We have a lot of new readers here, so let me reiterate the house rules.
Q3 2019 hedge fund letters, conferences and more
- I am not your financial advisor
- I don’t know why you bought or sold something. If you choose to buy something I write about, do your own work. NEVER rely on me
- If something goes down, I often have no idea why. Small-cap stocks are volatile. Get used to it
I put considerable effort into writing this blog, because I want to solicit feedback on positions. AiC has become my very own “expert network” which gives me a competitive edge against funds that are many times my size. I get dozens of brilliant emails each week from people who know these industries. I pass along my learnings to everyone when I feel it is appropriate—this is an open-source operation. Hopefully, you’ve made a bunch of money off the stuff I’ve written about. In return, I ask that when I write about something that you, your friends or relatives know something about, please reach out to me and share your knowledge. If you have comments, questions or corrections about something specific, I’m always happy to listen and answer. I genuinely learn from your questions and there’s almost no such thing as a bad question or comment.
At the same time, please don’t send me questions about why a stock dropped, what I thought of earnings, if I’m buying or selling or what a press release meant. I’m not your financial advisor—remember? If you don’t know what something means and don’t try to learn on your own, I can’t do your work for you. “Kuppy, what do you think of XYZ that just got announced,” is the sort of question I will no longer answer.
I’m on vacation—show some respect. (See the last post).
I got over a hundred silly questions on Altisource (ASPS – USA) in the last 3 days. Let me be clear; I don’t know why it dropped. The earnings seemed benign to slightly better than I had expected. Clearly the market disagrees. You can use this to your advantage, or you can sell here. I’m not here to make a judgement call on which is better. I have not made a single trade since earnings.
My model is simple. All numbers in millions
$66.4 TTM Adjusted Operating Income
+$7.8 because OCN is a messed-up muddle on sending cases and it’s probably more like $10m b/c June was similar
+$25 annualized VC losses (was $19 in first 9 mos)
+$9 from cloud migration savings (it’s a 2H event but I’m annualizing)
+$10 of “project catalyst” run-rate savings (probably very conservative as they guided to $65-90 million in savings with half taking effect in 2019)
Forward Adjusted Operating Income is $118.2 million.
Now adjust this for NRZ/OCN revenue going lower and other clients increasing. Adjust this for what you think defaults do in 2020. If you think defaults comp lower, this isn’t your stock. The likely range of estimates is some number between $90 and $140 million. (Yeah, my low-end is below mid-point because I’m trying to be conservative).
Assuming $118.2 million of Forward Adjusted Operating Income, I assume $200 million average debt (sell $40m of RESI and pay down $55m through cash flow) at 6% interest rate, is $12 million. That gets you $106.2 million pretax adjusted income. (Yea, RESI pays dividends and I’m ignoring the netting).
Now apply a 21% tax rate.
BOOM!! You have your model. Please, stop asking me to do your work. It’s all there. Management didn’t make this math idiot-proof in the press release—probably because they want to buy back as much stock as cheaply as possible. If that bothers you, go sell.
Returning to the questions I’ve received; if the stock dropping 30% leads to an epiphany that Bill Erbey owns stock, don’t bother telling me. Google him; he may have crossed some grey lines related to mortgage defaults—he never hurt shareholders. His ownership isn’t a new fact. If you’re suddenly stunned that one entity is more than half of EBIT, I’m sorry, I was pretty clear that they were “handcuffed to a potential corpse.” Could I be any clearer about my opinion here? Those two and many other concerns are why it’s cheap. Look, I mostly invest in stuff with hair. You think Aimia was clean and easy? Think shipping has good corp. governance? I bought JYNT when it had cash reserves to make it 9 more months at TTM loss rates. Viamed was effectively spun out of a fraud. Why else do you think it was trading at three times forward earnings? Super high ROIC businesses, growing like mad, aren’t usually that cheap. I know the problems with what I invest in. I tend to dumpster dive. The rather obvious flaws are what keeps others from digging in and seeing value. You don’t get multi-baggers on easy stuff—there are too many smart people watching the markets. If you want an easy one, buy Berkshire. If you’re short Altisource, fine, be short. I don’t care. Please, tell me what isn’t obvious here. Don’t repeat what a first-year analyst would tell you. Hypothetically; say Ocwen goes bust tomorrow, do you think they can just cancel the Altisource contracts? Default mortgage servicing is one of the most regulated industries in America. The transition costs would make it impossible for debt-holders to find a new servicer. Now prove me wrong—instead of telling me what is obvious. Meanwhile, Ocwen keeps ticking along in a state of semi-purgatory. If interest rates go up, Ocwen lives, maybe even thrives. I think rates are going higher. Yeah, that’s contrarian too. I think Altisource potentially has the most upside of anything I own—also potentially the most risk as well. On the upside, why can’t it be a few hundred a share if mortgage defaults pick up ever so slightly? Prove me wrong.
Back to the math at hand; I’m using $100m of adjusted pre-tax FCF for next year. Why? Because it’s a big round number and I think it’s a bit conservative compared to the math above. Will I be right? Of course not. The gap between potential outcomes is large enough to float a VLCC through. That’s why this opportunity exists. If you could model it, it would be priced fairly. For that matter, I usually invest near inflections. I take a leap of faith that I’m risking small to have huge upside. My models are abstract, vague and somewhat pointless in the big picture. Either there’s value or there isn’t. It’s that simple. I don’t let the short-term price action in an illiquid stock change my opinion.
I think an asset light service provider that is inflecting better is worth fifteen times pre-tax cash flow. That would be $1.5 billion or just under $100 a share. Last cycle, these guys had a few hundred million a year in EBITDA for multiple years. While the overall portfolio they manage has shrunk, so has their cost structure. Why can’t they substantially exceed $100 million a year in cash flow in a good year? Could this go to a few hundred a share with a moderate uptick in defaults?
In summary, absolutely nothing has changed in the week since earnings. If anything, things seem better than expected on the business front. More importantly, they seem committed to simplifying the business.
On a final note; I am not a big believer in betting on short squeezes or anything of that nature. However, it’s probably worth noting that excluding a few large owners and insiders who are highly unlikely to sell shares (along with index funds who own it by default) the float is 3.4 million shares. There are 1.8 million shares short and the company keeps buying back about .3 million shares a quarter. Basically, there’s 1.6 million shares of excess float left for the shorts to buy back before they’re forever trapped. That’s a mere 5 quarters from now at the current buyback pace. In fact, it’s probably less as owners like myself don’t intend to sell at anywhere near today’s prices. Add myself and some friends and there are less shares of available float than the 1.8 million of shorts. Very soon, the shorts will be hopelessly trapped. Basically, the share price ought to solve itself before too long, just through the buyback, unless the cash flow shuts off for some reason. This isn’t an investment thesis and those who play short squeezes often get it wrong, but I’m giving some basic math here as it seems compelling for why the shares can re-value—even without a recovery in mortgage defaults.
Readers of this site freaked out early in 2018 when Aimia had a confusing press release. A lot of people who didn’t understand the value sold and forced it lower than it probably should have gone. Six months later, it had tripled. I feel like a similar thing is happening where selling begets selling out of fear and confusion. If you don’t know what you own and why you own it, please don’t buy it. If you disagree with this analysis, please let me know and I’ll share it with everyone. I hope we’re clear. This is a journal of what I’m doing. I don’t care what you’re doing.
With that out of the way I’m off to drink a few more glasses of English Harbour and jump back into the ocean. Stop emailing me, unless you live in the Caribbean and want to buy me a drink. In that case, I’ll be making the rounds…
If you enjoyed this article, subscribe for more at http://adventuresincapitalism.com
Disclosure: Funds that I control are long shares of ASPS
Article by Adventures In Capitalism
