Kingstown Capital Boosts Ocwen Financial Stake

Michael Blitzer's hedge fund firm Kingstown Capital has filed an amended 13D with the SEC regarding its position in Ocwen Financial (OCN).  Per the filing, Kingstown now owns 9.97% of Ocwen with over 12.5 million shares (though they have an aggregate economic exposure to 14 million shares due to cash-settled total return swaps).

This is up from the 12 million shares they owned at the end of the first quarter. The filing was made due to activity on August 4th.  The return swaps were purchased on August 4th and 5th at prices of $8.0053, $7.6299, and $7.7450.

The 13D contains the standard activist boilerplate that they may meet with management etc.  Kingstown was the largest reported institutional shareholder of OCN shares as of the end of Q1.

Shares of OCN were hit pretty much all throughout 2014 as regulator Benjamin Lawsky came down hard on the company, forcing its Chairman Bill Erbey to resign, among other changes.  OCN fell from $55 to $15 in 2014 and has continued to fall in 2015 down to current levels of $8.11.  Kingstown initiated their position in the first quarter of this year and has just recently bought more.

As we've highlighted earlier this year, Kingstown was also involved in shares of Home Loan Servicing Solutions (HLSS), another one of the companies that was in Bill Erbey's previous empire.

Per Google Finance, Ocwen Financial is "a financial services holding company. The Company through its subsidiaries is engaged in the servicing and origination of mortgage loans. The Company operates in three segments such as, servicing, lending, and corporate items and other. The Company develops programs, such as Shared Appreciation Modification (SAM) which incorporates principal reductions and lower payments for borrowers while providing a net present value positive loss mitigation outcome for investors, including the ability to recoup losses if property values increase over time."

Lee Cooperman Trims Altisource Portfolio Solutions Stake

Omega Advisors' Lee Cooperman has filed a Form 4 with the SEC regarding his position in Altisource Portfolio Solutions (ASPS).  Per the filing, Cooperman has sold around 262,000 shares.

He was selling on March 16th and 17th at weighted average prices of $16.33 and $15.57.  ASPS has since continued to slide lower and currently trades around $12.73.  We've outlined the ASPS situation here previously.

Per Google Finance, Altisource Portfolio Solutions is "a provider of marketplace and transaction solutions for the real estate, mortgage and consumer debt industries. The Company operates through three business segments: Mortgage Services, Financial Services and Technology Services. The Company offers mortgage services, such as Asset management, Insurance services, Residential property valuation, Default management services and Origination management services. Financial Services provide collection and customer relationship management services to debt originators, servicers and the utility and insurance industries. Technology Services provides software applications and technologies that manage the end-to-end lifecycle for residential and commercial mortgage loan servicing, including the automated management and payment of a distributed network of vendors."

We've detailed other recent portfolio activity from Cooperman here.

Lee Cooperman Starts 2 New Stakes, Adds To 4 Positions, Trims Another

Omega Advisors' Lee Cooperman filed a myriad of amended 13G's with the SEC recently.  Here's the breakdown:


Starts 2 New Positions: Aspen Group & Arbor Realty Trust

The hedge fund manager has revealed newly bought stakes in two companies: Aspen Group (ASPU), an online education company, and Arbor Realty Trust (ABR), a specialized real estate finance company.  Both positions were disclosed due to activity on December 31st, 2014.

Cooperman now owns 7.11% of Aspen Group with 8 million shares and owns 7.53% of Arbor Realty Trust with over 3.77 million shares.


Adds to Altisource Portfolio Solutions, Calls Out Management

Also, Cooperman has filed a 13G, Form 3, and multiple Form 4's with the SEC regarding Altisource Portfolio Solutions (ASPS).  He disclosed an ownership stake of 11.14% of the company with over 2.25 million shares as of December 31st, 2014.  This means he's increased his position by almost a million shares since the end of the third quarter.

The Form 4 indicates that Cooperman bought ASPS shares at weighted average prices of $47.47 and $39.42 on December 19th and 22nd, respectively.

Shares of ASPS currently trade around $22 after the company has been hit with regulatory scrutiny as the New York Department of Financial Services (DFS) came down hard on ASPS's biggest customer, Ocwen Financial (OCN), and in turn ASPS as well.  Both companies were part of Bill Erbey's empire and as part of the settlement with the DFS, Erbey will step down from his posts at both companies.

Cooperman also recently appeared on a company conference call and lashed out at management for poor capital allocation decisions, asking "what I'm trying to figure out to be honest with you ... whether your testicles are bigger than your brains or your brains are bigger than your testicles."

The company bought back a ton of stock at much higher prices (around $104 per share) during the period of regulatory scrutiny, only to see their shares plummet much further down to current levels of around $22. 

Numerous hedge funds have been involved in ASPS and OCN shares and it will be interesting to see who held on through the carnage, who exited, and who might have picked up shares as a distressed play at the end of 2014.  Unfortunately, it will be another 3 weeks until those disclosures (Q4 13F filings) are submitted to the SEC.

At the end of the third quarter, the largest holders of ASPS were Luxor Capital, Omega Advisors, White Elm Capital, among others.  Top OCN holders included Pennant Capital, Highfields Capital, Baupost Group, Kingstown Capital, Own Creek Asset Management, White Elm Capital, among others.  Since the end of the third quarter, OCN is down 72% and ASPS is down 78%.


Adds to Atlas Energy & Atlas Pipeline Stakes

Next, the Omega Advisors founder has been out buying shares of Atlas Energy (ATLS).  Per the 13G filing, Cooperman now owns over 7 million shares (an increase of over 2.9 million shares since the end of the third quarter).

Additionally, he has also increased his exposure to Atlas Pipeline Partners (APL) and now owns over 7.45 million shares (compared to the 3.34 million he owned at the end of the third quarter).


Increases Gulf Coast Ultra Deep Royalty Trust Exposure

Next, Cooperman has disclosed an increased position in Gulf Coast Ultra Deep Royalty Trust Units (GULTU).  He previously owned 16.9 million shares but now owns 22.22 million, an increase of over 5.3 million shares since the end of the third quarter.


Slightly Trims Chimera Investment Corp Stake

Lastly, Cooperman disclosed in another 13G that he has ever-so-slightly reduced his stake in Chimera Investment Corp (CIM) by a minor 168,645 shares.  He still retained a position of over 64.3 million shares at the end of 2014.

For more of Cooperman's recent portfolio activity, head here.

What We're Reading ~ Hedge Fund Links 1/9/14

Love him or hate him, Bill Ackman now runs the top hedge fund [Bloomberg]

Meet the most powerful woman in hedge funds [CNBC]

ValueAct takes swipe at MSCI [FT]

Jeff Gundlach: I just hope the Fed thinks carefully about what it's doing [FUW]

Kyle Bass going after big pharma [Business Insider]

3G Capital eyes next targets [WSJ]

Mohnish Pabrai: I have no original ideas, I am a 100% cloner [Rakesh Jhunjhunwala]

Permanent capital: perpetual cash machines [FT]

Top hedge fund trends for 2015 [FINalternatives]

Tiger Global funds Glassdoor [Glassdoor]

Is something a 'failure' if other successes come from it? [Eddie Lampert]

Tom Brown on Ocwen's abominable deal with New York regulators [Bank Stocks]

What We're Reading ~ Analytical Links 11/5/14

The Misbehavior of Markets: A Fractal View of Financial Turbulence [Benoit Mandelbrot]

What's your investing edge? [Clear Eyes Investing]

Building a personal margin of safety [Abnormal Returns]

Managing someone else's emotions [A Wealth of Common Sense]

On taking losses and the value of survival [Long Short Trader]

A look at Ocwen Financial & Altisource Portfolio Solutions [Doug Kass]

A look at C.H. Robinson [Punch Card Investing]

On Hewlett Packard's break-up [Aswath Damodaran]

First time homebuyers hit lowest in nearly 30 years [CNBC]

On Japan and business vs economics [Paul Krugman]

Underwriting the next housing crisis [NYTimes]

An interview with Google's Larry Page [FT]

How confirmation bias can lead to spinning wheels [NYTimes]

Sears has a deal to offer its shareholders [Bloomberg View]

John Maynard Keynes is the economist the world needs now [BusinessWeek]

The way to make solar energy a hot investment? Make it a boring one [Slate]

Lee Cooperman's Value Investing Congress Presentation: Are Equities Still the Best House in the Neighborhood?

We're posting up notes from the 2014 Value Investing Congress in New York. Next up is Lee Cooperman of Omega Advisors who presented: Are equities still the best house in the financial asset neighborhood?


Lee Cooperman's Value Investing Congress Presentation

• Market is fully / fairly valued. There is time and price left in us equity bull market and a respectable  S&P return expected in 12-18 months. Repeated the caveat that a geopolitical event could upend this prediction

• “Bear markets are born in despair, grow on skepticism, mature on optimism, die on euphoria.” ‘08/’09 was deep pessimism, have seen skepticism lately but we are near the end of that  now. Sees few signs of euphoria

• Nearly all us fixed income securities w/ exception of structured credit are uninteresting and   unattractive. This includes treasuries, investment grade corporates, HY bonds and soverign debt

• Equity markets in Europe and Japan should deliver respectable returns over coming year, could   outperform us as they are further behind in business cycle. Japanese valuations are attractive   because they have a comparable dividend yield but sell at 13.6x P/E vs. 16.8x P/E in US

• Dollar should be a strong currency over coming year

• Looking at average cycles:
o Bear market of ‘09 was 2x the average bear market, down -57% vs. -26% average. Also lasted 17 months vs. 13 month average
o Recession duration also prolonged and deeper than average. The average recession is characterized by -2% GDP and lasts 10 months.  In the '09 recession, GDP declined -4.3% and lasted 18 months
o Average recovery lasts 60 months and we are on slight overtime at 63 months today. 
o Market peaks about 7 months prior to economic peak. Thinks we don't have recession in 2015 so doesn't see a market peak today
o Cooperman thinks this recovery has the potential to exceed the average because so many companies were operating below potential

• Reason for caution:
o Seeing a lot of capitulation from the permabears, now hearing 3,000 S&P predictions from holdouts.  People waking up and getting bullish now are making a mistake
o Getting a little nervous that so many people who couldn’t see the positive outlook a few years ago now see such good opportunity
o Reiterated geopolitical risk multiple times
o Very concerned about income disparity in the economy. 75mm youth around the world are unemployed.  In the '40s an average factory worker made 1/30th of a CEO, now 1/900th
o Next crisis will be in public sector fundings. US government has $17tn debt with an average maturity < 4 years.  Meanwhile corporates have high liquidity and the banking sector is so highly regulated these days that a crisis probably won't come from them
o Another risk: recession/deflation in Eurozone or US
o Stocks also aren't really cheap – showed Buffett’s favorite stock valuation chart

• Regarding rising rates:  o If Fed doesn't raise rates, we have a problem in the stock market. If cash belongs at 0% and govt belongs at 4%, you shouldn't be making 15% in the stock market.  Rising rates should be indicative of an improving economy
o 1958 was the year of yield reversal when equities started yielding less in dividend yield compared to treasuries.  Now over 25% of S&P 500 non-financials yield more than 10yr note
o Relative to alternatives, equities still better. Fixed incomes just not attractive


Longs:  

• GARP: Actavis (ACT), Citigroup (C), Thermo Fisher (TMO)
• Income growth: Atlas (ATLS), Gaming & Leisure Properties (GLPI), KKR (KKR), Nordic American Offshore (NAO) 
• Asset restructuring: QEP Resources (QEP), Supervalu (SVU)
• High risk/high return: Altisource Portfolio Solutions (ASPS), Louis XIII (577 Hk), Monitise (MONLLN), Sandridge Energy (SD).

Cooperman's pick of ASPS was analyzed in the May issue of our Hedge Fund Wisdom newsletter if you want to play catch up on the name quickly.



Be sure to check out the rest of the Value Investing Congress presentations here.

What We're Reading ~ Analytical Links 5/7/14

Charlie Munger's essay on wisdom as it relates to investment management [Ycombinator]

A pitch on Altisource Portfolio Solutions [Value Venture]

Is Barnes & Noble the next Gamestop? [MicroFundy]

Notes on the Outsider CEOs [Student of Value]

Alibaba files to go public in the US [Yahoo Finance]

All the western companies you'd have to combine to get something like Alibaba [Quartz]

US home ownership rate falls to lowest since 1995 [Bloomberg]

The financial vulnerability of Americans [House of Debt]

Why has student debt increased so much? [Vox]

Tax avoidance: the Irish inversion [FT]

Pay TV field could shrink with AT&T interest in DirecTV [LA Times]

As Netflix resists, most firms try to befriend Comcast [NYTimes]

On online video ads [NYTimes]

On the world of peer to peer lending [NYTimes]

Warren Buffett didn't belch at Coke pay plan [Bloomberg]

Steve Eisman on Ocwen Financial & Altisource Portfolio Solutions: Invest For Kids Chicago

Next up in our notes from Invest For Kids Chicago 2013 is Steve Eisman of Emrys Partners.  He pitched two ideas: Ocwen Financial (OCN) and Altisource Portfolio Solutions (ASPS).


Steve Eisman's Presentation at Invest For Kids Chicago 2013

•    His big trade is detailed in Michael Lewis' book, The Big Short
•    “Time to up meds” after Gundlach’s presentation
•    Been analyzing financial companies for over 20 years
•    This cycle is different
•    Discussion of regional banks
•    Past cycles when you come out of recession, the loan book gets better, then loan books expand
•    Credit quality has gotten better and there is no loan growth and the Fed is not going to raise rates anytime soon
•    Assumes US growth to be 2%
•    Looking for secular growth stories bc he doesn’t want to trust US growth
•    Looking specifically at mortgage sector


•    Idea #1: Ocwen Financial (OCN): Best story in financial services
o    Servicing of current mortgages and everything else
o    Servicing of everything else requires a human
o    Banks lose money servicing mortgages and so the shift is going away from banks and towards mortgage servicing companies such as Ocwen
o    Key is that it enjoys a 70% cost advantage over anyone else due to moving servicing to India
o    Earnings have gone up 7x since 2010 and still in middle innings
o    Another trillion of mortgage servicing rights to be transferred in the next few years (Ocwen has $400 billion pip by themselves)
o    Cash generation is huge: 16% 2014E Free Cash Flow Yield (not to mention 50% growth)
o    50% upside in the next year or two assuming no multiple expansion
o    And multiple expansion is definitely possible

Eisman pitched Ocwen at the Sohn Conference in New York as well earlier this year.


•    Idea #2: Altisource Portfolio Solutions (ASPS) 
o    Stock price of $144.8
o    Spun out of Ocwen and now have three businesses
o    Key to story is massive diversification
o    Growth is 42% year over year for Q3 2013
o    Hubzu is a part of mortgage solutions biz – until recently
o    Can buy a house online and is 15% of earnings of company
o    Zillow doesn’t own MLS system
o    70% ROE and PEG ratio of 0.34x
o    Covered by one sell side analyst
o    3 questions were asked on recent call and one sell side guy asked 2 questions
o    Hubzu has revenue of 35% of Zillow and Zillow is a $3 billion company 

We've posted an in-depth analysis of Altisource Portfolio Solutions for those interested


Check out the rest of the hedge fund presentations from Invest For Kids Chicago here.

Investment Thesis on Altisource Portfolio Solutions (ASPS)

The following is a guest post from Glenn Chan who is passionate about investing and maintains a blog at glennchan.wordpress.com.  He is based in Toronto and is currently looking for a position as a junior analyst.  He can be contacted at: glennchan [at] gmail [dot] com


Investment Thesis on Altisource Portfolio Solutions (ASPS)

Altisource is a rapidly-growing business that is riding the trend of financial companies outsourcing their mortgage servicing.  The process of servicing mortgages has become more complex as the US government continually adds more regulations to protect homeowners from foreclosure.  The cost of complying with government regulations and creating automated systems to handle mortgage servicing is mostly fixed.  These economies of scale will likely push the industry towards consolidation.

Altisource has grown its revenues per share by an incredible 36%/year from 2008-2012 (historical stats) and currently trades at a P/E ratio of 21.6 (at $97.36/share).  Its growth next year is practically guaranteed due to its unique relationship with Ocwen Financial (OCN).  ASPS' forward P/E is roughly 11.8 (according to Yahoo Finance).  I believe that Altisource is the best managed mortgage servicer in its field. 


History and Financial Structure

Altisource spun off from the parent Ocwen in 2009.  Altisource contains the “good” high-margin businesses while Ocwen is the “not as good” business with lower returns on capital.  Interestingly enough, the CFO at the time (Robert D Stiles) chose to jump ship and join the smaller company.  I’m guessing his stock options have done well since Altisource shares are up 508% since the spinoff.

Normally one would stay at the larger company as it is likely to pay a larger salary.  He had the foresight to jump ship to the rapidly-growing Altisource.  As the CFO, he structured Altisource as a Luxembourg company so that Altisource would save money on taxes.  I personally think that he is a very smart guy.  Unfortunately, he resigned on Feb 22, 2012.  Some of the clauses in his separation agreement suggest that he and his bosses had disagreements.  For example there is a clause that states: “The undersigned Managers agree not to disparage Stiles.”  I suppose I won’t know what happened.

One key aspect of the spinoff is that Ocwen has to use Altisource’s services.  This means that whenever Ocwen sells shares or raises debt to buy mortgage servicing portfolios, it brings business to Altisource.  Altisource does not have to spend money on attracting this new business.  And of course it grows when Ocwen grows.  The financial structure also allows Ocwen to grow very quickly through selling stock, allowing both companies to enjoy economies of scale.  If the endgame of the mortgage servicing industry is ‘survival of the biggest’, Ocwen and Altisource are well positioned.  Unlike Ocwen, Altisource will not face share dilution.  Altisource is buying back its shares, not selling them.


The Other Spinoffs and IPOs

William C. Erbey is the chairman of Ocwen and Altisource.  His empire has since expanded into even more companies.  Home Loan Servicing Solutions (HLSS) is an new company that raised funds in an IPO.  It will focus on owning mortgage servicing rights (MSRs).  HLSS use services from Ocwen and Altisource at cost plus a 15% markup.

Altisource split up into three stocks, of which there are four important entities:

ASPS - The parent company.

RESI - Altisource Residential.  RESI’s business model is to (A) buy and manage portfolios of non-performing and sub-performing mortgages and (B) rent out the homes they get stuck with whenever foreclosure cannot be avoided.  This is a new venture that has no operating history.  ASPS will benefit from growth in RESI as ASPS will provide services to manage RESI’s real estate.

AAMC - Altisource Asset Management.  AAMC is RESI's asset manager and is entitled to payments from RESI based on the level of RESI's dividend payments.

NewSource Title Reinsurance.  NewSource will provide title insurance services to Altisource/ASPS and RESI.  The financial structure is very tricky as all three companies have different positions in its ownership structure.  AAMC will invest $2M in NewSource equity while RESI will invest $18M into NewSource non-voting preferred shares (12% dividend).  ASPS will provide services to NewSource under a Title Insurance Services Agreement.  ASPS will receive 90% of NewSource’s net income after “NewSource pays Residential a preferred dividend of 12% (which is an annual cumulative rate)”.

RESI will receive a 12% dividend yield... this is a good return.

AAMC will receive $840K (adjusted by CPI) in management fees from NewSource plus 10% of net income.  This is a very high return for a $2M investment.  Net income will likely consist of returns from the insurance float and profit from title insurance/reinsurance, which has extremely high margins.  When homeowners buy a house, they typically go with the mortgage originator’s recommended title insurance company.  They overpay for title insurance because:

1. They may not know any better.
2. Compared to the cost of the house, title insurance costs very little.
3. They may not want the inconvenience of shopping around for title insurance.  A different title insurance company can lead to paperwork delays.

ASPS is the loser in this deal in my opinion.  ASPS will be directing its profitable title insurance/reinsurance business towards NewSource where RESI and AAMC will take their cut.  NewSource is expected to have a “steady stream of title insurance and reinsurance sourced by Altisource through its relationships with Ocwen and Lenders One, a national alliance of leading community mortgage bankers, correspondent lenders and suppliers of mortgage products and services” (see AAMC’s filings).

OCN, RESI, and HLSS will likely continue to raise capital and continue to do secondary offerings.  They will drive more business towards ASPS and AAMC.


Following the Money

Overall, Erbey's stock ownership looks something like this:

1. Altisource Asset Management (AAMC): 30.1% according to this 13D filing
2. Altisource (ASPS) – 25.4% (5,935,343 shares / 23.36M shares outstanding)
3. Ocwen (OCN) – 13.2%
4. Altisource Residential (RESI) – 9.9% after the secondary offering closes according to this 424B1 filing
5. Home Loan Servicing (HLSS) – 2.8%

Based on these ownership figures, AAMC and ASPS are the stocks to own.

Erbey owns a larger portion of AAMC than ASPS due to unvested restricted shares.  The 3-way split of ASPS/RESI/AAMC may have been designed to be beneficial to Mr. Erbey as he increased his ownership of the most desirable spinoff.  However, AAMC is quite overvalued at the moment so I am not interested in it.


Institutional Ownership

(This section by MarketFolly): Numerous hedge funds have been involved in OCN and we posted up how Steve Eisman pitched OCN at the Ira Sohn Conference.  Additionally, OCN has been analyzed in past issue of our Hedge Fund Wisdom newsletter.

Turning to top institutional owners of ASPS, Omega Advisors' Lee Cooperman is one of the largest owners of ASPS (he also owns OCN).  In a recent interview he said he likes both as housing proxy plays.

Other top holders of ASPS at the end of Q1 included Matt Iorio's White Elm Capital.  Prior to founding White Elm, Iorio worked at Steve Mandel's Lone Pine Capital.  Like Cooperman, Iorio owns both OCN and ASPS (and both were top 5 holdings at the end of Q1).

In White Elm's Q2 letter, they note:

"Altisource now trades at 10x 2013E consensus earnings per share.  Investors appear to be discounting (1) a material decline in foreclosure activity and (2) ongoing payments from Altisource to help fund Ocwen's future acquisitions.  These concerns are perplexing given that Ocwen's growth has virtually guaranteed a large pipeline of foreclosed properties for Altisource over the next three years and the non-default businesses are growing rapidly.  Over the next three years, we expect Altisource to grow earnings per share at a compound annual rate of nearly 40% and generate approximately $30 per share in free cash flow (or almost 40% of its current market value).  Based on our earnings growth expectations and assuming a modest multiple of 12x 2015E EPS, we believe our road-map to a three-year double with Altisource is achievable."

Quant firm Renaissance Technologies is also one of the top holders at of the end of Q1, though the position size was only a miniscule portion of their overall portfolio.  We won't see who the top holders as of Q2 were until mid-August due to SEC delay rules.  Now back to the rest of Glenn's writeup:


Industry Overview

The Mortgage Lifecycle

On a mortgage, the lender has to handle paperwork and mortgage payments.  If the homeowner is late on payments or stops paying entirely, then the lender has a lot more work to do.  The lender may try to negotiate with the homeowner to get back on track with paying their mortgage.  It may try to get the homeowner to participate in government programs designed to keep people in their homes (in the wake of the subprime housing crisis there are a lot of these programs).  It may try to work with the homeowner on a short sale to avoid the costs of a foreclosure.

Some mortgages will end up in foreclosure.  There are many laws and regulations designed to protect homeowners during the foreclosure process.  Lenders have compliance costs in making sure that they follow all laws and regulations.  After the lenders initiate the foreclosure process, things get really messy.  Ex-homeowners often completely trash the property and may steal appliances, wiring for scrap metal, etc.  Before the property is ultimately sold to a retail consumer, the property will need to be cleaned up and repaired.  Some people squat in their home and may return to it even after they are kicked out; this can sometimes create scary situations for others who are cleaning up the property.  Some lenders don’t want to deal with foreclosure-related problems so they will sell houses to investors for them to fix.  These houses are often sold at large discounts.  Or, they may pay fees to companies like Altisource to clean up the property.  As an alternative, the lender could hold onto the property and rent it out (this is Altisource Residential’s business model).

Mortgage servicers may handle some or all aspects of the mortgage lifecycle.  Some aspects of the mortgage lifecycle are very open-ended and create opportunities for adding value.


Ocwen/Altisource's Performance

A WSJ article makes the following points about Ocwen/Altisource:

- It "has won praise from consumer advocates for its willingness to re-work mortgages and help struggling borrowers stay in their homes".
- The vast majority of its labour force is in India and offshore.  While this lowers costs, there are some concerns about protection of personal data and regulatory compliance.
- It has many offshore incorporations to keep taxes down.

Ocwen/Altisource tries to automate as much as possible.  For example, delinquent mortgagers are sent multiple letters and a DVD explaining the situation (e.g. how to apply to HARP).  This saves time from having a call center employee repeat information to mortgagers.  However, there is still a need for trained call center workers as not everything can be automated.  On Ocwen’s website there is a Morningstar “Operational Risk Assessment” report that contains a lot of detail on Ocwen’s operations.

As for foreclosures, Ocwen/Altisource tries to minimize its sales commissions by running its own real estate portal (Hubzu) and offering real estate agents lower commissions.  Moving away from the traditional MLS models allows Ocwen/Altisource to lower their costs.  Not surprisingly, real estate professionals complain about this (see complaints about Hubzu/gohoming.com/Ocwen/Altisource on pissedconsumer.com).  For activities that require a human touch, Ocwen/Altisource is not perfect.  The complaints page on pissedconsumer.com does suggest that Ocwen/Altisource employees do make mistakes.  The webpage also suggests that Hubzu has a problem with fake bids.


Does Altisource Enjoy a Competitive Advantage?

Labour arbitrage:  I don’t know why but it seems that Altisource’s competitors have not set themselves up to use offshore labour.  Publicly-traded competitors such as Walter Investment Management (WAC) and Nationstar (NSM) only employ Americans.  Outsourcing labour to foreign countries is a difficult problem.  The problem is difficult enough that there are publicly-traded companies which specialize in it (G, CTSH).

Software:  Starting a successful software company is very difficult.  One of the hardest things to do is finding great programmers.  Joel Spolsky (he runs his software company) has a blog post that explains why the process is difficult.  Simply running a software company is very difficult by itself.  It’s even more difficult if you add in the complications of running a foreign operation.  My opinion is that the labour arbitrage is very difficult to pull off.  I don’t know how well Altisource has pulled off its labour arbitrage.  However, Altisource is highly profitable and has many job postings for Indian programmers/developers.

Business processes: Altisource is much better than its peers at working with delinquent mortgagers at restructuring loans.  I don’t know how easy/hard it is to duplicate this.

Overall, I don’t think that Altisource’s high margins are based on a single thing.  It is a combination of many things that they do well.  The Morningstar report referred to earlier “Operational Risk Assessment” provides a lot of insight into the many things that Altisource is doing.  Some of their practices seem to require hard-won experience.  Altisource takes many steps to prevent payment processing employees from stealing (e.g. video surveillance, no drawers in the room, etc.).

Scale:  I believe that scale gives a minor cost advantage.  Ocwen/Altisource is not the largest mortgage servicer however.  This Reuters article states that big banks such as BAC, Wells, Ally, JPM, and C are the leading mortgage servicers.  All five of these banks paid settlements over robo-signing… this suggests that they are not very good at mortgage servicing.  All these banks let ex-homeowners squat in their own homes without paying their mortgages for years during the subprime housing era (including Wells Fargo, a Warren Buffett favorite).  I think that Altisource is well-positioned against these larger mortgage servicers.  Ocwen has bought Ally’s Rescap unit and Goldman Sach’s Litton Loans.

Relationship with Ocwen:  Altisource’s relationship with Ocwen has been hugely beneficial for Altisource since Ocwen is a captive customer.  Better yet, Ocwen has been continually issuing equity and increasing its assets.  Altisource has been growing without having to spend advertising/marketing money to get more business from Ocwen.  However, Altisource would still do extremely well without Ocwen.  Ocwen’s share of Altisource’s mortgage services revenues has been declining as organic growth from non-Ocwen customers has exceeded Ocwen’s growth.  The 10-K provides relevant figures:

In 2010, related parties accounted for 73% of Altisource's mortgage services revenue.
In 2012, related parties accounted for 68% of Altisource's mortgage services revenue.


The Future of the Mortgage Servicing Industry

My guess is:

1. The major banks will get out of mortgage servicing and outsource.  They don’t seem to be very good at it (e.g. robo-signing)… engaging in illegal activities suggests incompetent management.

2. The trend towards outsourcing mortgage servicing will continue.  I think that this financial innovation does create value as companies that specialize in it have done a better job than the vertically-integrated operations of major banks.

3. The industry will consolidate into fewer players.  The cost of regulatory compliance will limit the number of new competitors.

4. My thinking is that Altisource has executed very well compared to industry peers such as Wells Fargo.  Altisource didn’t allow squatters to live rent-free for years.  It didn’t engage in robo-signing.  And it isn’t facing a litany of lawsuits for improper behaviour (simply go Google “Wells Fargo mortgage lawsuit“).  In one instance Wells Fargo, the judge characterized Wells Fargo’s behaviour as “highly reprehensible” and issued a $3.1M fine.

5. Out of the publicly-traded mortgage servicing-related stocks, I think that Altisource (ASPS) will do better than Ocwen (OCN), Walter (WAC), and Nationstar (NSM).  Its share price has certainly outperformed its peers.

Does Management Have Integrity?

Operationally, I think that the company is very ethical.  They have not done anything illegal such as robo-signing.  And they work hard to keep mortgagers in their homes.

As far as management goes, one could make some arguments against Mr. Erbey’s ethics.  Some articles in the press have commented negatively on the fact that Ocwen overpaid for Bill Erbey’s Atlanta multimillion dollar home.  (An 8-K filing shows that Ocwen paid $6.5M.)  However, people deserve to be fairly compensated when they have to relocate for employment.  Mr. Erbey can’t exactly enjoy his Atlanta home while working in the US Virgin Islands.  The 8-K states that he will be working on setting up Ocwen Mortgage Servicing, a new subsidiary.  AAMC is also headquartered in the Virgin Islands while Altisource is headquartered in Luxembourg.

As far as the ASPS/AAMC/RESI spinoff goes, the spinoff slightly enriches Mr. Erbey due to his restricted stock grants at AAMC.  It’s kind of sneaky that Altisource is funneling profits into NewSource, of which AAMC will likely be the greatest beneficiary.  A small amount of wealth may be transferred from Altisource to AAMC.  Erbey will own more AAMC than Altisource.  Overall however, Mr. Erbey compares favorably to John Malone.  Malone’s spinoffs are far more complicated and craftier.  Malone takes steps to goad institutional investors into making mistakes; Erbey has not done that.

As far as insider compensation goes, it is reasonable.  According to the SEC filings, the directors range in compensation from $52,900 to $162,990 (Mr. Erbey is the highest-paid director).  William Shepro, the CEO, has had his compensation range from $1.4M to $4.4M.  His Altisource shares are worth about $30M ($96.16 X 311.327 shares) so he has plenty of skin in the game.  The level of compensation paid to insiders doesn’t seem that out of line compared to other public companies.  I believe that the value management has created far exceeds their compensation.


Accounting Tidbits

The depreciation method used by Altisource is fairly reasonable if not on the overly conservative side.  Most of Altisource’s fixed assets consist of computer hardware and software.  These are depreciated over 2-3 years.  It is highly likely that Altisource continues to use computer hardware and software that is over 2-3 years old.  These assets would be carried at a value of 0 yet have a market value slightly above that.  Altisource’s accounting looks very reasonable to me and I do not see any signs of overly aggressive accounting.  Unlike other companies, Altisource does not capitalize any internal software development costs.  (Capitalizing software costs will increase reported profits.)


Hidden Assets

The relationship with Ocwen is arguably very beneficial to Altisource.  In the short term, Altisource is guaranteed to grow as Ocwen has significantly increased its loan base.  Altisource owns Hubzu.com (formerly GoHoming), which is an online real estate portal.  The site is being opened up to third-party listings.  In theory, this property can provide serious competition to the traditional real estate model and their MLS (multiple listing service) systems.  This could potentially turn into a business with very high returns of equity if it becomes more popular.  Hubzu has many competitors in this space including RedFin.  Management may try to IPO Hubzu given that other Internet companies have been fetching high valuations in the past few years.


Hidden Liabilities

As discussed before, the deal with NewSource funnels some value out of Altisource.


Other Deals Between Altisource and Ocwen

Altisource has used $200M of debt (maybe around 2 years worth of earnings) to buy servicing businesses from Ocwen.  Ocwen acquired those businesses when it made its large loan portfolio acquisitions.

Considering that Mr. Erbey owns a greater percentage of Altisource than Ocwen, this deal will likely be fair to Altisource shareholders.


Capital Allocation

Altisource has stated their share repurchase policy in their 10-K:

"We seek to deploy excess cash generated in a disciplined manner. Principally, we will continue to reinvest excess cash in developing compelling services that we believe will generate high margins. In addition, we may seek to acquire a limited number of complementary companies that fit our strategic objectives. Finally, given the tax inefficiency of dividends, the low returns earned on cash held and our current belief to pursue a limited number of acquisitions, we believe one of the best ways to return value to shareholders is through a share repurchase program."

For the most part, they have done what they said they would do.  Altisource has been buying back its shares at prices lower than the current market price.  However, the part about “the tax inefficiency of dividends” doesn’t entirely make sense.  The ASPS/RESI/AAMC spinoff can be seen as a ‘tax inefficient dividend’ and caused shareholders to pay taxes right away.  It was not structured in a way that deferred taxes.  On the other hand, the spinoff should work out fine.  RESI was able to raise a very large amount of capital, driving new business to Altisource.  This will likely compensate for the tax inefficiency of the spinoff.


The Big Picture

Warren Buffett wrote in his 1989 letter to Berkshire shareholders:

"It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.  Charlie understood this early; I was a slow learner.  But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements."

I think that Altisource satisfies both criteria of a first-class business and a first-class management. It should be a business that will be able to compound capital at high rates for a very long period of time.

I believe that the mortgage servicing industry has good economics.  It does not have the boom/bust cycles of commodity industries.  And it does not face the risk of a technological shift that makes the industry obsolete (think phone book directories, bricks and mortar stores that compete directly with Amazon, etc.).  On the other hand, mortgage servicing is a very tough field considering that the major banks have done a bad job at it and had to pay settlements.  They may be trying to sell their mortgage servicing businesses because they are losing money at it.

Altisource’s management is excellent.  However, if management were to leave, I’m not sure if the company will continue to do as well.

Overall, I see Altisource as a very attractive growth business with low risk and a reasonable valuation.


Other Considerations

ASPS Versus AAMC

In theory, AAMC is ‘better’ than ASPS because ASPS is structured to drive title insurance business towards AAMC (in the same way that OCN drives business towards ASPS).  However, AAMC’s current valuation is ridiculous.

AAMC’s main assets are:

1. 10% of NewSource’s profits.
2. An agreement that entitles it to management fees from RESI.

At $270/share, AAMC’s market cap is a $632M.
At $17.55/share, RESI’s market cap is $400M (22.8M shares after the secondary offering).
At $96.16/share, ASPS’s market cap is $2,228M.

For $400M, you can buy RESI outright.  So #2 can’t be worth more than $400M.  This implies a valuation of >$232M for #1.  If 10% of NewSource’s profits is worth >$232M, then NewSource in its entirety would be worth >$2,320M.  >$2,320M is more than Altisource’s entire market cap.


Erbey's Insider Trading

Looking at Erbey’s trades, he has made small sales of ASPS and OCN while he has been making small purchases of HLSS.  I am not going to read too much into these sales and purchases.  Erbey had legitimate reasons to sell stock as he needed to pay taxes on the ASPS/AAMC/RESI spinoff as the spinoff was not structured in a tax-efficient manner.  Erbey also needed money to startup HLSS as he invested $10M in the HLSS IPO.  Underwriters like to see that company insiders have some skin in the game as it aligns their incentives closer to that of shareholders.  (Of course if investors were smarter they would probably just buy ASPS instead.)  Erbey’s open market purchases of HLSS helps to promote the stock and helps HLSS in raising capital.

Overall, I think that Erbey’s ownership of ASPS and AAMC will increase over time while his ownership of RESI, OCN, and HLSS will decrease over time

*Disclosure:  Long ASPS.  Not long AAMC, RESI, HLSS, OCN at time of write-up.


Thanks again to Glenn Chann for the write-up.  He is based in Toronto and is currently looking for a position as a junior analyst.  He can be contacted at: glennchan [at] gmail [dot] com

What We're Reading ~ Analytical Links 6/5/13

The new R&D: Repurchases and dividends [Reformed Broker]

A macro update [Micro Fundy]

The long case on Altisource Portfolio Solutions (ASPS) [Seeking Alpha]

A look at Charter Communications (CHTR) [Brooklyn Investor]

Jeff Gundlach: short Chipotle and avoid everything Apple [Covestor]

Beware the hidden costs in tech [Barrons]

A bastardization of the process [Research Puzzle]

Buffett's Berkshire buys small Virginia newspaper [CNBC]

Harvard's Kaplan says to succeed know what you want [Bloomberg]

Mavericks lecture: Liberty Media's (LMCA) John Malone [Youtube]

The power of habit investments [Zen Habits]

Ben Graham's "foolproof method of systematic investment" [Greenbackd]

It's time for objectors of Bank of America's MBS deal to make their case [Reuters]

Prince Alwaleed and the curious case of Kingdom Holding Stock [Forbes]

An 18-minute plan for managing your day [Harvard Business Review]

On money and happiness [Harvard Gazette]

Lee Cooperman at the Skybridge Alternatives Conference (SALT 2013): Stockpicks & Market Thoughts

We wanted to highlight some notes from the Skybridge Alternative Conference, a.k.a. SALT 2013 taking place in Vegas this week.  Lee Cooperman of Omega Advisors gave his thoughts on the market and some of his holdings.


Market Thoughts From Cooperman

Cooperman says the market might be a little ahead of itself, the economy is limping along.  He doesn't see a reason for the market to decline a lot and says the only two ways that would happen is 1. a recession and 2. the market getting too frothy and the Fed removing quantitative easing.

The Omega Advisors man argued that the economic cycle could be longer than usual and also noted that many investors have de-risked since the financial crisis.  That said, he feels the market is ahead of the fundamentals.


Cooperman's Stock Picks

When asked where he would put new money to work today, he said he'd look to add to existing positions in his portfolio and singled out Monitise in the UK.  We highlighted Cooperman's Monitise stake before as it's a mobile wallet platform.

He also revealed he's been buying an engineering and construction firm Technip, involved in LNG platforms and after exiting Apple earlier, he's dipped back in around the low $400's in a "small size" position.

The Omega founder was asked about housing plays and noted he's missed the homebuilder trade, but has exposure via proxies like Ocwen Financial (OCN) and Altisource Portfolio Solutions (ASPS).  This week at the Ira Sohn Conference, Steve Eisman pitched OCN as a long.

Cooperman also touched on some other of his holdings that are trading below book value that he thinks are attractive:  American International Group (AIG), MetLife (MET), and Citigroup (C).

Omega also owns Facebook (FB) and they think people are underestimating the mobility opportunity and can achieve a much higher multiple.

At the SALT Conference, Cooperman was on the best ideas panel as well and said he likes Express Scripts (ESRX), the pharmacy benefit management company and Transocean (RIG), the deepwater driller.

Embedded below is a clip of Cooperman on CNBC from the SALT conference:



Lee Cooperman was named as one of the top 10 highest paid hedge fund managers of 2012.

Leon Cooperman on Bonds, Stocks, and Apple vs. Research in Motion

Leon Cooperman of hedge fund firm Omega Advisors yesterday sat down with Bloomberg Television to talk about the markets, his portfolio, and what he likes/dislikes at this juncture.

On Treasuries:

Cooperman said that, "I have great confidence the Fed is ultimately going to get their way. The Fed is trying to elevate asset prices, help consumption, help the economy and in two-three years time, we will be worrying about inflation and interest rates will be materially higher. An instrument that I have absolutely no interest in - the most widely traded instrument in the world - is US government bonds. I don’t think people understand how risky a US government bond is at 2% return."

On Equities:

After bashing government bonds, Cooperman also examined the potential of investing in high yield bonds but dismissed them as fully priced. So he turned to equities and said that, "the S&P, which is 13 ½ earnings, yields a bit over 2%, 10% below the historical multiple at a time when interest rates are below historical and you can find lots of cheap stocks out there that will yield more than bonds today that are good companies that will grow over time."

This is largely in line with what the hedgie has been preaching for sometime now. We've highlighted in the past his trademark phrase that equities are the best house in the financial asset neighborhood.

On Apple (AAPL) versus Research in Motion (RIMM):

The Omega Advisors founder thinks Apple (AAPL) is worth north of $600. On Research in Motion (RIMM), he notes that, "It's funny, it was really like a mass hysteria. We put about a half of one percent of our assets into RIM late last year on a theory that they had a revenue base that was being mispriced by the market. Which was 20% of what we had in Apple, we've owned Apple now for a long time, and we continue to own a big position, so we had five times more Apple investment than RIM."

He says they sold RIMM due to stop loss discipline, but he admits that it's still intriguing. David Einhorn's hedge fund Greenlight Capital recently bought shares of RIMM, as highlighted in this free excerpt from our newsletter.

Cooperman also mentioned that he likes gold, Qualcomm (QCOM), JPMorgan (JPM), Bank of America (BAC), Altisource Portfolio Solutions (ASPS), Unitedhealthcare (UNH), WellPoint (WLP), Boston Scientific (BSX), Echostar (SATS), and Dish Network (DISH).

Embedded below is the video from Cooperman's interview with Bloomberg TV:



For more from this hedgie, you can view Cooperman's presentation on risks to the equity outlook.