BLACK KNIGHT INC BKI
January 09, 2019 - 10:02am EST by
compass868
2019 2020
Price: 46.13 EPS 2.01 2.35
Shares Out. (in M): 148 P/E 23 19.6
Market Cap (in $M): 6,827 P/FCF 23 19.6
Net Debt (in $M): 1,380 EBIT 329 403
TEV ($): 8,207 TEV/EBIT 25 20

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Description

Overview:

 

BKI is a monopoly-like software and data business that has a multi-year runway to deliver HSD% revenue growth and teens% EPS growth as the company leverages its incumbent position with core customers to consolidate its market share and introduce value-add adjacencies. 

 

4Q market volatility, misplaced fears about mortgage market sensitivity, and investors' dislike of recent non-core DNB investment have created an entry point into a quality compounder that has an underappreciated position in transitioning the bank industry to digital mortgage production, beta to a significant upside rally in SPX, and downside protection because of limited cyclical exposure and rock-solid 2019/2020 EPS numbers.  

 

Our 1-year PT is $53-62 (+17%-+37%), based on 22-26x our 2020 EPS and 14-16x our EBITDA estimates, compared to current NTM multiple of 22.5x and 13.5x, respectively.   Beyond a 1-year PT, our view is that BKI can double its earnings power in the next 5 years, making BKI an attractive multi-year hold with double digit IRR potential. 

 

BKI’s secular growth position provides downside protection and limits potential for significant capital loss in the near term.  In a further market dislocation, BKI could trade at a market multiple in a worst case scenario, which would imply -20% (15x 2020 EPS).  We believe there would be a strategic or financial buyer for the asset  if it traded to those levels at a 20-30% premium, which would limit absolute capital loss. 

 

Business Description:

 

BKI is a provider of software, data and analytics solutions to the mortgage and consumer loan, real estate and capital market verticals. BKI serves the top 100 domestic banks by providing solutions for servicing and originating consumer mortgages and home equity lines.  BKI has 4 main products: mortgage servicing, home equity servicing, mortgage origination software, and real estate data and analytics.

 

The company has 62% market share in its core product (mortgage servicing),   and has signed contracts that will get them to 70% market share by 2020.  Servicing is close to a monopoly business with very high switching costs and built in annual price escalators.  Although the mortgage market is cyclical, mortgage servicing is not because BKI gets paid based on the total STOCK of mortgages in the banking system (which is not volatile), not the annual FLOW of mortgage originations. 100% of revenue is domestic. 

 

BKI has 15% market share in home equity servicing and has contracts signed that will get them to 30% market share by 2020. 

 

BKI’s mortgage origination business is growing off a small base and the company has runway to double or triple its business over the next 5 years. 

 

Valuation Construct:

 

We contemplate a price target for BKI at a 1.4-1.6x EBITDA peg, in-line with SPX at 1.4x and a discount to info services peers at ~2.0x

 

BKI’s closest valuation comparable are bank servicing platforms FISV, and JKHY because the end markets are the same and revenue streams are also defensive.  Over the past 5 years, BKI has traded at a premium to FISV and in-line with JKHY on EV/EBITDA.  Over the past 3-months, BKI has traded at a 5-10% discount to FISV and 20-25% discount to JKHY, despite having a superior growth profile to both.  On an absolute basis, BKI has de-rated from 17x NTM EBITDA in the beginning of 2018 to <14x currently.  This 18% de-rate compares to 5% for FISV and 6% for JKHY. 

 

Why Does Opportunity Exist?

 

1.       Market lacks conviction about sustainability of BKI’s revenue growth and the stock is priced in-line with FISV, implying the market believes 3-4% revenue growth is likely over the medium term, not the HSD% that we underwrite to.

2.       BKI has poor corporate governance, and the stock underperformed in November after the company announced it will be a minority investor in a pending LBO controlled by BKI's Chairman's investment vehicle and that BKI's CEO would become CEO of the acquired company upon close. 

 

What is market missing?

 

1.       Revenue growth sustainability:

a.       BKI has disclosed a revenue backlog through 2020 with specific annual details about revenue phase-in.  This gives us explicit conviction in ability for BKI to meet revenue targets for the next 2-years.  BKI does not have hidden cyclicality like others in the broader information services peer group. 

b.      Beyond 2020, BKI can maintain 6-8% revenue growth given its market share penetration opportunity and introduction of new products which will contribute to revenue growth in 2019 and beyond. 

i.      We believe the company will announce customers wins in its core mortgage servicing and origination products in the next 12-18 months.  In particular, it is possible they announce large contracts from WFC where management appears bullish.  Management’s intention is to grow its market share in mortgage and home equity servicing from 70% and 30% to 90% and 50% in the medium term. 

ii.      On new products, BKI is one of the only companies currently commercializing machine learning /artificial intelligence via its integration of August 2018 AIVA acquisition which helps banks reduce manual labor in the mortgage origination process.  Suntrust has been announced as a marquee pilot customer and we expect further announcements over the course of this year.  The company has not disclosed unit economics or pricing, but we believe that BKI will ultimately charge for the product on a value-add basis.  Based on our range of outcomes below, we think this product alone could ultimately be 2%+ accretive to annual revenue.  In addition to this narrow product, we believe BKI will become banks’ partner of choice to implement mortgage technology, lower overall cost of origination, and improve the consumer interface.  BKI has the customer relationships, technological expertise, and strategic vision to capitalize on change in the industry over the medium to long-term.

 

 

2.       The DNB transaction creates positively optionality and will not impact company fundamentals or the long-term BKI equity story. The market is worried about the three following issues, and we believe the stock now overly discounts the real and perceived risk:

a.       First, BKI CEO Anthony Jabbour will be focused on DNB turnaround instead of BKI's operations:

i. While the optics of Jabbour splitting his time is bad for investor sentiment, BKI's core business "runs itself," which is one of our main attractions to the asset.  Empirically, we point out that results or strategy did not change over the course of 2018 when the CEO role transitioned to Jabbour from prior CEO Tom Sanzone.  We also believe that in his previous role at FIS, Jabbour managed a much larger operation and is therefore capable of running both DNB and BKI.  Finally, other key executives will stay in their roles, including CFO Kirk Larsen, President Joe Nackashi, and Chairman Bill Foley.

b.      Second, BKI is Chairman Bill Foley's "piggbank" and BKI will become a conglomerate/ holding company like its predecessor FNF:

i.   We have an extensive history with Foley vehicles, and believe that Foley and management recognize the value of maintaining BKI as a stand-alone, high-growth software and data services company.  The company has indicated that it does not intend to become a holding company, and we believe there are two main reasons that BKI is participating in this deal.  First, Foley is bullish on the upside of the deal and he wanted to retain as much economics as possible.  Given that his holding company, Cannae, lacked liquidity, owning more DNB through BKI is a way to maintain exposure.  Second, Foley wanted BKI's management to help him restructure DNB because the team that turned BKI around when FNF bought BKI predecessor company in 2014 has a strong track record of margin improvement and operational execution

c.       Third, DNB is an over-levered asset and BKI will not receive an adequate return on its investment:

 i.   BKI's investment in DNB is 3-4% EPS dilutive in Year 1, as BKI will draw on its revolver to fund the $375mm transaction and incur incremental interest expense of ~$15mm.  Our Base Case LBO model implies that BKI's investment can earn a 50% return based on delevering and cost cuts, with upside based on potential revenue growth and multiple expansion upon exit.  We trust the Bill Foley playbook (see Ivampa1070 FNF write-up for previous discussion of Foley value creation)

 

Catalysts:

1.       Closing of DNB deal in 1H 2019

2.       Execution of organic growth revenue in 2019, regardless of macroeconomic environment

3.       Delevering and tuck-in M&A

4.       Potential for activist activity if discount persists because market is worried about governance issue.  Our view is that a nudge by a large shareholder to add independent board members would be well received by the market. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1.       Closing of DNB deal in 1H 2019

2.       Execution of organic growth revenue in 2019, regardless of macroeconomic environment

3.       Delevering and tuck-in M&A

4.       Potential for activist activity if discount persists because market is worried about governance issue.  Our view is that a nudge by a large shareholder to add independent board members would be well received by the market. 

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    Description

    Overview:

     

    BKI is a monopoly-like software and data business that has a multi-year runway to deliver HSD% revenue growth and teens% EPS growth as the company leverages its incumbent position with core customers to consolidate its market share and introduce value-add adjacencies. 

     

    4Q market volatility, misplaced fears about mortgage market sensitivity, and investors' dislike of recent non-core DNB investment have created an entry point into a quality compounder that has an underappreciated position in transitioning the bank industry to digital mortgage production, beta to a significant upside rally in SPX, and downside protection because of limited cyclical exposure and rock-solid 2019/2020 EPS numbers.  

     

    Our 1-year PT is $53-62 (+17%-+37%), based on 22-26x our 2020 EPS and 14-16x our EBITDA estimates, compared to current NTM multiple of 22.5x and 13.5x, respectively.   Beyond a 1-year PT, our view is that BKI can double its earnings power in the next 5 years, making BKI an attractive multi-year hold with double digit IRR potential. 

     

    BKI’s secular growth position provides downside protection and limits potential for significant capital loss in the near term.  In a further market dislocation, BKI could trade at a market multiple in a worst case scenario, which would imply -20% (15x 2020 EPS).  We believe there would be a strategic or financial buyer for the asset  if it traded to those levels at a 20-30% premium, which would limit absolute capital loss. 

     

    Business Description:

     

    BKI is a provider of software, data and analytics solutions to the mortgage and consumer loan, real estate and capital market verticals. BKI serves the top 100 domestic banks by providing solutions for servicing and originating consumer mortgages and home equity lines.  BKI has 4 main products: mortgage servicing, home equity servicing, mortgage origination software, and real estate data and analytics.

     

    The company has 62% market share in its core product (mortgage servicing),   and has signed contracts that will get them to 70% market share by 2020.  Servicing is close to a monopoly business with very high switching costs and built in annual price escalators.  Although the mortgage market is cyclical, mortgage servicing is not because BKI gets paid based on the total STOCK of mortgages in the banking system (which is not volatile), not the annual FLOW of mortgage originations. 100% of revenue is domestic. 

     

    BKI has 15% market share in home equity servicing and has contracts signed that will get them to 30% market share by 2020. 

     

    BKI’s mortgage origination business is growing off a small base and the company has runway to double or triple its business over the next 5 years. 

     

    Valuation Construct:

     

    We contemplate a price target for BKI at a 1.4-1.6x EBITDA peg, in-line with SPX at 1.4x and a discount to info services peers at ~2.0x

     

    BKI’s closest valuation comparable are bank servicing platforms FISV, and JKHY because the end markets are the same and revenue streams are also defensive.  Over the past 5 years, BKI has traded at a premium to FISV and in-line with JKHY on EV/EBITDA.  Over the past 3-months, BKI has traded at a 5-10% discount to FISV and 20-25% discount to JKHY, despite having a superior growth profile to both.  On an absolute basis, BKI has de-rated from 17x NTM EBITDA in the beginning of 2018 to <14x currently.  This 18% de-rate compares to 5% for FISV and 6% for JKHY. 

     

    Why Does Opportunity Exist?

     

    1.       Market lacks conviction about sustainability of BKI’s revenue growth and the stock is priced in-line with FISV, implying the market believes 3-4% revenue growth is likely over the medium term, not the HSD% that we underwrite to.

    2.       BKI has poor corporate governance, and the stock underperformed in November after the company announced it will be a minority investor in a pending LBO controlled by BKI's Chairman's investment vehicle and that BKI's CEO would become CEO of the acquired company upon close. 

     

    What is market missing?

     

    1.       Revenue growth sustainability:

    a.       BKI has disclosed a revenue backlog through 2020 with specific annual details about revenue phase-in.  This gives us explicit conviction in ability for BKI to meet revenue targets for the next 2-years.  BKI does not have hidden cyclicality like others in the broader information services peer group. 

    b.      Beyond 2020, BKI can maintain 6-8% revenue growth given its market share penetration opportunity and introduction of new products which will contribute to revenue growth in 2019 and beyond. 

    i.      We believe the company will announce customers wins in its core mortgage servicing and origination products in the next 12-18 months.  In particular, it is possible they announce large contracts from WFC where management appears bullish.  Management’s intention is to grow its market share in mortgage and home equity servicing from 70% and 30% to 90% and 50% in the medium term. 

    ii.      On new products, BKI is one of the only companies currently commercializing machine learning /artificial intelligence via its integration of August 2018 AIVA acquisition which helps banks reduce manual labor in the mortgage origination process.  Suntrust has been announced as a marquee pilot customer and we expect further announcements over the course of this year.  The company has not disclosed unit economics or pricing, but we believe that BKI will ultimately charge for the product on a value-add basis.  Based on our range of outcomes below, we think this product alone could ultimately be 2%+ accretive to annual revenue.  In addition to this narrow product, we believe BKI will become banks’ partner of choice to implement mortgage technology, lower overall cost of origination, and improve the consumer interface.  BKI has the customer relationships, technological expertise, and strategic vision to capitalize on change in the industry over the medium to long-term.

     

     

    2.       The DNB transaction creates positively optionality and will not impact company fundamentals or the long-term BKI equity story. The market is worried about the three following issues, and we believe the stock now overly discounts the real and perceived risk:

    a.       First, BKI CEO Anthony Jabbour will be focused on DNB turnaround instead of BKI's operations:

    i. While the optics of Jabbour splitting his time is bad for investor sentiment, BKI's core business "runs itself," which is one of our main attractions to the asset.  Empirically, we point out that results or strategy did not change over the course of 2018 when the CEO role transitioned to Jabbour from prior CEO Tom Sanzone.  We also believe that in his previous role at FIS, Jabbour managed a much larger operation and is therefore capable of running both DNB and BKI.  Finally, other key executives will stay in their roles, including CFO Kirk Larsen, President Joe Nackashi, and Chairman Bill Foley.

    b.      Second, BKI is Chairman Bill Foley's "piggbank" and BKI will become a conglomerate/ holding company like its predecessor FNF:

    i.   We have an extensive history with Foley vehicles, and believe that Foley and management recognize the value of maintaining BKI as a stand-alone, high-growth software and data services company.  The company has indicated that it does not intend to become a holding company, and we believe there are two main reasons that BKI is participating in this deal.  First, Foley is bullish on the upside of the deal and he wanted to retain as much economics as possible.  Given that his holding company, Cannae, lacked liquidity, owning more DNB through BKI is a way to maintain exposure.  Second, Foley wanted BKI's management to help him restructure DNB because the team that turned BKI around when FNF bought BKI predecessor company in 2014 has a strong track record of margin improvement and operational execution

    c.       Third, DNB is an over-levered asset and BKI will not receive an adequate return on its investment:

     i.   BKI's investment in DNB is 3-4% EPS dilutive in Year 1, as BKI will draw on its revolver to fund the $375mm transaction and incur incremental interest expense of ~$15mm.  Our Base Case LBO model implies that BKI's investment can earn a 50% return based on delevering and cost cuts, with upside based on potential revenue growth and multiple expansion upon exit.  We trust the Bill Foley playbook (see Ivampa1070 FNF write-up for previous discussion of Foley value creation)

     

    Catalysts:

    1.       Closing of DNB deal in 1H 2019

    2.       Execution of organic growth revenue in 2019, regardless of macroeconomic environment

    3.       Delevering and tuck-in M&A

    4.       Potential for activist activity if discount persists because market is worried about governance issue.  Our view is that a nudge by a large shareholder to add independent board members would be well received by the market. 

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    1.       Closing of DNB deal in 1H 2019

    2.       Execution of organic growth revenue in 2019, regardless of macroeconomic environment

    3.       Delevering and tuck-in M&A

    4.       Potential for activist activity if discount persists because market is worried about governance issue.  Our view is that a nudge by a large shareholder to add independent board members would be well received by the market. 

    Messages


    SubjectOCN?
    Entry01/11/2019 11:26 AM
    MemberMJS27

    thanks for the write up.  if you don't mind me switching to a tangential topic, i'm curious if you have a view on OCN?

    As I am sure you know, OCN is in the process of moving their portfolio of mortgage service rights onto Black Knight's platform.  In some ways OCN is a levered bet on BKI's success, because if OCN's transfer to BKI's platform goes smoothly and is completed in the next 7-10 months, regulators will once again allow OCN to grow and flex their operating structure.  With OCN at something like 25% of TBV (including off balance sheet assets) there should be a whole lot of upside.

    On the other hand, if BKI can't onboard OCN, that calls into question the BKI growth thesis to some extent... and if BKI can't onboard OCN, OCN will likely be forced to liquidate which theoretically provides some downside protection and even upside (although i'm sure it would be a mess).

    any thoughts appreciated - especially any view on past successes and failures of onboarding new portfolios of MSRs etc for BKI

     

    thanks

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