Description

FTDR is a reasonably high-quality business that is significantly underearning and represents an attractive play on an eventual moderation in labor/appliance inflation, with optionality that new CEO can structurally improve the business. Assuming normalized margins remain below long-term average = $2.50 of EPS. Applying 15x multiple = almost 90% upside and returning to historical >20x multiple = 1.5x return

Company Overview: #1 player in underpenetrated home warranty market – created the market in 1971. Service 2.2m customers through a 17k contractor base that handle 4m+ service calls annually.  82% of service calls are handled by a lower-cost, “preferred network” of contractors. FTDR’s scale allows for better contractor selection and more favorable cost-to-serve. Contractors are paid less on a per site visit (versus not using FTDR), while profitability / cash flow is not drastically different (no customer acquisition costs, handle payments, etc). Market penetration is low at 5.4m households versus 126m total occupied homes. 40+% market share, almost 4x the size of #2 player (First American). ROIC 20+%, FCF conversion 120% with negative W/C and aggressively buying back stock – In Q4, began $400m repurchase (40% complete, S/O -4.4%). Remaining authorization = 11+% S/O

Revenue Breakdown: Average plan costs $6-700+/year – ¼ of customers pay annually and ¾ pay monthly. The value proposition is high to consumers, centered on budget protection and convenience. Service calls are capped at $75-125/visit, depending on the tier of a customer’s plan, regardless of whether it is a repair or replacement. 72% of revenue is renewals, 13% in new DTC customers and 11% is from Real Estate channel (used to be 20%). The legacy business was largely focused on the Real Estate channel - when a home is bought, almost 20% include a warranty. Profitability is much higher than DTC given a lower customer acquisition cost and lower propensity to file a claim, while renewal rates are much lower than DTC (in the 20’s %-ige). Over the past decade, have pushed harder into DTC category. Renewal rates are higher than Real Estate (in the 80’s %-ige), while profitability is lower than Real Estate, especially in year 1. In the first year, a new DTC is more likely to file clams (typically 2+ claims), while customer acquisition costs are high, resulting in Y1 unit economics being EBITDA negative (CAC rolls off from year 2 onwards, i.e. LTV of customer is well above CAC). >70% of revenue is recurring and cyclicality is muted/low, e.g. grew revenue 4% in 2008 and 2% in 2009.

New CEO: Removed old CEO that was too focused on new tech offerings (Pro Connect and Streem) – both were running EBITDA negative (in the $10’s of millions), which should move back to EBITDA neutral in short-order (flex excessive spending). The focus on non-core technologies/offerings also resulted in weaker execution. New CEO (Bill Cobb) came from the BoD – was previously CEO of HRB and head of North America for eBay. Aiming to simplify the business, including offering a better customer experience, e.g. negative customer reviews are endless. FTDR has been plagued by complexity of internal processes/systems (limited automation), while improving both the go-to-market strategy with a more unified/simple product and customer service / ease of use, e.g. most claims still handled from an off-shore call center. 

Cyclical Pressure: Pre-COVID, since 2013, EBITDA margins have averaged 21+% with a low point of 19% in 2018, relative to 11% in 2022. GM 43.3% declined 910 bps from contract claim costs growing 23% (mid-high teens Q1). The margin pressure appears primarily/entirely cyclical, while consensus has embedded structural margin pressure with EBITDA margins expected to reach only 16% in 2024/2025, relative to pre-COVID trough of 19% and LT average of 21+%. While inflation may remain “stronger for longer”, construction wages and appliance/HVAC costs are showing signs of moderation. It pales in comparison, but the last time FTDR saw meaningful margin pressure was in 2018 when GMs declined 360 bps (record heat waves), which reverse with 400+bps of growth in 2019.

Normalized Earnings Potential: Assuming FTDR can get back to 19% EBITDA margins versus long-term 21+% average by 2024 = $2.50 of EPS, i.e. trading 8x normalized EPS and prior to 2022 downdraft, the business regularly traded for >20x EPS

Catalyst

Better profitability, early '23 Analyst Day