Description

Black Knight, Inc. (NYSE: BLK)

Recommendation: Long common @ $85.80

BUSINESS OVERVIEW

Black Knight, Inc. (NYSE: BKI) is a market-leading, end-to-end provider of software, data, and analytics solutions to the mortgage, consumer loan, real estate, and capital markets industries. 

• Software Solutions (~86% of revenue): BKI’s mortgage servicing technology platform (MSP) has processed 36M loans for 23 of the top 25 servicers. On the origination side, key functions include compliance validation, loan officer tools, and point-of-sale solutions for loan applications.

• 60% and 30% share of primary mortgages and 2nd-lien mortgages, respectively.

• Two servicing software client types: a) Core servicing platform provides a system of record for applications and tasks such as billing, reconciliation, etc. b) Specialty provides tools to aid clients with managing delinquencies, foreclosures, and loan modifications.

• Top five clients account for 34% of segment revenue (Wells Fargo at 12%).

• Competitors: Ellie Mae and servicers’ in-house/proprietary solutions.

• Data & Analytics (~14% of revenue): solutions for real estate professionals (pre-mortgage), mortgages (lenders), and post-mortgage (servicers and secondary markets).

• Real estate end market: lead generation analytics, listing service software, and tax data.

• Mortgage end market: Property and mortgage performance data, valuations, and portfolio analytics

INVESTMENT MERITS

• Mission critical software for mortgage servicers. BKI is the gold standard.

• Reliable software is required for lenders amidst increasing regulatory complexity. Bank and non-bank servicers have suffered penalties for servicing errors, extending to foreclosure practices and illegal communications.

• Outsourcing trends continue, adding risk (to regain margin). It has become paramount for servicers to invest in technology given the legal and financial ramifications for mishandling clients and their data. At the C-level, this translates to technology shifting from “expansion” expenditure to a maintenance investment.

• Natural barriers to entry, extremely high switching costs (process is 12-18 months, if feasible at all), and strong recurring revenue stream (avg. contract duration is an 18.5+ year term.)

• Scope. Client base has gradually and silently become increasingly all-encompassing. At present, roughly 3,500 lenders/brokers are now clients of BKI’s Product, Pricing and Eligibility Solutions offerings.

• Customer Data. BKI develops and maintains large data sets on mortgage loans that are customizable for clients. Key data sets and reports include loan-level data, customer behavior trends, portfolio analytics, market insights, and pricing models for esoteric assets such as mortgage servicing rights (MSRs).

• Scalability. Onboarding new clients carries limited incremental operating cost.

• Optionality. BKI may capture foreclosure-related transactional revenues upon expiration of the foreclosure moratoriums and loan forbearance plans.

• Inelasticity. Extremely high switching costs coupled with deeply-rooted, long-standing client relationships.

• Proprietary Analytics / Data Sets. BKI owns numerous, highly valuable pricing and analytics packages that mortgage market participants depend on to set their operations. 

• Reliability. Given the past issues faced by servicers moving loans between platforms or using proprietary platforms, in combination with the increasing regulatory oversight, scrutiny, and enforcement, having the gold standard servicing platform is paramount given the potential implications for servicers who will incur issues moving forward.

VARIANT PERCEPTION

• The backlog of foreclosures could be much larger than the market believes, which should result in excess earnings once the moratorium ends.

• Valuation implies very little, if any, value for BKI’s investment (market value of $1.4b) in Dun & Bradstreet (DNB). 

• Higher focus on cross-selling opportunities in the data/analytics segment can create double-digit revenue growth. Digitization of real estate is still in its early stages, but Black Knight touches all points of the mortgage life cycle. Mortgage servicers are adequately capitalized relative to the past, with many companies looking to enhance their data capabilities.

• Business opportunities are not as saturated as the market believes, with a large addressable market in second-lien mortgages. These have grown in scale relative to new originations due to monetary policy’s impact, which has made it easier for consumers to access such loans for existing homes.

VALUATION

• Price target of $113 per share, based on 20x EBITDA multiple and $887m of adj. EBITDA in 2023.

• BKI is one of only 9 US mid/large-cap companies with both annual revenue growth exceeding 5% and LTM EBITDA margins greater than 45%.

• PEG shows growth is currently cheap.
• Multiple selection (NTM basis): BKI has historically traded between 17-23x EBITDA and 30-37x EPS. I believe the premium is warranted given the average customer tenure of 17 years and revenue retention of 90%+.
• Valuation methods: Given BKI's unique position coupled with its valuable data-related assets, comparables were excluded given often mentioned comps. intersect too many sub-spaces within financial services.

KEY RISKS

• Market perception around the solvency of certain mortgage servicers, which could negatively impact shares given BKI’s clients include the largest mortgage servicers.

• Mitigant: If one of BKI’s servicer clients were to go under, I am confident that the mortgages would be transferred to another servicer and still reside on Black Knight’s MSP. The possible cost of moving the loans to another platform is simply too large to ignore. 

• Extension of the foreclosure moratorium.

• Levered servicing clients with exposure to increasingly delinquent loans could slow down the implementation of software. For certain servicers (% materiality undisclosed), excess delinquencies or foreclosures will increase debt levels and reduce their technology and software expenditures. 

Catalyst

• Backlog of foreclosures exceeds market expectations, which results in favorable revenue growth and Q1/Q2 earnings due to the additional transaction-based revenue.

• Accretive acquisition or management communication that indicates an increased probability of near-term share buybacks.

• New data that shows improved market share in second-lien mortgages.