By
Morningstar
:
By Brett Horn
CoreLogic's (
CLGX
) undervalued shares offer two different routes to investor gain,
in our opinion--through a buyout, or through market recognition of
the company's value.
CoreLogic provides data, analytical tools, and processing
services for the mortgage industry. While we knew 2011 would be a
tough year for the firm as the tailwind from the refinancing boom
recedes and mortgage origination remains weak, it has been even
tougher than we expected--even the company's default business is
struggling. The company's origination and default businesses
typically work against each other, but government interference has
caused the firm's default business to decline before origination
volume could pick up.
In August, when CoreLogic substantially lowered its outlook for
the year, the stock imploded. While the third quarter was much more
positive and the stock has risen materially, we still think the
shares are undervalued. Investors looking at the shares today have
two ways to win, in our view: either through a sale of the company
or a long-term convergence to fair value. While we're skeptical
that the company could achieve our fair value estimate of $21 per
share in a buyout, this route would result in a quick out for
investors. If the buyout discussions come to nothing, then
long-term investors can wait for the market to recognize
CoreLogic's fair value.
In the Long Term
CoreLogic is a solid business from a long-term perspective, in
our opinion. While smaller than peer Lender Processing Services (
LPS
), CoreLogic is a leader in certain areas and a solid number two
overall. We think it has sufficient size to leverage its fixed
costs and produce excess returns. As the company sells noncore
businesses, it will become more centered on the fundamentally
attractive and moaty data business.
While 2011 has been weaker than expected, we think the default
business won't necessarily follow a straight path down, and the
weakness in 2011 is a deferral of revenue, not a loss. While new
foreclosures are likely to remain low until the banks and the state
attorneys general work out a deal, and the timing of that deal is
difficult to predict, this does nothing to change the condition of
seriously delinquent but not-yet-foreclosed-upon borrowers.
Therefore, we think it is likely that we will see a spurt of
foreclosure activity once the legal issues are worked out.
Still, the long-term trend for the default business is
definitely down, as the volume of distressed mortgages remains well
above normal. While we believe that the robo-signing controversy
has temporarily accelerated what otherwise might have been a smooth
glide down for the default business, in the long term, this
business must ultimately fall off materially.
Mortgage originations remain weak, and the possibility of a
substantial near-term improvement is low, but long-term volume
should start to normalize. Home sales have been depressed since the
housing bubble burst and have shown no sign of improvement since,
absent some temporary spikes due to government programs designed to
spur sales. While we don't expect a quick recovery, house sales are
below levels reached even before the housing bubble and should
ultimately improve.
Even if industry conditions don't improve, the company's
restructuring efforts should boost profitability. In addition to
selling the bulk of its nonmortgage businesses, the company has
undertaken cost restructuring efforts. It initiated a head count
reduction this year, which management estimates will save $30
million annually (with only $20 million of those savings appearing
in 2011). Additionally, CoreLogic believes it can substantially
lower its IT costs by closing redundant data centers and
rationalizing end-user testing. Management estimates it can save
$50 million annually through these efforts, with those savings
developing over a two-year period. With the release of its
third-quarter results, the company raised its target for cost
savings through these actions to $80 million-$100 million.
Therefore, we think it's likely that the company can achieve
substantial bottom-line improvement before the mortgage market
normalizes.
In the Short Term
Shortly after releasing second-quarter results, CoreLogic
announced it was exploring strategic alternatives because of
pressure from a large shareholder. Then in late August, the company
announced that it had retained investment bank Greenhill (
GHL
) to look at ways to enhance shareholder value. We think the only
new option placed on the table then was a potential sale of the
company.
CEO Anand Nallathambi says he and the board agree that the
current market price dramatically undervalues the business, and
that this view is the driver behind the board's willingness to look
at strategic alternatives. So far, management has been excluded
from the buyout discussions. We think management is not a willing
seller at this point, as it doesn't believe it can achieve a fair
value in this environment. We don't see any obvious strategic
buyers, but we could see management accepting an offer below our
fair value estimate if an opportunistic buyer appeared.
Still, CoreLogic is not a forced seller, and a look at
comparable market valuations suggests a reasonable buyout price
could be at a premium to the current stock price, even after the
recent rise. CoreLogic is still profitable, holds a substantial
cash balance, and is not in imminent danger of violating its
covenants. As a result, we don't think it is under pressure to sell
at a price the board would find less than adequate. There has been
speculation that several potential buyers are looking at CoreLogic,
with most being private equity firms. If this is true, then it
would lend some support to the idea that CoreLogic could realize a
price above the current market price.
What Could Go Wrong
The main risks are more negative surprises in the near term,
legal risks, or a sale at a distressed price. Given the state of
the mortgage market, further bad news cannot be ruled out, and the
default business could continue to fall off more quickly than the
origination business can improve. Additionally, the company does
face some legal uncertainty. The FDIC recently filed a lawsuit
against CoreLogic and Lender Processing Services over appraisals
done for Washington Mutual. While we think CoreLogic has reasonable
defenses and this lawsuit itself is not a major threat (the damages
claimed only equal a little more than $1 per share), it could lead
to problems if the lawsuit were successful and encouraged others to
file similar claims. On the other hand, the fact that no bank has
brought charges on its own behalf argues against this being a
widespread issue. Finally, we're skeptical that the company can
realize a fair value for its business in this environment. A sale
for all or parts of the business below fair value cannot be ruled
out, although new investors shouldn't be too concerned on this
front, as even a sale below fair value would probably result in a
quick return.
See also
Time Travel, Growth And Valuation
on seekingalpha.com