Description

ICE agreed to acquire BKI for ~$82 (80% cash; 20% stock) in may 2022. There are doubts the deal will close given how aggresive the current FTC has been towards mergers. Stock now trades at a ~37% discount to agreed price. Basically, market is discounting that the deal will not go through. 

I think there is a higher than 50/50 chance this deal gets approved. There is not material overlap as most of BKI´s business is in loan servicing while ICE has a significant market share in originations after they acquired Ellie Mae. BKI also provides loan orginiation software, but is a smaller player at roughly 10% share. This is not the largest business inside the company and in the worst case, ICE could remedy the situation by disposing of that mortgage origination asset. ICE looks at this deal as vertical integration, instead of a move towards more share in the loan origination business.

ICE also has a history of acquiring businesses and according to the CEO, they hired a third party to review the proposal. While this is of little value, they got positive comments and suggeted to go ahead with the transaction. They already have the money, so no worries on the funding side.

My base case is this thing closes around june 2023, and we get a 37% return in a short amount of time with reduced market risk.

In case the deal fails, we will own a great business that should do ok over time.

BKI is trading at 22x FCF which is below the pre-merger and pre-pandemic average. This also seems reasonable on an absolute basis for a ~50% EBITDA margin business that should grow +5% over time. We would also get a ~$700mm breakup fee (8% of current market cap) which could be used for buybacks.

In the merger filings, BKI also disclosed how much interest there was for the company. A private equity consortium, offered $87.50/share back in august 2021 and $74/share in april 2022. My guess is they could find a buyer above current share price if they wanted to.

This gives me confidence that downside should be limited.

Black Knight is the dominant provider of software solutions to the mortgage servicing industry helping their clients with billings, foreclosures, reporting, etc. The company has relationship with most of the large industry players including banks and originators. This business is sticky, given customers rarely decide to change out of something that is essential and works. Retention is quite high and my guess is disruption during this acquisition process will be minimal, as the business is simple to run. Revenues are quite consistent as the $ amount of loans being serviced does not fluctuate much YoY. Also, the business has benefited from pricing over time. There is some customer concentration as the largest 5 account for 26% of revenues.

As mentioned before, the company also offers loan origination software which is a bit more cyclical, and might get hit due to the lack of new loan demand as rates have spiked. This is the business that mostly overlaps with ICE and causes concern. This business should be less than 30% of overall revenues. 

Finally, the company generates and aggregates real estate and mortgage data. This is then sold to interest parties such as originators, lenders, brokers, etc.

My guess is this has traded down as growth has slowed to low single digits and anything related to mortgages has traded down given how much demand has dried up. Mortage rates went up significantly, and now sit close to 7% which has basically killed demand. There is fear of what might happen if rates stay or keep going up, and what can happen to industry players. As explained before, most of the compay´s reveneus are from servicing which is quite stable. BKI is not totally inmune to challenges faced by their clients, but the business is quite resilient.

In summary, we should get close to $82 in 6 months or so, which is a 37% return. In case deal fails, downside should be limited as BKI is trading at a modest stand-alone valuation. Seems like a good bet.

Catalyst

Deal closing for $82 by june 2023