Share price: $57 Target Price: $60
Position size: 2.2% TTM return: 27%
BKI reported in-line revenue and better than expected EPS. Revenue guidance was lowered to the low end of original guidance but in-line with consensus. EPS guidance range was also lowered but the midpoint was still slightly ahead of the street. Revenues and adj. EPS were both +6%. The stock is down because of announced lawsuits between Black Knight and a client, PennyMac. PennyMac is making anti-trust claims against Black Knight and Black Knight is alleging breach of contract and misappropriation of trade secrets by PennyMac. PennyMac has been a customer of Black Knight’s mortgage software products since 2008 and claims that “due to limitations of BKI’s MSP product” they made some efforts to customize and enhance some modules of BKI’s software that they are now trying to claim as their own. Given BKI’s market share leading position, high retention rates and ability to replace the custom in-house solutions of large banks, the claims against them seem surprising and retaliatory. The lawsuit is concerning but does not suggest a change in thesis at this point.
Key Takeaways:
· Given the de-conversion of a specialty servicing client that impacted guidance last quarter and now the PennyMac situation, they are seeing some unusual headwinds into 2020 (~5% hit to top line). Long term targets continue to be 6-8% revenue growth and mid-teens EPS growth. By segment, the expectation is mid to high-single digit growth in Servicing, high-single to low-double digit growth in Origination, and low to mid-single digit growth in Data & Analytics.
· Data analytics segment (~14% of revenue) revenues were up 9% driven by growth in their property data and portfolio analytics businesses.
· Software Solutions segment (~85% of revenue) was up 5%.
o Within this segment servicing (~70% of revenue) grew 1%. This growth was impacted by the client de-conversion and early client termination mentioned on their 2Q earnings call. They continue to dominate first lien loans with leading share and are growing share in second lien loans. Market share for first mortgages has grown from 49% in 2010 to 63% as of the end of Q3.
o Originations (~16% of total revs) made up of new loans and refi’s – revenues increased 25% – lower rates help, but growth also aided by an acquisition and a termination fee.
Valuation:
· Trading at ~4.5% FCF yield on 2020 –valuation is supported by growth potential, strong ROIC with a recurring, predictable revenue model (>90% recurring revenue) and high FCF margins, which is aided by high incremental margins and capex (~9% of revenue now) which should taper as they grow.
· Leverage ratio now at 2.8x, high because of Dun & Bradstreet but decreasing.
· Capital allocation priorities include opportunistic share repurchases, debt pay down and potential acquisitions.
Thesis:
- Black Knight is an industry leader with leading market share of the mortgage servicing industry.
- Stable business with >90% recurring revenues, long-term contracts and high switching costs.
- BKI has high returns on capital and high cash flow margins.
$BKI.UA
[tag BKI}
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109
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