Description

Porch Group Convert Long

Idea: Go long Porch Group Senior Secured Convert in the mid 50s. 22.5% Yield to Maturity, 2.3X MOIC to maturity.  75% one year return from convert trading to 10% Yield to Maturity over the next 12 months.

Higher risk tolerance investors may want to go after the 2026 Notes in the 30s, more upside but more dependent on rebound in the housing markets.

Capital Structure (as of 1/25/24):

Thesis:

• After going public November 2020 at a $523MM valuation and trading up to a market cap north of $2B, Porch stock and debt was hit by a combination of macro events and self-inflicted missteps.

  • Decline in Macro environment for housing[2]

  • Extreme weather in Texas driving higher than historical “Catastrophic” Losses in the insurance segment in 2023[3]

  • Insurance business caught up in a Reinsurance fraud by an Israeli insurance fintech firm, Vesttoo, that had raised > $100MM including $80MM at a $1B valuation. Vestoo was, according to the bankruptcy docket, “brokering” reinsurance by forging letters of credit from commercial banks. Porch’s Homeowners of America insurance subsidiary had $175MM of reinsurance from Vesttoo backed by fraudulent letters of credit and was placed under temporary supervision by the Texas regulators. It was released after Porch invested $57MM in exchange for the Vesttoo claims and a $47MM surplus note.[4]

• Despite rocky noise- secured bonds retain strong coverage on value of underlying assets

  • $ 118.5MM of unrestricted Holdco cash at 9/30/2023- 36 cents of coverage for a secured bond trading at 55.

    • Company was EBITDA positive in q324 and has guided to EBITDA positive in 2H23 and full year 2024

    • Home services software business with $128.5MM of LTM revenue, grown via $202MM of acquisitions since 2014 and $~215MM of sales and marketing spending over the last 36 months (assuming 1/3rd of sales and marketing to insurance). Channel checks suggest proptech software M&A for growing firms in the $20-100MM revenue range at 5-12X revenue, public B2B comps trade at 5-15X 2024 revenue (UBS Software & SaaS index at 9.6X 2024E Revenue)

    • Mixed quality of businesses (ISN and Rynoh are category leaders, Floify was profitable at purchase in ’21, V12 has a strong data-sales business, less clear on others)

    • Assuming 50% of revenue comes from the higher quality business we see this business as worth 2X LTM revenue ($250MM), a significant discount to the M&A price plus recent sales and marketing growth spend ($417MM)

    • This equates to 76 cents of Bond value

  • Insurance Business

    • Hardest business to analyze given strong historical performance and recent re-pricing of book, offset by exposure to Vesttoo fraud and some big “extraordinary” losses in 2023.

    • Bond protection from $49.5MM (SOFR+9.75%) surplus note, which even in a downside scenario is likely saleable at par. $49.5MM (15 cents)

    • Real upside potential if business stabilizes it, but not needed from secured bondholder perspective.

  • Warranty business

    • Separate business which based on Stat reports appears profitable standalone and has grown significantly since purchase ($33MM). We assume it’s worth what Porch paid – (10 cents)

  • Vestoo claim- $118MM claim filed into Vesttoo owned directly by Porch (Collateral of the bond).  

    • Vesttoo disclosure statement expects 3-6 cents of recovery based on filed claims, plus the value of litigation claims against the various parties accused of committing fraud/ misappropriating assets.

    • At the mid-point of estimates with nothing for litigation this is $5.3MM. Given the incentive to overstate/duplicate claims and the potential value of litigation claims there is a real potential for this to be materially higher.

  • Aon Vesttoo settlement

    • Aon was Porch’s intermediary on reinsurance and brokered them into Vesttoo

    • As part of a holistic settlement of potential claims and reinsurance brokerage partnership Porch receives $25MM and an expected $5MM over the subsequent four years ($30MM total, 9.1 cents) [5]

• Total coverage

  • Cash -36 cents

  • Home Services Software- 76 cents

  • Insurance Surplus Note- 15 cents

  • Insurance Equity- 0 (but could be a big number)

  • Vesttoo claim recovery- 2 cents (but could be a big number)

  • Aon  Vesttoo settlement- 9.1 cents

  • Cost of a bankruptcy- likely you’re taken out by a DIP given 1st lien secured position but lets assume $50MM (-15 cents)

  • Adds up to 120.1 cents on a bond trading at 55, 22% YTM

• Well structured tight covenants protect the attachment point and limit leakage

• Secured Note was issued in April 2023, effectively as an “Uptier” with the documentation led by sophisticated investment firms

• Secured by effectively all assets of the company (secured by the equity of the regulated insurance subsidiary), with guarantees at all current and future domestic subsidiaries

• No ability to issue senior or pari debt without the vote of 2/3rds of the creditors

• Springing maturity ahead of the unsecured converts (company has to repurchase all notes at 106.5% of par June 15th 2026 if >$30MM of the 2026 notes remain outstanding

  • Cap of $25MM a year to repurchase junior notes unless secured leverage is below 3X

• 50% of proceeds from any asset sales >$20MM go to repurchase notes and the rest must effectively stay in the company as collateral of the loan

EBITDA positive 2024 and normalization of insurance markets brings high yield buyers back, Porch convert trades to a 10% yield – 75% 1 year return.

Business Overview - Two core business segments

• Home services software and services- 128.5MM of LTM Revenue

  • Grown through $202MM of acquisitions since 2014 with the last material acquisition being Floify for 95.4MM in 2021.

• Figure 1: Company Segment Overview 

• $323MM of Sales and Marketing Spend (across both segments) over the last 3 years has driven an increase in penetration rates offset by lower new home sales as interest rates have increased

• The home services software space is highly fragmented and growing at the expense of manual/ spreadsheet solutions. ISN and Rynoh are the leaders in their market category while Floify is a strong number two.

• Revenue in the home services segment is driven primarily by the number of either Home Sales (for the mortgage and inspection related businesses) or Moves (for ISN)

• While Moves have been relatively stable, home sales are down ~ 30% from the peak and mortgage volumes down more, offset by increased market share and cost controls- driving a 24% decrease in software revenue but staying EBITDA positive. [6]

• With rates having peaked early indicators like Mortgage purchase indications have rebounded, suggesting a return to growth.

• Insurance and Warranty –

  • Nationwide warranty business and growing home insurance business (with significant current exposure to the state of Texas, >50% but shrinking)

• Moving to a “Reciprocal Exchange” model which should drive less earnings volatility, with approval expected in 2024

After a tough 2023 they, like others in the industry, pushed through double digit rate increases. This dynamic has driven pure play insurance cos like Travelers and Allstate to record highs and should set Porch up for a strong 2024.  [7]

Disclaimers

This document has been prepared by an investment manager (the “IM”) that manages funds that hold this position within its portfolio.  The information contained herein is for informational purposes only and is not intended to, nor shall it be, construed as legal, tax or investment advice.   The IM makes no express or implied representation or warranty as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of the information or opinions contained herein.  Neither the IM, nor any of its employees or representatives shall have any liability whatsoever (in negligence or otherwise) for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection with this document.

This document contains forward-looking statements that involve risks, uncertainties and assumptions. If such risks or uncertainties materialize or such assumptions prove incorrect, the results stated herein could differ materially from those expressed or implied by such forward-looking statements and assumptions.

This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, in whole or in part, for any purpose.  By accepting this document you agree to be bound by the foregoing instructions and terms.

[1] 2023 Q3 10Q Filing; Bloomberg data

[2] https://www.nar.realtor/newsroom/existing-home-sales-slid-1-0-in-december

[3] https://www.reinsurancene.ws/porch-group-anticipates-18m-catastrophe-loss-in-q2/#:~:text=%E2%80%9CThe%20second%20quarter%20of%202023,wide%20claims%2C%E2%80%9D%20Porch%20explained.

[4] https://ir.porchgroup.com/investors/news/news-details/2023/Porch-Group-announces-cash-investment-in-HOA-its-insurance-carrier/default.aspx

[5] https://ir.porchgroup.com/investors/news/news-details/2024/Porch-Group-Receives-25M-with-Signing-of-Strategic-Agreement-with-Aon-2024-Vj_n8tCwNn/default.aspx

[6] https://www.nar.realtor/newsroom/existing-home-sales-slid-1-0-in-december

[7] https://www.wsj.com/finance/insurance-companies-profits-stock-ebae7fd1?mod=hp_lead_pos6

Catalyst

Normalization of insurance markets with strong pricing increases rolling through in 2024 and a rebound in the residential housing market as interest rates stabilize and / or come down.