http://glennchan.wordpress.com/2013/07/04/altisource-asps-updated-writeup/

(I see you've commented on my blog so you've already seen it.)

 

If both AAMC and ASPS were trading at book value, AAMC would likely be the stock to buy.  But AAMC's valuation is absolutely crazy right now... which I explain at the bottom of the writeup. 

 

I think RESI's and AAMC's optimal time to exist was a couple years before it was actually brought public.

I think it makes sense for RESI to exist.  Underlying all the businesses is a collection of mortgages.  Ocwen, Altisource, AAMC, and RESI are all involved in slicing up the profits from these mortgages.

 

When some of the underlying mortgages go bad, a few things can happen:

A- You fix up the property and sell it to new homeowners / retail buyers.

B- You don't fix the property and sell it to investors, who fix the place and sell it retail.

C- You fix the property, and rent it out.

 

It comes down to whether you want to fix the property or to rent it out.  I'm guessing that Erbey thinks it makes a little more sense to do the second.  It comes down to the economics of being a landlord or being a quasi-homebuilder.  Our low interest rate environment (A) makes the yield on rentals very attractive and (B) allows you to leverage that return with cheap debt.

 

SBY looks like it has a cap rate of at least 5%.  They're buying houses at around $75/sqft.  I believe new houses cost more than that to build even if the land is free.  (Of course you should probably buy Altisource instead of rental houses, RESI, SBY, OCN, etc.)

[G2]

AAMC at book value would be an amazing trade.  It was capitalized with $5m and is entitled to three earnings streams: 1) 90% of net profits from NewSource which exclusively provides highly profitable title insurance to RESI and 2) the dividend payment arrangement with RESI which pays half of the dividend as a performance fee after the final threshold, if I remember correctly and 3) the $840K which is adjusted for CPI.

 

If RESI can trade above book and continue to issue stock to acquire more loans and rent out more homes, then it'll be able to enter a virtuous cycle and increase its dividend and AAMC will collect a substantially larger performance fee.

 

In order to value AAMC, I think you need to confidently answer the following questions:

1) At what size and at what growth rate do you estimate the three earnings streams (the $840K adjusted for the CPI is the easiest and seems to cover annual overhead...)?

2) At what rate would you capitalize the two earnings streams related to RESI and NewSource?

3) How will Erbey invest the capital he'll accumulate and at what rate would you expect it to compound given the success he's found in past investments?

 

I only wish I'd discovered him sooner as I feel he's a bit like what John Malone is to telecommunications and media and what John Frederiksen is to shipping with all the spins he's done to exploit various concepts in the mortgage space.

 

I honestly have no idea how to make the necessary estimates and value the vehicle correctly due to the limited information in the initial filings but I remember when I was reviewing the AAMC agreements back in November it just looked like an entity that would be gushing cash.

 

The current $620m AAMC valuations seems extreme (heck it looked overvalued at $100/share to me so I was completely wrong there) but it'll definitely be interesting to watch how Erbey decides to turn it into his personal investment vehicle and how it plays out.

 

RESI could be an interesting short-term trade (like 18-24 months) based simply off waiting for it to receive consistent cash flow, distribute a dividend and wait for its cap rate to cause it to trade above book value.  Has anyone looked at estimates for these numbers or what the returns would look like with a 5% cap rate that another poster mentioned?  And if it is reasonable to assume a dividend after 18 months?  I can't remember the numbers off the top of my head for this one...

 

My sense is that RESI will have two competitive advantages over competitors: 1) primary (but not exclusive) access to deal flow at ASPS related to underwater mortgages that it can convert into rentals and 2) use of ASPS to do repairs, manage and sell the homes.  It has the experience and nationwide scalability that others like Silver Bay and Colony lack and these are both huge benefits and why I'd prefer it to the others if all traded at a similar valuation.

[ItsAValueTrap]

RESI could be an interesting short-term trade (like 18-24 months) based simply off waiting for it to receive consistent cash flow

Why would you buy RESI over ASPS?

[indirect]

AAMC at book value would be an amazing trade.  It was capitalized with $5m and is entitled to three earnings streams: 1) 90% of net profits from NewSource which exclusively provides highly profitable title insurance to RESI and 2) the dividend payment arrangement with RESI which pays half of the dividend as a performance fee after the final threshold, if I remember correctly and 3) the $840K which is adjusted for CPI.

 

If RESI can trade above book and continue to issue stock to acquire more loans and rent out more homes, then it'll be able to enter a virtuous cycle and increase its dividend and AAMC will collect a substantially larger performance fee.

 

In order to value AAMC, I think you need to confidently answer the following questions:

1) At what size and at what growth rate do you estimate the three earnings streams (the $840K adjusted for the CPI is the easiest and seems to cover annual overhead...)?

2) At what rate would you capitalize the two earnings streams related to RESI and NewSource?

3) How will Erbey invest the capital he'll accumulate and at what rate would you expect it to compound given the success he's found in past investments?

 

I only wish I'd discovered him sooner as I feel he's a bit like what John Malone is to telecommunications and media and what John Frederiksen is to shipping with all the spins he's done to exploit various concepts in the mortgage space.

 

I honestly have no idea how to make the necessary estimates and value the vehicle correctly due to the limited information in the initial filings but I remember when I was reviewing the AAMC agreements back in November it just looked like an entity that would be gushing cash.

 

The current $620m AAMC valuations seems extreme (heck it looked overvalued at $100/share to me so I was completely wrong there) but it'll definitely be interesting to watch how Erbey decides to turn it into his personal investment vehicle and how it plays out.

 

RESI could be an interesting short-term trade (like 18-24 months) based simply off waiting for it to receive consistent cash flow, distribute a dividend and wait for its cap rate to cause it to trade above book value.  Has anyone looked at estimates for these numbers or what the returns would look like with a 5% cap rate that another poster mentioned?  And if it is reasonable to assume a dividend after 18 months?  I can't remember the numbers off the top of my head for this one...

 

My sense is that RESI will have two competitive advantages over competitors: 1) primary (but not exclusive) access to deal flow at ASPS related to underwater mortgages that it can convert into rentals and 2) use of ASPS to do repairs, manage and sell the homes.  It has the experience and nationwide scalability that others like Silver Bay and Colony lack and these are both huge benefits and why I'd prefer it to the others if all traded at a similar valuation.

 

 

I think RESI should have its own thread.

 

I have looked at many ways of investing in the housing industry and this is the best way to invest in individual houses without hassles of management.

[G2]

RESI could be an interesting short-term trade (like 18-24 months) based simply off waiting for it to receive consistent cash flow

Why would you buy RESI over ASPS?

 

Most likely our differences are a matter of preference.  I like to stick with what I enjoy and fits my personality.  If I'd been involved with the ASPS spin in 09 then I'd prolly still hold it.

 

As for thought process--I like the trade's set-up.

 

Its a pile of cash embedded in an REIT structure.  A sensible business plan and management incentives tied to successful execution of the transformation are another plus.

 

For me, it was also a simple arbitrage of shareholder bases.  You're transitioning from ASPS holders that prefer fast-growing, asset-lite cos and RESI will transition to income-seekers indifferent to its capital intensity.  If you look at Erbey's other publicly-traded entities, this seems to be a common theme.  But that part of the thesis became less relevant with the capital raise in May.

 

Now its about the acquisition of sub-performing and non-performing loans, their conversion into single family rentals and entering a virtuous cycle of buying home loans at a discount with capital raised at a premium to book.

 

What I like most is the hard catalyst of a dividend distribution and its future growth which should force a re-valuation of RESI.

 

I enjoyed reading all your ASPS write-ups--I guess in the back of my mind, part of me wonders if part of Erbey's genius was to position his companies to be at the right place at the right time with respect to the whole mortgage crisis.  Do you see revenue growth from the past few years continuing for the next 5-10 years?

[G2]

I think RESI should have its own thread.

 

I have looked at many ways of investing in the housing industry and this is the best way to invest in individual houses without hassles of management.

 

I'll re-visit my notes and see if I can get something up in next few days.  If you post it first, then I'll be sure to join in on the conversation.

[ItsAValueTrap]

For me, it was also a simple arbitrage of shareholder bases.  You're transitioning from ASPS holders that prefer fast-growing, asset-lite cos and RESI will transition to income-seekers indifferent to its capital intensity.

 

I really think that you'd rather own the company with higher returns on capital.

 

I guess in the back of my mind, part of me wonders if part of Erbey's genius was to position his companies to be at the right place at the right time with respect to the whole mortgage crisis.

No idea.  I think that the RESI model made slightly more sense a few years ago.  There used to be a much bigger supply of foreclosures and the economics of being a landlord were just as good (if not better).

 

I think Erbey has been reactive for the most part.  When investors are willing to put a high valuation on assets, he has been selling stock.  That's why Ocwen became publicly listed in the first place.

[Ross812]

Earnings are out and look great:

 

http://www.reuters.com/article/2013/07/25/idUSnGNX3wsH48+1c4+GNW20130725

 

Valuetrap, thank you for the idea and the impressive writeup on your blog. I wish there was more discussion on some of these GAARP type investments.

 

Regards,

 

Ross

[ItsAValueTrap]

Thanks!

 

I wish there was more discussion on some of these GAARP type investments.

Why don't we do a thread on Express Scripts?  I'm trying to figure out this company right now.

[Ross812]

An Express Scripts thread sounds good to me. I spent some time last year trying to understand the business and started a small position in Q4'12 after assessing the business had a good moat and had a long runway in front of it. I would have been much more interested and done a lot more research if it had fallen further.

 

Lately I've been reading into Bollere, Fiserv, and Discover Financial. I'm starting to think DSF might be a great opportunity considering the PE discrepancy between DSF and AXP. This seekingalpha article came out about a week after I finished the '11 and '12 annual report. It lays it out pretty well:

 

http://seekingalpha.com/article/1558232-discover-financial-services-set-for-growth-with-new-strategies-and-network-partnerships

[ItsAValueTrap]

Ocwen and Altisource are dipping, likely due to fears that Ocwen's growth may slow down.  This might be an opportunity to pick up some shares.

 

Regulators have recently blocked Ocwen from buying mortgage servicing rights from Wells Fargo due to concerns over Ocwen's servicing quality.

http://www.reuters.com/article/2014/02/06/wellsfargo-ocwen-mortgages-idUSL2N0LB1DQ20140206

 

To me, this seems like a good problem to have.  They will still be able to grow earnings... but not as fast.  Altisource's earnings should grow next year as it boards more of Ocwen's loans.

 

2- To be fair, Ocwen recently had a settlement over its practices.  It paid only half of the cash settlement.  The rest of the $2B is in mortgage modifications that Ocwen would have arranged anyways (it is Ocwen's clients that will eat the cost of the mortgage modifications).

 

http://webcache.googleusercontent.com/search?q=cache:FISJ3Pou-K8J:online.wsj.com/news/articles/SB10001424052702303773704579268190251190358+&cd=5&hl=en&ct=clnk&gl=ca&client=firefox-a

 

3- Moodys states that its assessment of Ocwen's servicing quality remains stable for now.

https://www.moodys.com/research/Moodys-Ocwens-servicer-assessments-stable-but-concerns-remain--PR_291102

[yitech]

Ocwen and Altisource are dipping, likely due to fears that Ocwen's growth may slow down.  This might be an opportunity to pick up some shares.

 

Regulators have recently blocked Ocwen from buying mortgage servicing rights from Wells Fargo due to concerns over Ocwen's servicing quality.

http://www.reuters.com/article/2014/02/06/wellsfargo-ocwen-mortgages-idUSL2N0LB1DQ20140206

 

To me, this seems like a good problem to have.  They will still be able to grow earnings... but not as fast.  Altisource's earnings should grow next year as it boards more of Ocwen's loans.

 

2- To be fair, Ocwen recently had a settlement over its practices.  It paid only half of the cash settlement.  The rest of the $2B is in mortgage modifications that Ocwen would have arranged anyways (it is Ocwen's clients that will eat the cost of the mortgage modifications).

 

http://webcache.googleusercontent.com/search?q=cache:FISJ3Pou-K8J:online.wsj.com/news/articles/SB10001424052702303773704579268190251190358+&cd=5&hl=en&ct=clnk&gl=ca&client=firefox-a

 

3- Moodys states that its assessment of Ocwen's servicing quality remains stable for now.

https://www.moodys.com/research/Moodys-Ocwens-servicer-assessments-stable-but-concerns-remain--PR_291102

 

What do you think the lawsuit PIMCO and other MBS investors are preparing to file against Ocwen on the loan modifications will have on the share price going forward?

[ItsAValueTrap]

No idea about where the share price is headed in the short term.

 

Business-wise:

 

The regulators are pushing the mortgage servicers into giving more loan modifications for delinquent homeowners (that's what I'm going to call them).  They want people to stay in "their" homes, as if homedebtorship is a god-given right.  A lot of their actions are politically motivated. 

 

The investors who own the mortgage-backed securities tend to want the servicers to give less loan modifications.  They want to make money.  To some degree, many of the investors bought distressed MBS and want to see a high rate of return on their investment.  If the home is foreclosed and sold, the investors can make a quick buck.

 

2- Legally I have no idea where Ocwen stands.

[yitech]

No idea about where the share price is headed in the short term.

 

Business-wise:

 

The regulators are pushing the mortgage servicers into giving more loan modifications for delinquent homeowners (that's what I'm going to call them).  They want people to stay in "their" homes, as if homedebtorship is a god-given right.  A lot of their actions are politically motivated. 

 

The investors who own the mortgage-backed securities tend to want the servicers to give less loan modifications.  They want to make money.  To some degree, many of the investors bought distressed MBS and want to see a high rate of return on their investment.  If the home is foreclosed and sold, the investors can make a quick buck.

 

2- Legally I have no idea where Ocwen stands.

 

Yeah, I think senior MBS holders would prefer foreclosure as subordinate classes would get hit first, but loan modifications would hurt all classes equally. I have no idea the likely legal exposure is there either, so I am staying on the sideline until it hits low $30s.

[ItsAValueTrap]

I don't think that the legal risk is a big deal.  Most large companies have some legal risk.

 

Microsoft has been hounded by regulators.  (In my opinion, quite unfairly.)

RIM/Blackberry was patent trolled for billions.

Goldman Sachs and investment banks regularly pay out large settlements.  (However, I think that many of those settlements are justified and that the investment banks engaged in egregious behaviour.)

Visa and Mastercard paid out large settlements.

Berkshire Hathaway ran into trouble with the SEC in the early days.  (In my opinion, it wasn't fair.)

[yitech]

I think the downside is probably limited after the 40% drop. I got out not long after Q3 call because I thought the MSR transfer may slow down and the stock was pricing in paid MSR transfers from big banks. They were able to sell MSR-backed debt north of $100M recently. The drop in CPR is a nice tailwind as rates rise. But one thing for sure is that the growth will slow down sooner than expected as they encounter more regulatory scrutiny. I may look to accumulate gradually again going forward as the stock falls further.

 

Here is an interesting take on the steady-state sustainable FCF from an author in SeekingAlpha. It's a bit dated and published before the regulatory scrutiny, but shows a good framework IMO as the company does not originate loans and the MSR transfer will stop at some point in the future.

http://seekingalpha.com/article/1969761-untangling-ocwens-free-cash-flows

[bz1516]

The whole MSR space is one I'm going to watch for a turnaround.  Taking off the NYS regulatory pressures coupled with a renewed flow of Basel III unloading by banks and these stocks can see significant upside again.  maybe it won't happen, but worth watching to see if it does.

[ItsAValueTrap]

Does anybody know where you can read either:

1- A prospectus for a mortgage backed security.

or...

2- The contract for mortgage servicing rights.

 

I'm trying to get a better understanding on how the MSR contracts work and Ocwen's legal liability.

[yitech]

It would be very hard unless you know what MBS PIMCO and Blackrock bought that contain part of the collateral pools currently serviced by Ocwen. I used to work in a consulting firms that help model the these MBS structures. Trust me. Unless you are Mike Burry, you wouldn't want to reverse-engineer the deal structure from a prospectus.

 

MSR fees go with the loan pools, so you would need to track which loans got modified and the amount of the loan reduction and wether these loans are part of the collateral pools of the MBS deals held by PIMCO and Blackrock...etc. That's no easy task.

 

As to how MSR works, this blog offers great tutorials: http://reminiscencesofastockblogger.com/

[timidbid]

ItsAValueTrap, Ocwen has a broad spectrum of servicing agreements but if you are really curious you can take a look at:

 

1. Fannie Mae's base prospectus for single family MBS: http://www.fanniemae.com/portal/jsp/mbs/documents/mbs/prospectus/index.html

2. Fannie Mae's servicing guide: https://www.fanniemae.com/content/guide/svc031412.pdf

 

Hope that helps