Description

ASPS: Altisource Portfolio Solutions

I am proposing a long position in Altisource Portfolio Solutions, an asset-light, high margin, and cash generative business that trades at attractive valuation due to its embattled past and bumpy transition away from its reliance on Ocwen.  I see 60% upside to $44 as the company sees non-OCN servicer revenue growth in the coming year, gets traction in some of its other business lines, and potentially sees OCN transition from run-off back into growth mode.

Business Summary and History:

ASPS (along with OCN, RESI, AAMC, HLSS) was formerly run by embattled mortgage servicing pioneer Bill Erbey, and was spun off of Ocwen Financial (OCN) in 2009 as a provider of software and services to the non-bank servicer sector.  ASPS is now a marketplace and transaction solutions provider for the real estate, mortgage and consumer debt industries, offering servicer solutions, origination solutions, and real estate investor solutions, in addition to several smaller growth initiatives.  Ocwen remains the major customer for ASPS, with 74% of total service revenue in 2016 generated from the OCN loan servicing portfolio.   OCN has had multiple issues of its own, over the past couple of years, which have contributed to ASPS’s stock devaluation.  However, OCN has recently made progress with the company’s state monitors and has seen somewhat of a stabilization in its business (though it is currently still in run-off mode pending final word from the monitors, at which point the company will seek reinstatement of its ability to buy MSRs).

Investment Thesis:

·   ASPS is an asset light, high-margin business which will continue to generate strong free cash flow.  Over the past twelve months ASPS has produced $167 million in free cash flow, and I expect the company to produce at least $270m in free cash flow in the next two years and then grow cash flow going forward.  This near-term cash flow equates to greater than 50% of the current market cap or nearly all of current net debt, helping to minimize the downside if company growth initiatives stall or if OCN remains in run off and is never able to purchase new mortgage servicing rights (MSRs).

·   Ocwen Financial, whose business represents 74% of service revenue, as mentioned previously, has addressed many of its regulatory issues, is nearing settlements with state regulators, has had its servicer ratings upgraded to an acceptable level, and is beginning the process of pursuing permission to obtain new MSRs.  ASPS is being valued as if OCN business is in run-off, whereas I believe there is potential upside to OCN’s business in the coming 24 months.

·   The company has reduced its cost base by nearly $100m on an annualized basis as its service revenue from OCN-based business has shrunk, positioning the company well, cost-wise, going forward.

·   The company has a very strong balance sheet, with  $135m in cash on its books and $45m in short term investments, totaling 34% of market cap.  Net debt of $300m is down 27% over the past year and is less than 2x adjusted EBITDA.  Solid cash generation and a strong balance sheet will continue to allow ASPS to invest in non-OCN businesses, opportunistically repurchase debt below par, and buy back stock.  During the first three quarters of 2016, ASPS has used cash generated to repurchase 1.27 million shares of its common stock at an average price per share of $26.94 and repurchase $51 million of its senior secured term loan at a weighted average discount of 13.2%,

·   Non-OCN business opportunities have continued growth off of a low base in 2016.  I expect non-OCN growth of 40% annually in the coming 3 years.  Servicer solutions contract wins should accelerate in 2017 as ASPS executes with its current clients and wins increased business as a result.  ASPS has a strong base of customers, including six of the top ten servicers, as well as a decent sales pipeline. This excerpt from the last call explains the upcoming progression of opportunities with new servicer solutions clients:

Bill Shepro, CEO: “We performed very well on these what they call preliminary score card. And then we start receiving an actual score card. So no additional volumes, but now we are actually going to perform for the next couple months creating up to about a month ago where we are now getting a score card. And I can tell you out of the nine roughly providers we are at the top in terms of our performance. We are doing really, really well for this particular client. And so, what they told us though they only do market share adjustments a couple of times a year.”

“Now we happen to get an off market share adjustment about two weeks ago, but they are going to do another market share adjustment in November, December of this year. And we fully anticipate based on our performance and all the feedback I have seen from this client that we are doing a really good job, and they are going to grow with us. And they spent a lot of money on that. And I think we'll do more than a million dollars a month, well more than that in 2017…”

“But, we do believe that these opportunities are tremendous. And the feedback we are getting from these customers is really, really good, both during our key stage and after we received the work. But it's a process to win the business. It's a process to get it on-boarded. And it's process then to grow and stabilize that business and add new statements of work with those existing customers. It just takes time. But we still believe that we're -- it is just a function of timing. And ultimately, we are going to see a lot of growth from these customers.”

·   Additionally, I also expect growth through the company’s unique approach to real estate investor solutions.  Other areas of focus for the company, to which I have not assigned value, but which could potentially create value if growth takes hold, are the origination solutions group, which focuses on growing originations, and the consumer real estate solutions group with owners.com (though this is admittedly in the very early innings and inconsequential in its financial impact currently).

·   Should operations indeed surprise to the upside or should OCN begin growing its MSR business again, ASPS is set up well for a short squeeze.  There are currently 19.5m diluted shares outstanding, with just over 5 million shares sold short.  That’s 26% of shares outstanding.  Additionally, there are around 11 million shares held by shareholders who have said they are committed to the company:  3 million held by David Glancy at Putnam Investments, 2 million held by Leon Cooperman at Omega Advisors, and 6 million held by founder and former Chairman Bill Erbey. So the traded float is much smaller than the shares outstanding.

·   Despite OCN-related business shrinkage and its related business risks for the company, ASPS is trading too cheaply.  I expect ASPS to have adjusted earnings of just above $5 for 2016, followed by trough earnings of $4.15 per share in 2017 before seeing earnings growth again in 2018.  ASPS currently trades at 5.5x this years earnings and 6.7x 2017 earnings.  The company has an EV/Ebitda of 4 currently.

Risks:

·   The biggest risk facing ASPS materializes if they are unable to grow servicer revenue from other major MSR holders as the OCN book shrinks.  OCN is currently seeing a run-off of their portfolio and are unable to purchase new MSRs due to a regulatory constraint against purchases.

·   Clearly there is key customer risk for ASPS, so any further adverse regulatory issues at Ocwen could impact ASPS.  As I have mentioned, OCN appears to be in the later innings of turning around their operational and regulatory issues.

·   ASPS recently used $48m in cash to buy a passive investment in RESI as a vote of confidence of some sort.  RESI is a client and former Erbey-led company. This investment in RESI is unjustifiable in my opinion, and the cash could have been better put to use to buyback stock or repurchase more debt at a discount to par.  Management has indicated that this will not be done in the future (and the holding is classified as a short-term investment), but given the Erbey complex’s history this casts doubt on management’s trustworthiness.  The only silver lining is that RESI yields 5% and will bring in ~$2.5 million as a result.

Catalyst

• Continued growth in the non-Ocwen business, especially increased business from top-10 banks in the high-margin servicer solutions segment.
• Additional opportunistic retirement of debt, especially below par.
• Reinstatement of Ocwen’s ability to purchase mortgage-servicing rights.
• Accelerating success in real estate investor solutions or mortgage origination solutions.