Description

I advocate a short position in the common stock of Real Matters, Inc. (“REAL” or the “Company”), as it is overvalued by the market with an intrinsic value of ~$3.0, representing upside of approximately 40%.

The Short thesis for this $391 million market cap Canadian based appraisal management services company focuses primarily on the threat of competitors such as Black Knight and CoreLogic expanding in this market, the lack of data, and changes in the requirements for refinancings that reduce the need for appraisals. REAL’s lofty valuation is benefitting in part due to the momentum for growth stocks and REAL’s ability to show growth off a small base. 

I believe the timing for this short is attractive due to Black Knight (BKI) and CoreLogic’s (CLGX) potential expansion in this segment, the loss of market share as evidenced by recent performance.

Description - What does REAL do?

Ø  REAL is focused on the residential mortgage appraisal market in the US and Canada. They use algorithms to find the best available appraiser for a given job.

Ø  They have access to 34,000 appraisers - who they have ranked and evaluation based on 40 metrics (performance, error rate, time to serve and availability...etc.). REAL is able to add value to the buyer and the appraiser, but its key customer is the mortgage lender.

Ø  REAL has MSA agreements with 60 of the top 100 mortgage lenders in the US as customers including all six of the Tier-1. As larger lenders want to multisource, REAL could continue to penetrate the rest of the top 100.

Ø  The Brand Solidifi Appraisal Management is the core Appraisal Management Company (AMC) for residential real estate valuations in the US and Canada.

Ø  The company also provides title and closing services, including title search, closing and escrow, and title policy issuance services; and other capital markets services, as well as providing access to its software platforms to other title insurance agencies and mortgage lenders for a subscription fee under the Solidifi brand.

Ø  The company was formerly known as Solidifi Inc. and changed its name to Real Matters Inc. in July 2010.

Ø  REAL IPO was priced at CDN $13.00 and trading in Toronto on May 11, 2017. The IPO generated CDN$156.7m and reports financials in US dollars with a September fiscal year end.

Who does what – Process and Players

Ø  The Lender and The Borrower: The lender wants to underwrite more loans at lower risk. The borrower wants lower total borrowing costs and have a smooth transaction. Both want completion in a timely manner. Because of regulations, neither the lender nor the borrower is allowed to choose an appraiser. Quality and turn-around time seem to be the most important points.

Ø  The Appraiser - Appraisers want to maximize their fees/volumes while minimizing marketing costs. While

AMC’s provide a stream of work/revenue, they have used their position to squeeze appraisers on fees and have used professionals that are often inexperienced. REAL does performance assessments and as appraisers' performance improves, they get more work from REAL at a minimum premium rate.

Ø  The workflow - When a lender makes a request to an AMC it goes to REAL through a standard API. These APIs are typically made through the predominate providers: Real EC, Empower Origination System, Mercury VMP or FNC.

Generally, the lenders software will allocate appraisal jobs along predetermined weights. REAL will receive the work order and allocate. Instead of doing a reverse auction to find the lowest bidder, REAL's software will find the highest performing, efficient and experienced appraiser plus it could cluster jobs geographically.

TAM

Ø  The US residential housing market is over $33 trillion, the largest asset class in the world. Approximately $10 trillion of this is debt in mortgage finance system. REAL' core market of residential home appraisal market has been at estimated TAM of $4.0 billion. REAL has an 11.7% share of this core market and targets expansion to a 26%-28% share over the next five years. The market for title & closing services is materially larger, valued at $11.7 billion. REAL estimates its share, with limited Tier-3 and Tier-4 mortgage lenders, to be 2.1% and targets expansion to a 6%-8% share over the next five years.

Ø  In 2020, there were 78,015 real estate appraisers in the US as of 2018, according to the Appraisal Institute. Surveys conducted by Appraisal Press, an average appraiser completes around 220 to 240 appraisals per year. This is just slightly more than one per business day. Total volume of appraisals is 18-20 million per year based on Industry data from Appraisal Press.

Ø  Appraisal fees vary state and from appraisal vendor management software MercuryVMP, appraisal fees average in the $400-$600 range.

Ø  Turnaround times can vary by state and can averages of eight days for states like Florida and California to 20 days for states like North Dakota, Oregon and Montana.

Ø  REAL uses an appraisal cost of $472 and actual turnaround time of 5.3 days.

Short Thesis

Ø  Direct Impact by Automation and Big Data Application Valuation — Less Appraisers

o   “Appraisals are changing from a people business into a technology platform. In the long run, data analytics and automated valuation models will improve and handling of exceptions will become the future option”.

o   "If you could eliminate appraisals, loans would close almost 2 weeks faster and cheaper." Why? "The biggest problem for the appraiser is scheduling a meeting time with the property owners and the paperwork."

o   "The value of an appraisers is declining rapidly - against Zillow, is their opinion worth $500-$600?"

o   Source: Expert formerly with Black Knight and CoreLogic

o   Fannie Mae has introduced “enhanced property inspection waiver" which will allow some refinancing to bypass a human appraiser in favor of Fannie Mae's AVM under the following conditions:

o   a valid appraisal has been submitted in the last 4.5 years

o   asset is worth less than $1 million

o   an LTV of under 90%.

Under the program, 3% of applications are eligible but many believe this could climb to 10% especially in a low interest rate environment.

o   In October 2016, Freddie Mac added new capability to Loan Advisor Suite and offered a “no-cost automated appraisal" starting in 2017. From June 2017, Freddie announced appraisal requirements were waived with LTV<80% and no cash out refinancing.

o   Bloomberg Article - "The Next Job Humans Lose To Robots: Real Estate Appraisers" I have the article (or just google it) but the key point is: In 2006, Zillow's gap between its “Zestimate” and actual sale price was 14% - recently, the gap has closed to under 5%.

Ø  Transaction (not license or subscription) revenue

o   REAL' revenue is driven by transactions rather than a recurring license or subscription.

o   REAL earns revenue based on the volume of appraisals completed and is paid by the mortgage lender a fee of $400-$600 when the appraisal report is delivered.

o   REAL pays an approved appraiser on the platform after a successful report is completed and accepted. REAL will pay the appraiser before it receives payment from the mortgage lender, which creates a working capital headwind.

o   Appraisers' top concern was that fees for their work are too low. In addition, AMCs continue to demand more detailed explanations, without compensation for the added time. There is a total lack of client loyalty, as appraisers have found that if they produced the best appraisal at an above average time to completion, AMCs would pass them by on the next assignment because they found a fee somewhere for $10 less. One appraiser stated that "AMC’s only care about the cheapest and the fastest way to do things. They just want to make the profit."

o   Other appraisers had concerns regarding blacklisting (no longer eligible to provide work for a lender), with little recourse for appeal or even being notified that they have been blacklisted.

Ø  Refi Market and Rising Interest Rates — Headwind For Available Appraisals

o   The MBA Mortgage Finance Forecast Report estimates a mortgage origination market of $1.29 trillion in 2020 down from 2.06 trillion in 2019 which was second only to 2.31 trillion in 2007. The volume of mortgage origination and real estate transactions is highly variable.

o   Refis are particularly at risk. The US market allows refinancing of 30 year mortgages with little penalty. Over the past few years, this has created significant support for the refinance market as home prices rise and interest rates decline. At some point, the housing market will be negatively impacted by rising mortgage rates.

Ø  CoreLogic & Black Knight are building Analytical or Processing Platforms - Additionally, CLGX and BKI have been acquiring AMCs which will effectively squeeze REAL Out Of The Market.

o   The key competitors for Lenders Software Platforms are:

o   CoreLogic (CLGX), ServiceLink (Black Knight (BKI) has appraisal business built in - 25% market share with 65% of top 5 lenders

o   Streetlinks by Assurant

o   Clear Capital

o   TSI Appraisal (owned by Quicken)

o   Red Sky (owned by US Bank)

o   This is the key to the kingdom - being on the lenders desktop. CLGX is building an improved platform and they are considered the market leader with 80% market share in credit and flood certification. CLGX is a data analytics company.

o   BKI is the leading platform player with MSP Servicing, loan modification and origination platforms. Real-EC (BKI) is the platform used by all large banks to order title and appraisal products. Empower Origination (BKI) is used by some larger banks for new purchase origination.

o   Acquisitions by CLGX pose trouble for REAL. These are clear signals that CLGX and BKI are intent on owning the mortgage market from origination to closing.

o   In Q416, CLGX purchased two AMC’s and the FNC platform. One was Landsafe (which was the exclusive BOA's internal AMC) and RELS (Wells Fargo exclusive internal AMC) and FNC is a large player in collateral. Through this platform, FNCs' "Appraisal Port" will connect mortgage lenders to 80,000 appraisers.

o   This is a big deal as BOA & WF are ~20% of the mortgage market.

o   REAL states that CLGX does not own the exclusivity with BOA and WF — however, I would bet that CLGX gets a 90% of all appraisals.

o   In June 2017, CLGX purchased the remaining piece of Mercury Network. Mercury is a meaningful player in appraisal management workflow and is on the desktop of 800 mid-tier mortgage lenders.

o   Additionally, Quicken has become a dominant player in recent years as Charles Schwab wraps their loans. Quicken tends to build their own technology and has their own title insurance company. Additionally, they have their own appraisal network (TSI) which pays more than Solidif, BKI or CGLX. They claim to have 200 appraisers on staff and 200 exclusive independents. They have a closed wired appraisal process.

o   "Solidifi doesn't own or have ANY data — you can't win long term without big data." - Expert. CoreLogic and Black Knight are the premier data platforms. REAL understands this and is now starting to build and market their data platform.

Ø  Rollup — acquiring most of the growth

o   REAL' first adjacency target was the title & closing market, given its similar network management challenges with ~70% of the market coming from small local professionals.

o   The current base of customers is almost entirely Tier-3 and Tier-4. Despite being the fifth largest provider at the time of acquisition, Linear Title has only ~2.1% market share.

o   History of Acquisitions

o   In 2012, acquired Buffalo, New York Kirchmeyer & Associates to build momentum in the US market and with Tier-2 clients in particular.

o   In 2015, raised CDN$60 million and acquired Ohio-based Southwest Financial Services to add new US customers and access cross-selling opportunities. Southwest was a leading home-equity service provider in the US through mortgage appraisal and flood determination services. The majority of Southwest's revenues were derived from appraisal and title search in the home equity channel. Purchased for $27.9m cash - .65x TTM Rev. of $42.2m or 9x TTM EBITDA of $3.0m.

o   In April 2016, raised CDN $100 million equity financing and made an acquisition in Linear Title & Closing based in Rhode Island. Purchased for $97.9 million including $31.7 million earnouts and $22 million in stock. .70x TIM Rev. of $68.5m or 10x TTM EBITDA of $9.8 million.

Catalyst

The mortgage app business was tracking pretty close to total market in 2018/2019 and then it falls massively behind - like they are struggling to grow in what is a hot mortgage market. On the titles business they were moving pretty close to the market until 2019 when they started underperforming consistently. Additionally, they are going to start lapping really hard mortgage application comps as well which makes timing for this interesting.