NATIONSTAR MORTGAGE HOLDINGS NSM
July 09, 2015 - 10:07am EST by
aviclara181
2015 2016
Price: 16.86 EPS 0 0
Shares Out. (in M): 109 P/E 0 0
Market Cap (in $M): 1,840 P/FCF 0 0
Net Debt (in $M): 1,659 EBIT 0 0
TEV ($): 3,497 TEV/EBIT 0 0

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Description

 
Market Cap: $1.8bn
Share Price: $16.86
Target Price: $35.00, 100% upside, based on SOTP, with incremental potential upside for accretive M&A and its online real estate platform, XOME, which could be worth multiples of the current share price.
 
Introduction:
Nationstar (NSM) is an undervalued, out of favor investment opportunity with several catalysts over the next few quarters to highlight the SOTP / underlying earnings power / upside optionality. We see 100% - 500% upside and limited downside, driven by:
 
1) Validating the valuation for Solutionstar at $1.5bn+ via sale of minority stake to a third party
2) Improving profitability in its core mortgage servicing business as one-time headwinds reverse and operating efficiencies / scale are leveraged
3) Additional mortgage servicing rights (MSR) acquisitions with excess capital raised in March / financing partners; these deals are highly accretive with high incremental margins, particularly if rates start to rise
4) Rising rates environment leading to slower portfolio amortization and increased value of MSRs
5) Free optionality on XOME, an online / mobile real estate platform similar to Zillow / Trulia launched at the end of June
6) Near tangible book value, we think it is highly unlikely investors will lose money, even if Solutionstar is not monetized and they cannot improve profitability in servicing
7) Optionality on M&A via acquisition of smaller mortgage servicers, in particular Walter Investment Management (WAC), which is also extremely undervalued by the market we think the synergies would be huge and accretion for NSM 75%+
8) Transition to a capital light model over time, selling MSRs to NRZ / FIG at higher rates and moving to a fee for service model; asset managers generally trade at high multiples of earnings (15x 20x+)
9) Record high short interest, with over 10mm shares short, representing >25% of the float and >10 days of volume to cover
 
Key Terms:
- Non-bank Servicers: Entities that are not classified as banks and not regulated by the OCC. Following the financial crisis, Ocwen Financial (OCN), NSM, and WAC along with other non-bank servicers came to prominence, primarily to service the huge pools of subprime, defaulted loans that the banks were unwilling or unable to handle. This led to mass transfer of these loans to non-bank servicers, who were not subject to Basel and other capital rules / regulations. The explosive growth in this sector led to increased regulatory scrutiny and the opportunity today in NSM and WAC
- MSR: mortgage servicing rights; the contractual right of a mortgage servicer to service a loan, primarily via payment collection and processing, and receive a fee in return. MSRs are capitalized on the balance sheet as the present value of the expected future fee streams. A key input variable is future rates, as rates rise, borrowers are less likely to refinance and pay off the loan, increasing the value of the MSR, and vice versa. If a borrower goes into default, it is the servicer’s responsibility to try and remediate the situation, through outreach, refinancing, modifications, or ultimately foreclosure, and to limit the losses for the owner of the underlying credit. The mortgage servicer does not have significant capital at risk in a default scenario and generally gets paid additional fees for performing default services
- UPB: unpaid principal balance; the face value of the mortgages underlying the MSRs
- Agency MSR: a MSR where the underlying credit is owned by a Government Sponsored Entity (GSE) Fannie, Freddie and Ginnie
- Private Label MSR: a MSR where the underlying credit is owned by private investors, generally through Residential Mortgage Backed Security (RMBS) pools which are overseen by trust administrators, generally a commercial bank
- Interest Rate Sensitive MSR: MSR that is considered “prime” where the borrower is unlikely to default, and the value primarily fluctuates with the likelihood of the buyer to refinance / pay down the loan, which is driven by interest rates
- Credit Sensitive MSR: MSR where there is a higher likelihood of default, requiring the mortgage servicer to advance payment on the mortgage (first lien priority), investigate the source of missed payments, remediate the borrower back to performing if possible via correcting an oversight or modifying the principal / future payments, and eventually foreclose / sell the property to recover value for the owners of the credit
- Amortization / Disappearance: As MSR runs off and is paid down / goes into default, the book value of the MSR runs through the income statement as Amortization. NSM recaptures a portion of the disappearance through its originations segment and is able to recapitalize that as MSR and also earn fees on the origination
- HARP: Home Affordable Refinance Program; a Fannie / Freddie program that enables borrowers with little or no equity in their homes to refinance into more affordable mortgages if their loans. HARP loans are more profitable to originate as borrowers are highly unlikely to ever refinance, given the below market rates afforded to them through the program, and
therefore the MSRs are more valuable
- REO: real estate owned; when the owner of the credit seizes the underlying collateral (the home) in foreclosure and typically puts the home up for auction / sale to recover value
- Reverse Mortgage: a home loan for older homeowners in which they receive a lump sum payment or payments over time in exchange for equity in their home. The loan requires no cash mortgage payments by the borrower (hence reverse) and is subject to strict regulatory limits on the % of home equity that can be loaned and how that loan can be accessed over time. The reverse mortgage accretes value over time (similar to a PIK) and payment is due when the homeowner dies or moves out of the home
 
Business Overview:
NSM operates in 3 segments:
 
Servicing (~35% of EBIT):
- The largest non-bank mortgage servicer in the US, with over $400bn of UPB
- Collects servicing fees based on contractual bps of UPB of loans serviced as well as ancillary fees for modifications and performance incentives
- Provides loan administration, payment processing, mortgage escrow account administration, collection of insurance premiums, and loss mitigation solutions including loan modifications, foreclosures, and property dispositions
- Services both Agency and Non-Agency mortgages
- Adds MSRs via bulk acquisitions, usually in conjunction with selling excess spread to its financing partner, New Residential (NRZ), who captures a piece of the economics in exchange for purchase financing
- Also acquires MSRs through its own originations platform and through sub-servicing for third parties / origination flow
- MSRs run off and amortize over time either through voluntary (eg the homeowner sells home and moves) or involuntary (homeowner defaults on mortgage payments) and therefore need to be replaced
- Traditionally built its UPB primarily through bulk acquisitions of credit sensitive MSRs but in recent years has also originated / acquired interest rate sensitive loans as well
- Includes a reverse mortgage business, which currently generates little to no profit given regulatory changes 2 years ago; we believe there is upside to earnings from second draws on recent originations in the future that we have not included in our estimates
 
Originations (~40% of EBIT):
- Originates conventional residential mortgage loans; licensed in all 50 states and Washington DC
- Primarily markets mortgage products to existing servicing customers via refinances (generally via the HARP program) or recapture of voluntary prepayment
- Also markets to customers of homebuilder partners (eg KBH) and participates in the correspondent market
- Currently building out a consumer direct business, which can potentially leverage the XOME platform (more on that later)
 
Solutionstar (~25% of EBIT):
- Technology and real estate services segment that focuses on the provision of enhanced technology and data solutions to homebuyers, home sellers, real estate agents and companies engaged in the origination and/or servicing of mortgage loans
- Real Estate Exchange, via homesearch.com, provides a portal to auction REO and other properties
- Real Estate Services provides title and escrow, collateral valuation and asset management services
- Traditionally, Solutionstar only served internal servicing / originations clients, but is diversifying quickly, with 30% of
revenues in Q1-15 from third party with the goal of 50% by year end
 
SOTP / Valuation:
We value NSM primarily via a SOTP, breaking out Solutionstar separately given the capital-light, fee stream nature of this business and large market / growth opportunity. We value Solutionstar at 10x EBITDA. We value the core servicing / originations business at 10x earnings, which we view as conservative, and then given NSM credit for the $250mm of capital raised in its common equity offering in March that has yet to be deployed.
 
NSM SOTP      
Share Price     $16.86
Shares O/S     109.0
Market Cap     1,838
       
Cash and Equivalents (pro forma) 500
Corporate Debt   2,159
Enterprise Value   3,497
       
Solutionstar 2016 EBITDA   180
Multiple     10.0x
Solutionstar Valuation   1,800
Less: Solutionstar CEO Bonus (34)
Solutionstar Value per Share $16.20
       
Run-Rate EPS   $2.56
Solutionstar EPS   $0.91
Core Run-Rate EPS   $1.65
Servicing / Originations Multiple 10.0x
Core Value per Share   $16.51
       
Excess Capital Raise   250
Excess Capital Value per Share $2.29
       
Total Value per Share   $35.01
Upside / (Downside)   107.6%
 
Solutionstar in the fall of 2014 hired Kal Raman as CEO, who is the former COO and head of Asia for Groupon, VP of Global Fulfillment at eBay, and SVP at Amazon in charge of retail technology and marketing. Mr. Raman will receive 8.5% of the increase in value of Solutionstar from his start date to when the valuation is validated via third party investment or a change of control (sale or spin). This makes up the majority of his compensation package. Based on our math, the fair value was marked at $1.4bn, meaning he would get $34mm if Solutionstar is valued at $1.8bn. We view our valuation for Solutionstar as conservative, given the growth prospects, limited capital required to grow the business, high margin structure and free option on XOME.
 
Management has discussed their plans for Solutionstar publicly, so this is not just a theoretical SOTP exercise. At the Wells Fargo conference in May, CEO Jay Bray stated (per Bloomberg transcript):
 
“From a third-party capital standpoint, I think we this year will go out and chat with some investors and chat with some potential minority investors that want to come in. And we haven't really determined the exact timing or the exact amount, but I think the thought process would be, before you're in, we will establish a third-party value on that platform. Again, my view is that it will be a pretty significant value.
 
And then, from there, I think your options are, you could spin it, you could IPO it, you can sell it. And I think that horizon again, we have really determined what that will be. Some of that will depend on yes, the success of the launch of the app. And once we launch it, and start driving the traffic and proving to the market that, that we can actually drive transactions, then you have a ton of momentum. And I think you can probably separate sooner rather than later, but that's a lot of ifs and buts, and we got to execute ultimately. But I think the other thing that's happening within Solutionstar, now Xome is the third party business has gone up a lot, right? We originally, Solutionstar was really build for Nationstar to provide us with a better customer experience or to provide our customers with a better customer experience and to capture that value.
 
Now, 31% of the revenue is coming from third parties. We think that will be over 50% by the end of the year, which again, I think, will add more value to that business and the market will realize that it's a lot more than just Nationstar provider. So that's kind of the timeframe.”
 
We also adjust NSM’s tangible book value for Solutionstar, which we believe has market value well in excess of its (likely) limited book value and arrive at a similar valuation (although we think the core business is worth above current tangible book value). We also marked to market NSM’s MSRs to current rates (up 30 bps from Q1-15). MSRs are one of the few investments that appreciate in a rising rate environment.
 
NSM Book Valuation    
NSM Book Value   1,676
Goodwill     63
Deferred Financing Costs   43
Intangible Assets   39
Tangible Book Value   1,531
       
Shares O/S     109.0
Tangible Book Value / Share $14.04
       
Rates Increase (30 bps)   100
MTM TBV     $14.96
       
Solutionstar Fair Value   1,766
Solutionstar TBV (Estimated) 50
Excess Fair Value   1,716
Excess Fair Value per Share $15.75
       
Total Value per Share   $30.70
Upside / (Downside)   82.1%
  
XOME:
NSM launched XOME as a standalone online / mobile real estate platform at the end of June. You can view the website here: https://www.xome.com/ as well as download the mobile app. As you can see, the inventory of homes for sale is huge and comparable to Z / Trulia, with over 80% of MLS listings. Based on our analysis, the website is already generating significant traffic despite only recently launching with limited advertising / marketing spend. We think NSM has been waiting for the XOME launch to monetize Solutionstar at a higher price.
 
I am sure most of you are familiar with the Z / Trulia model, which we won’t go through here, however the XOME model is different in a few key respects (caveated with this is early days and NSM has not fully laid out the model / strategy yet this is based on our use of the website and best guesses).
 
Listings are accompanied by a selling broker. There are no brokers on the buyer’s side, and XOME passes along this savings to the customers (1% of the purchase price to the buyer and 1% of the purchase price to the seller, so 2% of the ~5% total). XOME “concierge” provides a lot of the services a buying broker normally would, but most of the searches are generated by the user on the website / mobile platform. XOME will take a cut of the eventual sale and NSM would then offer ancillary services through Solutionstar and its Originations platform title service, insurance, pre-qualifying for a mortgage, etc. - providing ancillary business to the rest of the NSM platform. XOME also includes the inventory of auction homes through its servicing platform, primarily REO, which is a differentiator vs. other platforms.
 
We have constructed a very rough back of the envelope, highly preliminary analysis of XOME. We assume 275k hits to the website per day, with 10 bps conversation rate to a sale, and $1,000 fee to XOME per transaction (roughly 50 bps of a $200k home sale – we assume of the traditional 5% paid in broker fees, 2% is passed on in savings, the selling broker still gets 2.5%, and XOME gets the remaining 50 bps). This results in $99mm of revenues, at a 30% margin that’s $30mm of EBITDA, 15x multiple that is $4.00 per share of upside.
 
XOME Valuation Analysis  
Website hits per day (000's) 275
Website hits per year (mm) 99
Converstion rate (bps)   10
Transactions per year   99,000
$ per transaction   $1,000
Revenue ($mm)   99
EBITDA margin (%)   30.0%
EBITDA ($mm)   30
Multiple     15.0x
Value     446
Value / Share   $4.09
 
We have not included any value for XOME in our analysis at this point. In fact, XOME launch / marketing / operating expenses are in the Solutionstar segment but are not generating any revenue in our SOTP analysis. In addition, our XOME analysis does not include any potential increases in originations and ancillary services via transactions on the XOME platform. If XOME works, it will generate significant growth in originations and servicing (while still generating earnings on its own) and drive earnings in those businesses well above our estimates.
 
XOME Upside Analysis    
Homes sold in US   5,000,000
Average home price   $200,000
Total transaction value ($bn) 1,000
Broker fees as %   5.0%
Addressable market ($bn) 50
XOME market share   2.0%
Revenue ($mm)   1,000
EBITDA margin (%)   35.0%
EBITDA ($mm)   350
Multiple     20.0x
Value     7,000
Value / Share   $64.22
 
This analysis is predicated on XOME management’s business case, which at this point is highly speculative. The point is, even if XOME does not generate any profits on its own, to the extent it provides cost-free leads to its originations / ancillary businesses, it would provide significant upside to our forecasts.
 
The Opportunity:
NSM shares are down 40% YTD and 50% from peak in the fall due to a variety of factors.
 
- NSM raised capital via a common offering of 17.5mm shares at $28.50, a 5% discount to prior close, and the shares collapsed to $25 following poor communication of the rationale for raising capital and thereby diluting existing holders by 20% and the expected returns for deployment of that capital
- Q1-15 earnings were a disaster, missing the street consensus by a wide margin, compounded by confusing changes to its disclosure / presentation materials leading to sell-side downgrades, a material reset of earnings expectations and a violent sell-off to $20
- Continued regulatory scrutiny / uncertainty, particularly in light of the issues faced by OCN with the NYDFS over related parties, the state of California and other federal and state agencies
 
Despite the poor communication and timing right before a poor earnings report, we view purchasing MSRs as an attractive use ocapital for NSM, generating levered equity returns after-tax in the mid-teens with conservative assumptions, and much higher returns if rates rise or if NSM is able to better leverage its scale and platform. The timing of the equity raise, right before an earnings miss, certainly did not help management’s credibility, however given OCN’s announcement to sell its Agency book (and potentially non-Agency as well at some point given the recent downgrade to below average from S&P), NSM viewed the market opportunity as too good to pass up.
 
We view the earnings miss and subsequent stock reaction as mostly due to some timing / one-time factors as well as, again, poor communication by management. Please see the profitability walk below for our view on earnings power in the Servicing segment vs. Q1-15 results. We believe that NSM will show progress throughout the rest of the year towards its goal of 5-7 bps of Servicing EBIT and should exceed that over time in a steady state, when NSM is not engaging in large bulk acquisitions and normalized rate environment. Earnings expectations / sentiment have reset significantly to a pretty low bar at this point.
 
Mortgage servicing / originations are highly regulated industries, with multiple federal and state agencies overseeing both capital and operational aspects of the business. OCN is a cautionary tale, as it took shortcuts on its operations, compliance / risk framework, and was far too aggressive with its related parties structure / corporate governance. We believe that NSM will not
become the next OCN:
- NSM’s “Above Average” servicer rating was recently affirmed by S&P, and it has 5 star ratings from Fannie / Freddie. In
addition, NSM has been able to secure approvals from all required regulators for recent bulk MSR transfers
- NSM has significant cushion under the capital rules recently announced by the FHA / GSE’s
- NSM’s platform is not built on aggressive automation and offshoring like OCN
- Solutionstar has >30% of revenues from third parties, validating its business model / arrangements as arm’s length with NSM servicing / originations, unlike ASPS which effectively had 100% of revenues from OCN serviced mortgages before the NYDFS investigation (which initially included a letter to NSM management at same time it began investigating OCN, but nothing came of it, unlike OCN who ended up with millions of dollars of fines, MSR divestments, and monitors for multiple years paid for by shareholders)
- We also view its relationship with NRZ as arm’s length; in fact we believe that NSM has materially worse agreements with NRZ than OCN had with HLSS, based on our analysis. The terms are potentially below market for NSM, not the other way around (and also unlike the OCN structure, Fortress’ economic interests are vastly concentrated in NSM, the servicer, instead of affiliate companies)
- Ben Lawsky, who spearheaded the NYDFS investigation, has stepped down to join the private sector
 
We view most of the bad news on the regulatory front as behind NSM / the industry for the most part, with better defined roles for regulators, capital rules in place, and the OCN situation mostly resolved.
 
Profitability Walk:
NSM reported minimal profit in its Servicing segment in Q1-15, generating Operating Profit of only 0.4 bps of UPB. This was partially due to timing of performance / incentive fees, heightened amortization due to the collapse in interest rates during the quarter (leading to heightened refinance activity) and excess capacity in anticipation of the transfer of bulk MSR acquisitions. We are modeling 5.5 bps of Operating Profit vs. management’s target of 5-7 bps. We believe they should be at this run-rate exiting this year / entering next year, and over time should perform above this range as the portfolio matures / stabilizes. We also believe there is upside to NSM’s reverse mortgage business that is not currently factored into our estimates.
 
NSM Profitability Walk                    
      Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Adj vs. Q1 Run-Rate   Notes
bps of UPB                      
Revenue     39.2 40.5 39.4 38.2 37.1 1.4 38.5   Performance / Incentive Fees
Labor / Direct Expenses   21.3 22.5 18.2 19.2 20.3 (1.3) 19.0   Operating efficiencies / completion of onboards
Financing Payments   9.5 11.4 11.0 10.7 9.9 (0.4) 9.5   Decline as PLS advances recovered
EBITDA     8.4 6.6 10.2 8.3 6.9 3.1 10.0    
                       
Amortization   4.6 3.5 5.6 4.9 6.5 (2.0) 4.5   Decline as rates normalize
Operating Profit   3.8 3.1 4.6 3.4 0.4 5.1 5.5   NSM mgmt. target 5-7 bps
 
Revenues can be lumpy, as NSM earns incentive / performance fees above the contracted servicing fees based on a cash basis, not on an accrual basis. Q1-15 was abnormally low due to the timing of Fannie / Freddie incentive programs and we believe this reverses back to a more normalized level. On the expense side, NSM is running with ~10% excess operational capacity in anticipation of onboarding bulk MSR acquisitions. We believe a steady state is conservatively at 19 bps. Financing payments are elevated due to advances required to work out credit sensitive pools of loans; as the book normalizes these will come down over time. Amortization is a function of refinance activity which is a function of interest rates. During Q1-15, the 10 year fell 25 bps, leading to heightened amortization. We believe that as rates normalize and the portfolio matures, amortization will come down over time, extending the tail of its MSRs and increasing their value.
 
Putting this together with pro forma UPB of $407bn and our view on originations and Solutionstar, we estimate run-rate EPS of $2.56 for NSM. Note that an incremental $30bn of UPB needs to be acquired to remain in this steady state we believe the amortization representing this run-off ($175mm) can be used as equity capital to replace more than this required UPB at mid-teens levered returns and maintain earnings at this level. We also believe that, over time, NSM can grow its originations business to enough scale to fully replace run-off of MSRs in the future, through targeting its core, lower income consumer as the mortgage market recovers, which we have also not factored into our estimates (primarily just recapture of the existing portfolio assumed).
 
Run Rate Earnings Build     Servicing Earnings Model     Originations Earnings Model  
          UPB         Run-off %     13.0%
Operating Profit Build       BOP     407   Recapture %   25.0%
Servicing     216   Run-off     (51)          
Originations     255   Recapture     13   Recapture Volume ($Bn)   13
Reverse     0   Consumer Direct   3   Cash Gain on Sale (bps)   100.0
Solutionstar     160   Correspondent   5   OMSR (bps)     100.0
Other     0   EOP     377   Total Direct Margin (bps)   200.0
Corporate G&A   (20)   Avg.     392          
Total     610             Direct Margin ($mm)   255
          bps of UPB                
Corporate Interest Expense (160)   Revenue     38.5   Correspondent Volume ($Bn) 5
PBT     450   Labor / Direct Expenses   19.0   Direct Margin (bps)   10.0
          Interest Expense   3.5   Direct Margin ($mm)   5
Taxes     171   Excess Spread   6.0          
Net Income     279   EBITDA     10.0   Consumer Direct Volume ($Bn) 3
          Amortization   4.5   Direct Margin (bps)   50.0
Diluted EPS     $2.56   Operating Profit   5.5   Direct Margin ($mm)   15
Shares O/S     109.0                    
          Revenue     1,509   Total Direct Margin   275
Tax Rate %     38.0%   Labor / Direct Expenses   745   Overhead Expenses   20
          Interest Expense   137   Operating Profit   255
          Excess Spread   235          
          EBITDA     392          
          Amortization   176          
          Operating Profit   216          
 
WAC M&A Scenario: 
Please see below for a hypothetical scenario in which NSM buys WAC for $27.50 per share, a 38% premium to last close of $20.02, for a mix of cash and stock. Given the upside from synergies, we believe a potential deal could be compelling for both company’s shareholders, even more so than the standalone prospects. Our math suggests accretion to NSM earnings of nearly 80%.
 
We assume cost synergies in servicing / allocated overhead are ~$200mm taken out of a base of ~$1.2bn given the scale nature of mortgage servicing. Likewise, we assume scale benefits in originations and the reverse businesses. For Solutionstar, the incremental WAC UPB will enable NSM to capture additional ancillary service fee streams. Finally, some of the higher cost WAC debt can be refinanced at lower rates. The combined company given its larger scale and market-leading position with botcustomers and the regulators would trade at a higher multiple, in our view.
 
      Run Rate
      WAC NSM Adj Pro Forma
Operating Profit Build          
Servicing     208 216 196 619
Originations     148 255 85 488
Reverse     0 0 30 30
Solutionstar     0 160 33 193
Other     5 0 0 5
Corporate G&A   (5) (20) 10 (15)
Total     356 610 354 1,320
             
Corporate Interest Expense (140) (160) 14 (286)
PBT     216 450 368 1,034
             
Taxes     82 171   393
Net Income     134 279   641
             
Diluted EPS     $3.52 $2.56   $4.53
Shares O/S     38.0 109.0   141.4
             
Accretion / (Dilution)         77.0%
             
Tax Rate %     38.0% 38.0%   38.0%
             
EPS ex Solutionstar   $3.52 $1.65   $3.69
Multiple     10.0x 10.0x   12.0x
Value ex Solutionstar   $35.21 $16.51   $44.24
             
Solutionstar Value per share $0.00 $16.20   $14.64
Excess Capital per share   $0.00 $2.29   $1.77
             
Total value per share   $35.21 $35.01   $60.65
Upside / (Downside)   75.9% 107.6%   259.7%
 
Management / Fortress:
Fortress Investment Group (FIG) owns >60% of NSM and Wes Edens is Chairman of the Board. We believe that Fortress / Wes are significantly involved in key operational and strategic decisions. We do not believe Fortress are sellers anywhere close to the current price they IPO’ed at $14 in March of 2012, however this was well below the expected range of $17 - $19. In addition, they have not sold in the interim years despite NSM trading into the $50’s in 2013 and in the $30’s for most of 2014. In a recent Bloomberg article (http://www.bloomberg.com/news/articles/2015-05-04/fortress-revs-mortgage-machine-as-its-buyout-funds-stall) on Fortress and its mortgage investments: “I’ve been around the fixed-income market for 30 years, and I don’t know another asset that goes up in value as rates rise,” said Edens from Fortress’s New York headquarters. “It is a terrific time” to buy servicing rights.
 
We view management as strong operators whose main issue is communication with investors. However, management needs to re-establish its credibility with the street, and we believe they will accomplish this through returning Servicing to profitability, validating Solutionstar via a minority investment, and continuing to execute on bulk MSR acquisitions.
 
Risks:
- Regulatory risks (discussed above)
- Depressed housing market impacting originations (although this would benefit Solutionstar and likely bulk transfers of credit sensitive MSRs)
- Inability to execute on servicing profitability margins; given the implied valuation of 40 bps for NSM’s MSRs (after backing out Solutionstar), we believe that either NSM will figure out how to make money with its MSRs or someone else will, via acquisition of MSR pools or of the entire company
- Inability to develop purchase money origination business to profitable scale to offset portfolio run-off
 
Conclusion:  
We believe there is 100% upside or more with limited downside, multiple near term catalysts, anda free option on XOME gaining traction in the huge real estate transaction market. In addition, we believe that there will be consolidation in the space over time, with huge potential synergies between the remaining players and significant benefits to scale.
 
We view Walter Investment (WAC) as a very attractive investment opportunity as well with a severely depressed valuation and near term catalysts, including capital raises at its financing vehicle Walter Capital Opportunity (WCO) enabling incremental MSR purchases and the transition to a capital light model over time.
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

- Acquire additional bulk MSRs

- Return servicing to profitability

- Validate the Solutionstar / XOME valuation via sale of minority stake

- Potential for accretive M&A

- Rising rates

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    Description

     
    Market Cap: $1.8bn
    Share Price: $16.86
    Target Price: $35.00, 100% upside, based on SOTP, with incremental potential upside for accretive M&A and its online real estate platform, XOME, which could be worth multiples of the current share price.
     
    Introduction:
    Nationstar (NSM) is an undervalued, out of favor investment opportunity with several catalysts over the next few quarters to highlight the SOTP / underlying earnings power / upside optionality. We see 100% - 500% upside and limited downside, driven by:
     
    1) Validating the valuation for Solutionstar at $1.5bn+ via sale of minority stake to a third party
    2) Improving profitability in its core mortgage servicing business as one-time headwinds reverse and operating efficiencies / scale are leveraged
    3) Additional mortgage servicing rights (MSR) acquisitions with excess capital raised in March / financing partners; these deals are highly accretive with high incremental margins, particularly if rates start to rise
    4) Rising rates environment leading to slower portfolio amortization and increased value of MSRs
    5) Free optionality on XOME, an online / mobile real estate platform similar to Zillow / Trulia launched at the end of June
    6) Near tangible book value, we think it is highly unlikely investors will lose money, even if Solutionstar is not monetized and they cannot improve profitability in servicing
    7) Optionality on M&A via acquisition of smaller mortgage servicers, in particular Walter Investment Management (WAC), which is also extremely undervalued by the market we think the synergies would be huge and accretion for NSM 75%+
    8) Transition to a capital light model over time, selling MSRs to NRZ / FIG at higher rates and moving to a fee for service model; asset managers generally trade at high multiples of earnings (15x 20x+)
    9) Record high short interest, with over 10mm shares short, representing >25% of the float and >10 days of volume to cover
     
    Key Terms:
    - Non-bank Servicers: Entities that are not classified as banks and not regulated by the OCC. Following the financial crisis, Ocwen Financial (OCN), NSM, and WAC along with other non-bank servicers came to prominence, primarily to service the huge pools of subprime, defaulted loans that the banks were unwilling or unable to handle. This led to mass transfer of these loans to non-bank servicers, who were not subject to Basel and other capital rules / regulations. The explosive growth in this sector led to increased regulatory scrutiny and the opportunity today in NSM and WAC
    - MSR: mortgage servicing rights; the contractual right of a mortgage servicer to service a loan, primarily via payment collection and processing, and receive a fee in return. MSRs are capitalized on the balance sheet as the present value of the expected future fee streams. A key input variable is future rates, as rates rise, borrowers are less likely to refinance and pay off the loan, increasing the value of the MSR, and vice versa. If a borrower goes into default, it is the servicer’s responsibility to try and remediate the situation, through outreach, refinancing, modifications, or ultimately foreclosure, and to limit the losses for the owner of the underlying credit. The mortgage servicer does not have significant capital at risk in a default scenario and generally gets paid additional fees for performing default services
    - UPB: unpaid principal balance; the face value of the mortgages underlying the MSRs
    - Agency MSR: a MSR where the underlying credit is owned by a Government Sponsored Entity (GSE) Fannie, Freddie and Ginnie
    - Private Label MSR: a MSR where the underlying credit is owned by private investors, generally through Residential Mortgage Backed Security (RMBS) pools which are overseen by trust administrators, generally a commercial bank
    - Interest Rate Sensitive MSR: MSR that is considered “prime” where the borrower is unlikely to default, and the value primarily fluctuates with the likelihood of the buyer to refinance / pay down the loan, which is driven by interest rates
    - Credit Sensitive MSR: MSR where there is a higher likelihood of default, requiring the mortgage servicer to advance payment on the mortgage (first lien priority), investigate the source of missed payments, remediate the borrower back to performing if possible via correcting an oversight or modifying the principal / future payments, and eventually foreclose / sell the property to recover value for the owners of the credit
    - Amortization / Disappearance: As MSR runs off and is paid down / goes into default, the book value of the MSR runs through the income statement as Amortization. NSM recaptures a portion of the disappearance through its originations segment and is able to recapitalize that as MSR and also earn fees on the origination
    - HARP: Home Affordable Refinance Program; a Fannie / Freddie program that enables borrowers with little or no equity in their homes to refinance into more affordable mortgages if their loans. HARP loans are more profitable to originate as borrowers are highly unlikely to ever refinance, given the below market rates afforded to them through the program, and
    therefore the MSRs are more valuable
    - REO: real estate owned; when the owner of the credit seizes the underlying collateral (the home) in foreclosure and typically puts the home up for auction / sale to recover value
    - Reverse Mortgage: a home loan for older homeowners in which they receive a lump sum payment or payments over time in exchange for equity in their home. The loan requires no cash mortgage payments by the borrower (hence reverse) and is subject to strict regulatory limits on the % of home equity that can be loaned and how that loan can be accessed over time. The reverse mortgage accretes value over time (similar to a PIK) and payment is due when the homeowner dies or moves out of the home
     
    Business Overview:
    NSM operates in 3 segments:
     
    Servicing (~35% of EBIT):
    - The largest non-bank mortgage servicer in the US, with over $400bn of UPB
    - Collects servicing fees based on contractual bps of UPB of loans serviced as well as ancillary fees for modifications and performance incentives
    - Provides loan administration, payment processing, mortgage escrow account administration, collection of insurance premiums, and loss mitigation solutions including loan modifications, foreclosures, and property dispositions
    - Services both Agency and Non-Agency mortgages
    - Adds MSRs via bulk acquisitions, usually in conjunction with selling excess spread to its financing partner, New Residential (NRZ), who captures a piece of the economics in exchange for purchase financing
    - Also acquires MSRs through its own originations platform and through sub-servicing for third parties / origination flow
    - MSRs run off and amortize over time either through voluntary (eg the homeowner sells home and moves) or involuntary (homeowner defaults on mortgage payments) and therefore need to be replaced
    - Traditionally built its UPB primarily through bulk acquisitions of credit sensitive MSRs but in recent years has also originated / acquired interest rate sensitive loans as well
    - Includes a reverse mortgage business, which currently generates little to no profit given regulatory changes 2 years ago; we believe there is upside to earnings from second draws on recent originations in the future that we have not included in our estimates
     
    Originations (~40% of EBIT):
    - Originates conventional residential mortgage loans; licensed in all 50 states and Washington DC
    - Primarily markets mortgage products to existing servicing customers via refinances (generally via the HARP program) or recapture of voluntary prepayment
    - Also markets to customers of homebuilder partners (eg KBH) and participates in the correspondent market
    - Currently building out a consumer direct business, which can potentially leverage the XOME platform (more on that later)
     
    Solutionstar (~25% of EBIT):
    - Technology and real estate services segment that focuses on the provision of enhanced technology and data solutions to homebuyers, home sellers, real estate agents and companies engaged in the origination and/or servicing of mortgage loans
    - Real Estate Exchange, via homesearch.com, provides a portal to auction REO and other properties
    - Real Estate Services provides title and escrow, collateral valuation and asset management services
    - Traditionally, Solutionstar only served internal servicing / originations clients, but is diversifying quickly, with 30% of
    revenues in Q1-15 from third party with the goal of 50% by year end
     
    SOTP / Valuation:
    We value NSM primarily via a SOTP, breaking out Solutionstar separately given the capital-light, fee stream nature of this business and large market / growth opportunity. We value Solutionstar at 10x EBITDA. We value the core servicing / originations business at 10x earnings, which we view as conservative, and then given NSM credit for the $250mm of capital raised in its common equity offering in March that has yet to be deployed.
     
    NSM SOTP      
    Share Price     $16.86
    Shares O/S     109.0
    Market Cap     1,838
           
    Cash and Equivalents (pro forma) 500
    Corporate Debt   2,159
    Enterprise Value   3,497
           
    Solutionstar 2016 EBITDA   180
    Multiple     10.0x
    Solutionstar Valuation   1,800
    Less: Solutionstar CEO Bonus (34)
    Solutionstar Value per Share $16.20
           
    Run-Rate EPS   $2.56
    Solutionstar EPS   $0.91
    Core Run-Rate EPS   $1.65
    Servicing / Originations Multiple 10.0x
    Core Value per Share   $16.51
           
    Excess Capital Raise   250
    Excess Capital Value per Share $2.29
           
    Total Value per Share   $35.01
    Upside / (Downside)   107.6%
     
    Solutionstar in the fall of 2014 hired Kal Raman as CEO, who is the former COO and head of Asia for Groupon, VP of Global Fulfillment at eBay, and SVP at Amazon in charge of retail technology and marketing. Mr. Raman will receive 8.5% of the increase in value of Solutionstar from his start date to when the valuation is validated via third party investment or a change of control (sale or spin). This makes up the majority of his compensation package. Based on our math, the fair value was marked at $1.4bn, meaning he would get $34mm if Solutionstar is valued at $1.8bn. We view our valuation for Solutionstar as conservative, given the growth prospects, limited capital required to grow the business, high margin structure and free option on XOME.
     
    Management has discussed their plans for Solutionstar publicly, so this is not just a theoretical SOTP exercise. At the Wells Fargo conference in May, CEO Jay Bray stated (per Bloomberg transcript):
     
    “From a third-party capital standpoint, I think we this year will go out and chat with some investors and chat with some potential minority investors that want to come in. And we haven't really determined the exact timing or the exact amount, but I think the thought process would be, before you're in, we will establish a third-party value on that platform. Again, my view is that it will be a pretty significant value.
     
    And then, from there, I think your options are, you could spin it, you could IPO it, you can sell it. And I think that horizon again, we have really determined what that will be. Some of that will depend on yes, the success of the launch of the app. And once we launch it, and start driving the traffic and proving to the market that, that we can actually drive transactions, then you have a ton of momentum. And I think you can probably separate sooner rather than later, but that's a lot of ifs and buts, and we got to execute ultimately. But I think the other thing that's happening within Solutionstar, now Xome is the third party business has gone up a lot, right? We originally, Solutionstar was really build for Nationstar to provide us with a better customer experience or to provide our customers with a better customer experience and to capture that value.
     
    Now, 31% of the revenue is coming from third parties. We think that will be over 50% by the end of the year, which again, I think, will add more value to that business and the market will realize that it's a lot more than just Nationstar provider. So that's kind of the timeframe.”
     
    We also adjust NSM’s tangible book value for Solutionstar, which we believe has market value well in excess of its (likely) limited book value and arrive at a similar valuation (although we think the core business is worth above current tangible book value). We also marked to market NSM’s MSRs to current rates (up 30 bps from Q1-15). MSRs are one of the few investments that appreciate in a rising rate environment.
     
    NSM Book Valuation    
    NSM Book Value   1,676
    Goodwill     63
    Deferred Financing Costs   43
    Intangible Assets   39
    Tangible Book Value   1,531
           
    Shares O/S     109.0
    Tangible Book Value / Share $14.04
           
    Rates Increase (30 bps)   100
    MTM TBV     $14.96
           
    Solutionstar Fair Value   1,766
    Solutionstar TBV (Estimated) 50
    Excess Fair Value   1,716
    Excess Fair Value per Share $15.75
           
    Total Value per Share   $30.70
    Upside / (Downside)   82.1%
      
    XOME:
    NSM launched XOME as a standalone online / mobile real estate platform at the end of June. You can view the website here: https://www.xome.com/ as well as download the mobile app. As you can see, the inventory of homes for sale is huge and comparable to Z / Trulia, with over 80% of MLS listings. Based on our analysis, the website is already generating significant traffic despite only recently launching with limited advertising / marketing spend. We think NSM has been waiting for the XOME launch to monetize Solutionstar at a higher price.
     
    I am sure most of you are familiar with the Z / Trulia model, which we won’t go through here, however the XOME model is different in a few key respects (caveated with this is early days and NSM has not fully laid out the model / strategy yet this is based on our use of the website and best guesses).
     
    Listings are accompanied by a selling broker. There are no brokers on the buyer’s side, and XOME passes along this savings to the customers (1% of the purchase price to the buyer and 1% of the purchase price to the seller, so 2% of the ~5% total). XOME “concierge” provides a lot of the services a buying broker normally would, but most of the searches are generated by the user on the website / mobile platform. XOME will take a cut of the eventual sale and NSM would then offer ancillary services through Solutionstar and its Originations platform title service, insurance, pre-qualifying for a mortgage, etc. - providing ancillary business to the rest of the NSM platform. XOME also includes the inventory of auction homes through its servicing platform, primarily REO, which is a differentiator vs. other platforms.
     
    We have constructed a very rough back of the envelope, highly preliminary analysis of XOME. We assume 275k hits to the website per day, with 10 bps conversation rate to a sale, and $1,000 fee to XOME per transaction (roughly 50 bps of a $200k home sale – we assume of the traditional 5% paid in broker fees, 2% is passed on in savings, the selling broker still gets 2.5%, and XOME gets the remaining 50 bps). This results in $99mm of revenues, at a 30% margin that’s $30mm of EBITDA, 15x multiple that is $4.00 per share of upside.
     
    XOME Valuation Analysis  
    Website hits per day (000's) 275
    Website hits per year (mm) 99
    Converstion rate (bps)   10
    Transactions per year   99,000
    $ per transaction   $1,000
    Revenue ($mm)   99
    EBITDA margin (%)   30.0%
    EBITDA ($mm)   30
    Multiple     15.0x
    Value     446
    Value / Share   $4.09
     
    We have not included any value for XOME in our analysis at this point. In fact, XOME launch / marketing / operating expenses are in the Solutionstar segment but are not generating any revenue in our SOTP analysis. In addition, our XOME analysis does not include any potential increases in originations and ancillary services via transactions on the XOME platform. If XOME works, it will generate significant growth in originations and servicing (while still generating earnings on its own) and drive earnings in those businesses well above our estimates.
     
    XOME Upside Analysis    
    Homes sold in US   5,000,000
    Average home price   $200,000
    Total transaction value ($bn) 1,000
    Broker fees as %   5.0%
    Addressable market ($bn) 50
    XOME market share   2.0%
    Revenue ($mm)   1,000
    EBITDA margin (%)   35.0%
    EBITDA ($mm)   350
    Multiple     20.0x
    Value     7,000
    Value / Share   $64.22
     
    This analysis is predicated on XOME management’s business case, which at this point is highly speculative. The point is, even if XOME does not generate any profits on its own, to the extent it provides cost-free leads to its originations / ancillary businesses, it would provide significant upside to our forecasts.
     
    The Opportunity:
    NSM shares are down 40% YTD and 50% from peak in the fall due to a variety of factors.
     
    - NSM raised capital via a common offering of 17.5mm shares at $28.50, a 5% discount to prior close, and the shares collapsed to $25 following poor communication of the rationale for raising capital and thereby diluting existing holders by 20% and the expected returns for deployment of that capital
    - Q1-15 earnings were a disaster, missing the street consensus by a wide margin, compounded by confusing changes to its disclosure / presentation materials leading to sell-side downgrades, a material reset of earnings expectations and a violent sell-off to $20
    - Continued regulatory scrutiny / uncertainty, particularly in light of the issues faced by OCN with the NYDFS over related parties, the state of California and other federal and state agencies
     
    Despite the poor communication and timing right before a poor earnings report, we view purchasing MSRs as an attractive use ocapital for NSM, generating levered equity returns after-tax in the mid-teens with conservative assumptions, and much higher returns if rates rise or if NSM is able to better leverage its scale and platform. The timing of the equity raise, right before an earnings miss, certainly did not help management’s credibility, however given OCN’s announcement to sell its Agency book (and potentially non-Agency as well at some point given the recent downgrade to below average from S&P), NSM viewed the market opportunity as too good to pass up.
     
    We view the earnings miss and subsequent stock reaction as mostly due to some timing / one-time factors as well as, again, poor communication by management. Please see the profitability walk below for our view on earnings power in the Servicing segment vs. Q1-15 results. We believe that NSM will show progress throughout the rest of the year towards its goal of 5-7 bps of Servicing EBIT and should exceed that over time in a steady state, when NSM is not engaging in large bulk acquisitions and normalized rate environment. Earnings expectations / sentiment have reset significantly to a pretty low bar at this point.
     
    Mortgage servicing / originations are highly regulated industries, with multiple federal and state agencies overseeing both capital and operational aspects of the business. OCN is a cautionary tale, as it took shortcuts on its operations, compliance / risk framework, and was far too aggressive with its related parties structure / corporate governance. We believe that NSM will not
    become the next OCN:
    - NSM’s “Above Average” servicer rating was recently affirmed by S&P, and it has 5 star ratings from Fannie / Freddie. In
    addition, NSM has been able to secure approvals from all required regulators for recent bulk MSR transfers
    - NSM has significant cushion under the capital rules recently announced by the FHA / GSE’s
    - NSM’s platform is not built on aggressive automation and offshoring like OCN
    - Solutionstar has >30% of revenues from third parties, validating its business model / arrangements as arm’s length with NSM servicing / originations, unlike ASPS which effectively had 100% of revenues from OCN serviced mortgages before the NYDFS investigation (which initially included a letter to NSM management at same time it began investigating OCN, but nothing came of it, unlike OCN who ended up with millions of dollars of fines, MSR divestments, and monitors for multiple years paid for by shareholders)
    - We also view its relationship with NRZ as arm’s length; in fact we believe that NSM has materially worse agreements with NRZ than OCN had with HLSS, based on our analysis. The terms are potentially below market for NSM, not the other way around (and also unlike the OCN structure, Fortress’ economic interests are vastly concentrated in NSM, the servicer, instead of affiliate companies)
    - Ben Lawsky, who spearheaded the NYDFS investigation, has stepped down to join the private sector
     
    We view most of the bad news on the regulatory front as behind NSM / the industry for the most part, with better defined roles for regulators, capital rules in place, and the OCN situation mostly resolved.
     
    Profitability Walk:
    NSM reported minimal profit in its Servicing segment in Q1-15, generating Operating Profit of only 0.4 bps of UPB. This was partially due to timing of performance / incentive fees, heightened amortization due to the collapse in interest rates during the quarter (leading to heightened refinance activity) and excess capacity in anticipation of the transfer of bulk MSR acquisitions. We are modeling 5.5 bps of Operating Profit vs. management’s target of 5-7 bps. We believe they should be at this run-rate exiting this year / entering next year, and over time should perform above this range as the portfolio matures / stabilizes. We also believe there is upside to NSM’s reverse mortgage business that is not currently factored into our estimates.
     
    NSM Profitability Walk                    
          Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Adj vs. Q1 Run-Rate   Notes
    bps of UPB                      
    Revenue     39.2 40.5 39.4 38.2 37.1 1.4 38.5   Performance / Incentive Fees
    Labor / Direct Expenses   21.3 22.5 18.2 19.2 20.3 (1.3) 19.0   Operating efficiencies / completion of onboards
    Financing Payments   9.5 11.4 11.0 10.7 9.9 (0.4) 9.5   Decline as PLS advances recovered
    EBITDA     8.4 6.6 10.2 8.3 6.9 3.1 10.0    
                           
    Amortization   4.6 3.5 5.6 4.9 6.5 (2.0) 4.5   Decline as rates normalize
    Operating Profit   3.8 3.1 4.6 3.4 0.4 5.1 5.5   NSM mgmt. target 5-7 bps
     
    Revenues can be lumpy, as NSM earns incentive / performance fees above the contracted servicing fees based on a cash basis, not on an accrual basis. Q1-15 was abnormally low due to the timing of Fannie / Freddie incentive programs and we believe this reverses back to a more normalized level. On the expense side, NSM is running with ~10% excess operational capacity in anticipation of onboarding bulk MSR acquisitions. We believe a steady state is conservatively at 19 bps. Financing payments are elevated due to advances required to work out credit sensitive pools of loans; as the book normalizes these will come down over time. Amortization is a function of refinance activity which is a function of interest rates. During Q1-15, the 10 year fell 25 bps, leading to heightened amortization. We believe that as rates normalize and the portfolio matures, amortization will come down over time, extending the tail of its MSRs and increasing their value.
     
    Putting this together with pro forma UPB of $407bn and our view on originations and Solutionstar, we estimate run-rate EPS of $2.56 for NSM. Note that an incremental $30bn of UPB needs to be acquired to remain in this steady state we believe the amortization representing this run-off ($175mm) can be used as equity capital to replace more than this required UPB at mid-teens levered returns and maintain earnings at this level. We also believe that, over time, NSM can grow its originations business to enough scale to fully replace run-off of MSRs in the future, through targeting its core, lower income consumer as the mortgage market recovers, which we have also not factored into our estimates (primarily just recapture of the existing portfolio assumed).
     
    Run Rate Earnings Build     Servicing Earnings Model     Originations Earnings Model  
              UPB         Run-off %     13.0%
    Operating Profit Build       BOP     407   Recapture %   25.0%
    Servicing     216   Run-off     (51)          
    Originations     255   Recapture     13   Recapture Volume ($Bn)   13
    Reverse     0   Consumer Direct   3   Cash Gain on Sale (bps)   100.0
    Solutionstar     160   Correspondent   5   OMSR (bps)     100.0
    Other     0   EOP     377   Total Direct Margin (bps)   200.0
    Corporate G&A   (20)   Avg.     392          
    Total     610             Direct Margin ($mm)   255
              bps of UPB                
    Corporate Interest Expense (160)   Revenue     38.5   Correspondent Volume ($Bn) 5
    PBT     450   Labor / Direct Expenses   19.0   Direct Margin (bps)   10.0
              Interest Expense   3.5   Direct Margin ($mm)   5
    Taxes     171   Excess Spread   6.0          
    Net Income     279   EBITDA     10.0   Consumer Direct Volume ($Bn) 3
              Amortization   4.5   Direct Margin (bps)   50.0
    Diluted EPS     $2.56   Operating Profit   5.5   Direct Margin ($mm)   15
    Shares O/S     109.0                    
              Revenue     1,509   Total Direct Margin   275
    Tax Rate %     38.0%   Labor / Direct Expenses   745   Overhead Expenses   20
              Interest Expense   137   Operating Profit   255
              Excess Spread   235          
              EBITDA     392          
              Amortization   176          
              Operating Profit   216          
     
    WAC M&A Scenario: 
    Please see below for a hypothetical scenario in which NSM buys WAC for $27.50 per share, a 38% premium to last close of $20.02, for a mix of cash and stock. Given the upside from synergies, we believe a potential deal could be compelling for both company’s shareholders, even more so than the standalone prospects. Our math suggests accretion to NSM earnings of nearly 80%.
     
    We assume cost synergies in servicing / allocated overhead are ~$200mm taken out of a base of ~$1.2bn given the scale nature of mortgage servicing. Likewise, we assume scale benefits in originations and the reverse businesses. For Solutionstar, the incremental WAC UPB will enable NSM to capture additional ancillary service fee streams. Finally, some of the higher cost WAC debt can be refinanced at lower rates. The combined company given its larger scale and market-leading position with botcustomers and the regulators would trade at a higher multiple, in our view.
     
          Run Rate
          WAC NSM Adj Pro Forma
    Operating Profit Build          
    Servicing     208 216 196 619
    Originations     148 255 85 488
    Reverse     0 0 30 30
    Solutionstar     0 160 33 193
    Other     5 0 0 5
    Corporate G&A   (5) (20) 10 (15)
    Total     356 610 354 1,320
                 
    Corporate Interest Expense (140) (160) 14 (286)
    PBT     216 450 368 1,034
                 
    Taxes     82 171   393
    Net Income     134 279   641
                 
    Diluted EPS     $3.52 $2.56   $4.53
    Shares O/S     38.0 109.0   141.4
                 
    Accretion / (Dilution)         77.0%
                 
    Tax Rate %     38.0% 38.0%   38.0%
                 
    EPS ex Solutionstar   $3.52 $1.65   $3.69
    Multiple     10.0x 10.0x   12.0x
    Value ex Solutionstar   $35.21 $16.51   $44.24
                 
    Solutionstar Value per share $0.00 $16.20   $14.64
    Excess Capital per share   $0.00 $2.29   $1.77
                 
    Total value per share   $35.21 $35.01   $60.65
    Upside / (Downside)   75.9% 107.6%   259.7%
     
    Management / Fortress:
    Fortress Investment Group (FIG) owns >60% of NSM and Wes Edens is Chairman of the Board. We believe that Fortress / Wes are significantly involved in key operational and strategic decisions. We do not believe Fortress are sellers anywhere close to the current price they IPO’ed at $14 in March of 2012, however this was well below the expected range of $17 - $19. In addition, they have not sold in the interim years despite NSM trading into the $50’s in 2013 and in the $30’s for most of 2014. In a recent Bloomberg article (http://www.bloomberg.com/news/articles/2015-05-04/fortress-revs-mortgage-machine-as-its-buyout-funds-stall) on Fortress and its mortgage investments: “I’ve been around the fixed-income market for 30 years, and I don’t know another asset that goes up in value as rates rise,” said Edens from Fortress’s New York headquarters. “It is a terrific time” to buy servicing rights.
     
    We view management as strong operators whose main issue is communication with investors. However, management needs to re-establish its credibility with the street, and we believe they will accomplish this through returning Servicing to profitability, validating Solutionstar via a minority investment, and continuing to execute on bulk MSR acquisitions.
     
    Risks:
    - Regulatory risks (discussed above)
    - Depressed housing market impacting originations (although this would benefit Solutionstar and likely bulk transfers of credit sensitive MSRs)
    - Inability to execute on servicing profitability margins; given the implied valuation of 40 bps for NSM’s MSRs (after backing out Solutionstar), we believe that either NSM will figure out how to make money with its MSRs or someone else will, via acquisition of MSR pools or of the entire company
    - Inability to develop purchase money origination business to profitable scale to offset portfolio run-off
     
    Conclusion:  
    We believe there is 100% upside or more with limited downside, multiple near term catalysts, anda free option on XOME gaining traction in the huge real estate transaction market. In addition, we believe that there will be consolidation in the space over time, with huge potential synergies between the remaining players and significant benefits to scale.
     
    We view Walter Investment (WAC) as a very attractive investment opportunity as well with a severely depressed valuation and near term catalysts, including capital raises at its financing vehicle Walter Capital Opportunity (WCO) enabling incremental MSR purchases and the transition to a capital light model over time.
    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

    - Acquire additional bulk MSRs

    - Return servicing to profitability

    - Validate the Solutionstar / XOME valuation via sale of minority stake

    - Potential for accretive M&A

    - Rising rates

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