Description

Thesis

CoreLogic is a misunderstood provider of mission critical data to participants in the mortgage industry and represents one of the few still cheap ways to play a recovery in the housing market.  The Company should benefit in four ways that are not reflected in analyst estimates or the current valuation: i) top line growth driven by the continued healing of the housing market and a regulatory push towards more disclosure / transparency in the mortgage market; ii) margin improvement resulting from actions that have already been taken as well as the implementation of further already identified initiatives; iii) the continuation of capital returns to shareholders primarily in the form of stock buybacks; and iv) a re-rating of the stock that trades at a meaningful discount to comps.  In a base case, we see 44% upside to the current share price, while in a more bullish scenario we believe the stock could nearly double.

Company Description

CoreLogic provides data and analytics to mortgage originators, servicers, brokers, and investors, as well as other participants in the mortgage industry.  The Company has the most comprehensive set of property databases covering 99% of US properties, and CLGX is notorious for the accuracy of its data.  CoreLogic operates in three segments:

• Data & Analytics (37% of YTD 2012 revenues): This segment provides customers access to real estate, mortgage security and credit information on a subscription basis.  Customers including mortgage lenders, government agencies, MBS investors, and insurers, use the Company’s data for risk management, collateral assessment and fraud prediction.  In addition to database access, through advisory services which management expects to be a growing part of this segment, Data & Analytics provides customers with specialized data retrieval and customized build outs of analytical tools.  This segment also provides realtor solutions through its Multiple Listing Services (”MLS”) platform.            
• Mortgage Origination Services (41% of YTD 2012 revenues): Through this segment, CoreLogic is the leading provider (50%-60% share) of tax and flood data services used in the mortgage origination and closing processes.  Federal law requires most mortgage lenders to obtain a determination of flood zone status at the time each loan is originated and to obtain updates during the life of the loan.  Mortgage originators and servicers use the Company’s flood data to comply with these laws, while insurance companies use this data for risk mitigation purposes.  Mortgage originators and servicers use the Company’s property tax data that is pulled from 20,000 taxing authorities to monitor the tax payment status of their loans.  The revenues in this segment are largely driven by mortgage volumes, and management has indicated that a $100bn change in mortgage originations translates into a $20mm-$25mm change in revenues and $15mm-$20mm change in EBITDA.
• Default Services (22% of YTD 2012 revenues): Unlike LPS which is a default processor, CoreLogic’s default business is more of a problem loan manager, and so the revenue driver for this segment is not default volumes but the stock of problem mortgage loans outstanding.  The Company’s Field Services group works on behalf of mortgage servicers to inspect and maintain vacant properties.  This segment also provides broker price opinions and REO asset management services.  In the context of an improving housing market, we would expect this business to decline with the stock of problem loans, though it does seem that the Company is continuing to grow by capturing share.

Investment Drivers

• Revenue Growth:Revenue growth will be driven through: i) improvements in the housing market; ii) a regulatory push towards more disclosure and transparency; and iii) price increases. 
• An improving housing market benefits CoreLogic in a few ways: i) an increase in mortgage volumes directly drives growth in the Mortgage Origination Services segment; ii) a growing housing market will bring in more participants (originators, servicers, brokers, investors, etc.) who will license CLGX data; and iii) a recovery in housing and resolution on QM and QRM could bring non-agency, private-label players back into the mortgage market and this is a segment for which CoreLogic is the dominant data provider.  As om730 pointed out in his write-up of FNF last week, the mortgage market remains at depressed levels. Mortgage Bankers Association expects $1.75tn in total mortgage originations for 2012 (actual data not yet available for Q4), which compares to an average market size of $1.79tn over the last 20 years (numbers are not inflation adjusted and U.S. population has grown by 58mm or 23% over the last 20 years).  While refinancings have been strong, driven by low rates and government programs (HARP), the mortgage purchase market is at trough levels.  The expectation for 2012 mortgage purchase volumes is $503bn, which compares to 20 and 5-year averages of $844bn and $662bn, respectively.  Given that the purchase market has been depressed for the last five years and the U.S. population has grown by 13mm (4%) over the same period, we believe there is a significant amount of pent-up home demand that could drive purchase volumes above their historical averages for a period of time.  We believe the purchase market, which is already beginning to recover based on weekly data from MBA, will continue to recover as we’ve worked through much of the outstanding home inventory (according to the National Association of Realtors, U.S. existing home inventory of 2mm is the lowest in ten years and down from over 4mm in 2007) and home prices are beginning to rise (Case-Shiller has begun to show broad-based home price appreciation).  On the refinancing side, we believe the strong volumes will continue over at least the intermediate term.  WFC indicated last week that there are still hundreds of billions of dollars of refinancing opportunities in its servicing portfolio, and we believe that QM resolution may remove some of the overhang that had been holding banks back from refinancing certain loans.
• The regulatory push towards electronification, documentation and transparency in the mortgage market should drive further adoption of CoreLogic products by industry participants.  Examples of this include mandatory second appraisals in certain loan instances, as well as credit and income verification.    
• The cost of CoreLogic’s data represents a small fraction of the total economics of a mortgage which allows the Company to push pricing annually. Our conversations with industry participants suggest that the Company implements 3%-5% annual price hikes.
• Margin Expansion: Management has taken a number of actions since CoreLogic was spun off from First American Financial in June 2010 to improve the profitability of the business.  This includes exiting under-performing and low return businesses, reducing headcount and driving other efficiencies.  YTD 2012 adjusted EBITDA margins of 29.7% compare to margins of 22.2% in the first nine months of 2011.  The largest driver of the margin improvement in 2012 was Project 30, a program focused on streamlining technology shared service functions and improving facility and procurement management, which has delivered $51mm in 2012 cost savings through September and will deliver in excess of $60mm in savings for the full year.  Going forward, we expect Project 30 to contribute an additional $20mm in cost savings in 2013, and then we should begin seeing the benefits from management’s latest cost reduction program, the Technology Transformation Initiative (involves transitioning current infrastructure to a shared-services network in an effort to lower application management and development costs), which management estimates will reduce operating expenses by $175mm-$200mm over the next seven years.  We’ve also seen margin expansion in the Mortgage Origination Services (YTD 2012 Adjusted EBITDA margins of 41% vs. 29% in first nine months of 2011) business from operating leverage and we’d expect this to continue as CoreLogic continues to grow its top-line.  While the Company has made solid progress on the margin improvement front, we believe there remains a lot of upside here, especially when we compare CoreLogic’s YTD 2012 adjusted EBITDA margin of 29.7% to Verisk Analytic’s 45.2% adjusted EBITDA margin.  Verisk is a leading provider of data and analytics to the insurance industry, and while there are some structural reasons why Verisk should have higher margins (data retrieval is less manual for Verisk, for example), we believe there is an opportunity for CoreLogic to meaningfully close this gap.  
• Continuation of Capital Returns: Since becoming a standalone company in June 2010, CoreLogic has repurchased $433mm of stock.  In FY 2011, the Company repurchased 9.5mm shares (8% of beginning of year shares outstanding) for $176mm representing 200% of 2011 FCF, while through the third quarter of FY 2012 CLGX has bought back 10mm shares (9% of beginning of year shares outstanding) for $227mm representing 110% of YTD 2012 FCF.  After blowing out Q3 expectations, CLGX surprisingly traded down 11% driven in part by concern about the Company’s capital return plans going forward.  On the call, management indicated that its capital management strategy would remain as it has been, looking first to either re-invest capital at high returns back into the business or to make bolt-on acquisitions, and second at capital returns to shareholders.  Any fears that investors had about capital management going forward should have been put to rest on December 13 after the Q3 earnings report when CoreLogic put in place a new $250mm share repurchase program.  We expect CoreLogic to continue buying back stock given the attractive valuation and the fact that management’s comp is tied to EPS and EBITDA per share targets.  If CoreLogic uses 50% of its FCF to repurchase shares in 2013 and 2014, a large reduction in the proportion of capital used for buybacks, we estimate that CLGX will shrink its share count by another 10%+ depending on the stock price.  The sell-side models no or de minimis share buybacks going forward.
• Multiple Re-Rating: CLGX trades at 7.5x 2013 consensus EBITDA and a 10% 2013 FCF yield on our estimates.  This 2013 EBITDA multiple compares to a median multiple of 9.5x for comparable data and analysis companies.  Admittedly, the Default segment which should slowly decline as the housing market improves and the Mortgage Origination Services segment which is largely transactional warrant lower multiples than do the data and analytics business.  We place a 10x multiple on the data and analytics business (37% of ’13E EBITDA), an 8.0x multiple on the mortgage origination services business (50% of ’13 EBITDA), a 6.0x multiple on the default business (13% of ’13 EBITDA), and arrive at a weighted average multiple for CLGX of 8.5x.  We believe that CLGX’s multiple discount is largely driven by the misperception that the entire company is transactional / there is not a recurring component to the revenue stream.  As CoreLogic outperforms expectations and the Street realizes that a large portion of the revenue stream is recurring, we expect the stock to re-rate to our 8.5x weighted average EBITDA multiple.

Key Risks

• Mortgage Market Slowdown: The biggest risk to a long position in CoreLogic is that a fall-off in mortgage refinancing volumes happens faster than expected and the recovery in mortgages for home purchases happens slower than expected.  The consensus view (using MBA forecasts) is that the mortgage market declines from $1.75tn in originations in 2012 to $1.4tn in 2013, and the stock appears to be pricing in these market expectations (a quick review of sell-side models indicates that analysts expect CLGX’s mortgage origination services business to decline in 2013).  While we don’t believe the mortgage market will decline at all for the reasons discussed above, if it were to decline more than expected, then the stock would likely come under pressure.
• Competition: LPS has indicated that they are in the process of building out a competing data and analytics product, and if this were to be introduced CoreLogic’s market share and pricing power could be challenged.  CoreLogic’s property databases are the most comprehensive and accurate property databases because the Company has spent years gathering property data.  Given that the gathering and maintenance of property data is time and labor intensive (involves manually pulling data from courthouses) and expensive (CoreLogic spends more than $100mm per year updating and refining its database), building out a competitive offering seems tough. Further, our conversations with industry participants suggest that LPS is years away and that even if LPS shows up with competitive product, switching to LPS would be difficult because CoreLogic customers have built models and applications around the CoreLogic interface.

Valuation

Catalyst

• Housing market recovery
• Cost take-outs
• Outperformance vs. expectations
• Share buybacks