Description

 2023-02-22 ASPS Investment Review  

Pitch  

Through a series of management misadventures in the capital markets ASPS is on sale here and deserves a look.  ASPS had been trading in the $10 range post the very profitable divestiture of Pointillist for $106M last year.   Earlier this year the stock crested at $15 as the market started to get excited about the removal of the Biden foreclosure moratorium and the potential for a pure play foreclosure specialist in a market that could see a meaningful pick up in the pace of foreclosures.  ASPS then made a series of missteps which created what we believe to be a massive opportunity.  ASPS decided to address a term loan that was coming due in 2024.  They did so by first filing a registration statement and ATM facility.  While they did NOT use the ATM facility the market was both confused by the filing (the company had $50mm on the balance sheet and a loan not due until 2024) and hated the idea of a capital raise, especially with an ATM which has historically driven share prices in one direction.  Then word leaked the ASPS had hired Guggenheim to renegotiate the term loan.  The market did not expect this to occur for some time and the news that a restructuring banker was working with the banks caused further fear.  At this point the share price had come in 50% and the market knew something was up.  ASPS announced better than expected numbers and a renegotiated term loan and immediately launched a private placement through Guggenheim.  Guggenheim is not an active player in the private placement market and the deal was ultimately priced at $5 per share, which was nearly 40% below where the stock had been trading a week earlier.  Had ASPS done a secondary when the stock was at $15 and THEN renegotiated the debt all of this could have been avoided, but while this is a sad story for existing shareholders who were massively diluted by the equity raise and the warrants issued during the renegotiation of the debt, a compelling opportunity is created for those looking for a cheap entry point into a countercyclical business with leverage to the foreclosure cycle which lies ahead.  Full disclosure, we bought over 5% of the Company down here and are excited about the opportunity.  Management also participated in the financing.  Importantly, if foreclosure rates get back to 2019 levels this is a homerun.  If foreclosure rates climb above this, we will look back fondly at this entry price.  There is mounting evidence in consumer loan books and auto books of distress in consumer land.  This is typically the forward indicator of home loan issues.  

Summary  

Altisource (ASPS) is an integrated service provider to the US mortgage and real estate industries, spun off from Ocwen (ticker: OCN) in 2009. The company offers an asset-light suite of solutions that support the default servicing, real estate, and origination lifecycles. The servicing of defaulted loans, and the management and disposition of homes, collectively account for 95% of ASPS’s adjusted EBITDA.    

The company’s earnings inflect when rising delinquencies turn into a pickup in defaults and foreclosures. Today’s 1.8% delinquency rate for single-family residential mortgages (per FRED, as of 9/30/22) is below pre-pandemic levels, but delinquencies are accelerating off of record lows. The US economy may be headed into recession, and a recessionary environment dramatically increases APSP’s profitability. This makes ASPS compelling today – A counter-cyclical investment that currently trades at a discount on both recessionary earnings and non-recessionary normalized earnings. The stock has been oversold due to a poorly-timed equity raise, and a dilutive refinancing, creating a favorable reward to risk at today’s price.   

Company Overview  

Altisource’s primary business is offering default and origination services. Collectively, this total service revenue accounts for 94% of ASPS’s total revenues, with reimbursable expenses and non-controlling interests accounting for the balance. Default services, called the Servicer and Real Estate (“SRE”) segment by Altisource, are 78% of total service revenue, and 95% of adj EBITDA as of 12/31/22. The SRE segment provides solutions to loan servicers and real estate investors that support the servicing of defaulted loans, and the management and disposition of homes. From the pre-foreclosure process, to foreclosure, to the real estate owned (“REO”) management and disposition process (if necessary), Altisource offers solutions along the entire path. The company’s higher-margin offerings are towards the foreclosure and REO management stages. Of particular importance is Hubzu, Altisource’s high-margin online real estate auction platform. We believe the Hubzu marketplace alone could be worth most of ASPS’s entire enterprise value.    

Simply, the SRE business is driven by defaults, foreclosure starts, and real estate sales. From 2020-2021, the COVID-induced foreclosure moratoriums and borrower relief measures led to a ~90% peak-to-trough reduction in foreclosure starts. These relief measures expired in December 2021, and while foreclosure starts are still ~30% below pre-pandemic levels as of December 2022, starts are accelerating out of the pandemic, with initiations growing +409% in 2022. In today’s environment, it typically takes ~2 years to convert foreclosure starts to foreclosure sales, and ~6 months to market and sell any resulting REO.  

Moving to Altisource’s Origination (“ORG”) segment, this business is 22% of total service revenues, and 5% of adjusted EBITDA. This segment provides originators (mortgage bankers, banks, and credit unions) solutions that support loan originations. These solutions include mortgage origination underwriting, brokering, valuation, and appraisal. Included in this segment is Lenders One (43% of segment revenues), a cooperative that Altisource manages, which collectively through its ~250 members originates ~15% of all US residential mortgages. Altisource runs the vendor marketplace and automation platform for Lenders One. The balance of the segment (56% of segment revenue) is Solutions, which includes mortgage loan fulfillment, title and escrow, valuation products, and loan manufacturing insurance. Margins across the Origination segment are fairly low.     

Earnings & Valuation Expectations  

In a normal default market, which Altisource likens to 2019’s environment, ASPS expects to earn $42M in adj EBITDA. The stock trades at 7x that normalized EBITDA level, and we expect ASPS to trade closer to 10x as prospects improve. The normal market ASPS assumes here is non-recessionary. In a recession, the delinquency rate likely will reach a mid-single digit % range. In the wave of post-GFC defaults, SF resi mortgage delinquency was as high as 11.5%. At that time, between 2010-2013, ASPS’s EBITDA multiple fluctuated between 10-20x, on strong $100-300M adj EBITDA numbers (peak multiple on peak earnings).   

Again if we use management’s normalized $42M EBITDA expectation, ASPS trades at a reasonable 6.5x multiple. But the upside potential is there in a recession, where we could see the EBITDA figure move much higher, and see a >10x multiple. We believe ASPS has a favorable reward/risk, albeit with a wide range of outcomes. We think assigning a 7-10x multiple for the business is fair given forward expectations. As the default market firms up, a 10x multiple on $42M of normalized EBITDA implies a $11 stock price, or ~+100% upside from today’s $5.69 price (target assumes $30M par paydown from current $20M – See Capital Raise & Balance Sheet section for more detail on par paydown).   

Competitors & Valuation  

Altisource doesn’t have a true like-for-like competitor to reference, but has overlap with other businesses across units. ASPS has overlap with Mr. Cooper (ticker: COOP), which is one of the largest non-banks in mortgage origination and servicing (via ownership of a MSR and subservicing portfolio). COOP also has a foreclosure platform called Xome that competes with Hubzu. Management thinks Xome can do $120M in EBIT when reaching a normalized run rate for foreclosures, and believes that Xome could be valued at over $1B (8x normalized EBIT). We believe Hubzu can do ~$40M in EBITDA in a normalized foreclosure environment, on >50% EBITDA margins (before corporate expenses, which we estimate at ~$10M). Xome is more scaled than Hubzu, and generally COOP trades at a significant premium to ASPS, but we’d feel conservative enough applying a 5x multiple to Hubzu’s normalized ~$30M EBITDA (post corp expenses), implying a ~$150M valuation at normalized, non-recessionary EBITDA. Post GFC, Hubzu was earning ~$150M in adj EBITDA. In a recession for today’s healthier housing market, we think closer to ~$75M in adj EBITDA is possible.   

Capital Raise & Balance Sheet  

Altisource has recently shored up its balance sheet, refinancing the company’s existing April 2024 $247M term loan to a new April 2025 $242M term loan, with an option to extend maturity to April 2026, which we believe the company will exercise. ASPS has already paid down $20M of this new term loan, financed through a $21.2M equity raise, bringing its pro forma debt balance down to $222M.  Altisource also has $50mm of cash on the balance sheet. 

The terms of the new term loan aren’t favorable – Interest rate on the loan is ~15% (SOFR + 5% cash + 5% PIK). There were also penny warrants issued with the term loan, which started at 20% of shares outstanding (or 3.2M shares), however ASPS has a par paydown option that reduces the PIK interest rate and warrants issued. With the $20M that ASPS has paid down, the warrant issuance drops to 16% (or 2.6M shares). If ASPS pays down an additional $10M, which we expect, then warrant issuance drops to 10% (or 1.6M shares). In terms of the PIK interest rate, if ASPS pays down $30/50/70M of par within the first year of the transaction, the PIK moves down to 3.75/2.50/0% respectively.  

Again, this was an expensive and dilutive transaction, but it provides essential liquidity for ASPS as the default and foreclosure market firms up. ASPS’s pro forma net debt sits at $177M, with a fully diluted share count 23.2M following the $20M par paydown. At the $30M paydown threshold, fully diluted shares would be 22.2M.  

Risks  

1. Soft or no landing scenario. In the economic goldilocks scenario, the residential mortgage delinquency rate may not return to the 2019 ~3% level. This could create challenges for ASPS in servicing its expensive debt load, and could lead to another dilutive refinancing or capital raise.   
2. Another foreclosure moratorium would raise solvency risk dramatically for ASPS.   
3. The cycle takes longer to materialize and ASPS has to come back to the equity markets. 

Disclosure

Catalyst

1. Acceleration in US resi mortgage delinquencies and foreclosures
2. Declining macro picture