Description

Thesis summary

I believe CLGX is a classic spin-off opportunity. It is relatively unknown as a recent spinoff, it is a great business, and it is attractively priced off of what I believe are cyclical trough numbers despite significant secular growth prospects at high returns on capital.

FAF was previously written up twice on VIC. I recommend reading those posts for some context and history. FAF is effectively following the FNF playbook of separating information solutions businesses (high quality / high multiple businesses) from the title insurance business (medium quality / low multiple businesses) to unlock shareholder value.  FAF is worth consideration, but I prefer CLGX.

It is my impression that most FAF investors were interested in the title business, and that the valuation was largely book value-driven similar to other title insurance companies as they had the same sell-side analysts. This partially explains why the opportunity is available.

Business Description

CoreLogic has three segments: Business and Information Services (50% of 2009 revenue / 53% of EBITDA), Data and Analytics (35% / 43%), and Employer, Legal and Marketing Services (15% / 4%).

• (1) Business and Information Services
  • a. Mortgage Origination
    • i. Property tax monitoring
      • 1. Protects lenders against losses resulting from delinquent taxes
      • 2. #1 market share (65% of outsourced)
      • 3. Covers the life of the loan
      • 4. Demand driven by mortgage originations for purchase
    • ii. Flood Zone monitoring
      • 1. Federally mandated
      • 2. Provides lenders a report on a property's flood hazard status as outlined by FEMA
      • 3. Demand driven by mortgage originations for purchase
  • b. Default Services & Technology
    • i. Software and services to mitigate losses on default, manage foreclosures, maintain/sell REO, and process foreclosure claims
    • ii. Property valuation to mortgage lenders via BPOs (broker price opinions) and AVMs (automated valuation models)
    • iii. Demand driven mostly by default (some origination via BPOs and AVMs)
• (2) Data & Analytics
  • a. Specialty Finance
    • i. Provides merged credit reports - 50% market share
    • ii. Provides lead generation, ID verification, and compliance (significant exposure to auto credit)
    • iii. Realtor Solutions - MLS software with 45% market share
    • iv. Demand driven by home sales and general demand for credit
  • b. Risk & Fraud
    • i. Licenses and analyzes data relating to mortgage securities and loans
    • ii. Risk Management and collateral assessment analytics
    • iii. Database access tools for real estate
    • iv. Demand driven by the amount of outstanding credit and desire for data driven solutions
• (3) Employer, Legal, and Marketing Services
  • a. First Advantage Employer Services - background checks, drug screening, resume verification
  • b. LeadClick Media - lead generation for credit
  • c. Litigation Consulting - eDiscovery handles recovery, restoration, collection, conversion and aggregation of legal files.
  • d. Based on management commentary, I'd expect this segment to be sold at some point in the next two years. Management has been pretty open about their willingness to shed this business.

For further detail, I recommend reviewing the presentation they did ahead of the spin-off: http://investors.corelogic.com/phoenix.zhtml?c=118425&p=irol-calendarPast.

I would argue that the BIS and D&A segments are great businesses because of their significant barriers to entry, high market shares, and high switching costs, allowing them to generate great returns on capital and sustain high margins. The barriers to entry are the data assets, analytic capabilities and customer relationships. The switching costs of transitioning to a different platform are likely not worth the effort as the products is relatively low cost as a percentage of the product and largely passed on to consumers. I view further bank consolidation as the primary competitive threat as the big four national banks could begin to take more functions in-house. So far, we haven't seen this happen.

Cyclical Headwinds / Secular Tailwinds

Cyclical Headwinds

As with any company near housing, CLGX is facing very strong headwinds. The primary demand driver for tax monitoring and flood zone services (~35% of revenues) is mortgage origination which is abysmal right now as a result of the expiration of the first time home buyer tax credit. Demand was pulled forward from 2010 into 2009, and we are seeing the effects now. As the article below states, mortgage applications have not been this low since February 1997.

http://www.theatlantic.com/business/archive/2010/06/mortgage-purchase-applications-continue-to-plummet/57900/

The time immediately after the expiration of the tax credit will likely be the worst point (anyone close was highly motivated to close ahead of the deadline), but I expect the hangover to continue for at least six months if not longer.

I recommend spending some time on the MBA's website reviewing historical data and outlook, but I would highlight the second link as their forecast for mortgage originations which indicate the mortgage originations for purchases was $1,924B in 2009 and is expected to be $1,442B in 2010. Going out any further is difficult because refinancing volumes are highly dependent on interest rates. If rates stay low or go lower, we'll likely get a small refi boom. If they rise, refis could be terrible.

It's worth noting that the tax monitoring and flood zone businesses recognize revenue over the life of the loan, so there is some smoothing relative to any given year's volume. As the mortgage market (hopefully) rises over time, this makes cash flow stronger than earnings (beyond the amortization discussed later), but can make for lumpy cash flows. My FCFE number used later does not try to anticipate this but rather assumes revenue recognized in a given year = cash received which it will be over time. The company is testing moving towards annual payments to smooth the cash flows.

http://www.mbaa.org/ResearchandForecasts/EconomicOutlookandForecasts

http://www.mbaa.org/files/Bulletin/InternalResource/73093_.pdf

This is partially offset by the windfall business they are getting in the default segment, but across segments, they are clearly net losers from a decline in the mortgage market. However, as the tax credit hangover subsides, CLGX will benefit from the combination of improved originations and still strong default business. Given that delinquency rates are still rising, default operations are likely to remain very busy. Industry checks indicate growth through 2012 (I'm assuming they level out at 2010 levels).

Secular Tailwinds

The primary secular tailwind that CLGX benefits from is the increasing use of data to make credit decisions. This primarily benefits their Risk & Fraud segment where industry checks have generated very positive feedbacks. It typically takes a couple years for bankers to get used to the system and buy into the process, but it materially improves their results and streamlines processes. The company also has the opportunity to create a number of product extensions. One example they like to give is providing mortgage payment and housing value data to credit card issuers. Knowing approximately how much equity a person has in their home, combining it with

Finally, I think they have a great opportunity to expand internationally. The products won't translate perfectly, but many of the products and processes can be adapted from US products much more cheaply than they could be created from scratch. As more of the world uses credit, there will be more credit decisions to be made and more of those decisions are being made with data-driven applications.

Valuation

Below is an excerpt from my model. My 2010 estimates generally mirror management guidance which was provided about a month ago. I believe there is upside to my 2011 estimates from (1) better revenue upside than I have projected, (2) cost savings from integration of JVs, and (3) accretive acquisitions and/or buybacks (I model FCF as reduction in debt).

As you see below, I've adjusted the shares and net debt to reflect recent and future transactions. CLGX issued $250m worth of shares to FAF upon the spin. I estimated the shares using the closing share count on the first day of separate trading. CLGX will also issue 2.5m shares to buy in the remaining minority shareholders of a JV. Finally, CLGX will pay Experian $314m at year end for their stake of the FARES JV.

Most metrics that I think one would care about are listed below. I think the most relevant metric is FCF to equity which I calculate as EBITDA - Change in NWC - Interest Expense - Cash Taxes - Capex.

At the current price of $17.95, I estimate that CLGX is trading at 10.5x / 8.6x (or 9.5% / 11.7% FCF yield) 2010/2011 FCFE. This seems too low for a high quality business that is conservatively financed (1.3x Net Debt / EBITDA including Experian buy-in obligation), is likely at or near a cyclical trough in 2010, and has attractive secular growth opportunities at high returns on capital. Even while throwing off that much FCF, I expect the business to be able to grow the top line organically at a mid-single digit rate and have operating income (and FCFE) grow at a high single digit rate.

FCFE is greater than net income due to the amortization of acquired intangibles. These arose from the purchase of other companies/products, buy-ins of previous stakes, purchases of stakes in JVs, etc. The largest category of intangibles is customer lists - these will not require additional cash outlays to maintain for current products as customer relations/sales functions are on-going.

I have not adjusted the tax rate for cash taxes. However, I do not expect them to pay a full cash tax rate. They have historically been able to defer a significant portion of their taxes. I will leave this as an upside opportunity to my FCFE number.

Additionally, I think CLGX is attractively priced relative to peers. Analysts have and will likely continue to focus on EBITDA. Should CLGX get a similar multiple to FIS or FISV, the stock would trade at ~$25/share using 2011 estimates. That price would also correspond with a P/FCFE of 12x 2011, a pretty reasonable valuation for a high quality business.

I would also note that neither FIS nor FISV look particularly expensive and FIS recently rejected a buyout offer that equated to ~9.3x 2010 estimates of EBITDA. LPS has significant business overlap with CLGX, but LPS has a heavier default exposure at over 50% while CLGX is roughly 20% default. Given default businesses are closer to peak earnings than trough, it makes sense to apply lower multiples to them. However, CLGX has a much higher exposure to origination, which will likely in 2010 (and if 2010 isn't the trough, the S&P is going much lower).

 Estimates for peers used above are FactSet consensus estimates. FWIW, I don't really trust their FCFE numbers, but the rest are checked.

Risks

(1) Mortgage origination being even worse than I expect and not recovering in 2011 (importantly, this business is driven by volume of housing transactions, not price).

(2) Cuomo suit - NY's AG filed suit against CoreLogic, alleging that CLGX's eAppraiseIt unit conspired with Wamu to inflate home values by using a list of pre-approved appraisers. It's unclear to me how exposed CLGX really is to this. As long as the appraisers (pre-approved or not) meet a quality standard, it should be hard to prove CLGX conspired to inflate home values (and even harder to prove they succeeded). It's also pretty difficult to manipulate a market with so motivated of buyers and sellers who should ignore an unreasonable appraisal. I would also add (cynically) that Cuomo is running for governor, so this suit may lose priority as he shifts into the governor's mansion and a new AG looks to distinguish himself from Cuomo. My base case is that they settle this for a modest amount and adjust their business practices in this area, but I am not taking that for granted and will continue to follow up on this.

(3) Further bank consolidation - banks pay in part based on volume with larger originators paying a lower price. If CLGX gets compensated less per transaction on the same number of transactions, this is obviously a negative. Based on my checks, banks are attempting to pass these costs on to customers and are generally not sensitive to pricing because of the low cost (particularly tax and flood).

Spin-off dynamics

(1) Technically, CLGX is the parent from the spin-off. However, I view it as the spin because the name and ticker went with FAF and sell-side coverage has always been from the title insurance angle. I think the shift in coverage will result in multiple expansion at CLGX.

(2) Parker Kennedy remains chairman of both CLGX and FAF. Executives seem to be split about as would be expected. Executives received a comp package upon spin-off.

Catalysts

(1) Analyst coverage - I would expect a number of information services analysts to pick up coverage of the name over the coming weeks and months. Based on the quality of the business and attractive valuation, my guess is that they'll be receptive to the name. Importantly, I think both the sell-side and buy-side will generally be a different group of analysts looking at CLGX than did FAF which was covered by title insurance analysts.

(2) Focus turning to 2011 from 2010 and mortgage market recovery

(3) Resolution of Cuomo lawsuit

(4) Accretive buybacks and/or acquisitions

Catalyst

(2) Focus turning to 2011 from 2010 and mortgage market recovery

(3) Resolution of Cuomo lawsuit

(4) Accretive buybacks and/or acquisitions