BKI - Black Knight: FTC Drops Lawsuit A 30% Return Arbitrage Investment

2023-08-18 04:22:25 ET

Summary

• The Federal Trade Commission (FTC) has withdrawn its lawsuit against Black Knight and Intercontinental Exchange, increasing the chances of their merger being finalized.
• BKI shareholders may receive a premium and ICE shares if the deal goes through, but there is still uncertainty priced into the market.
• BKI's intrinsic value remains intact regardless of the deal outcome, and it has a solid track record of growth and shareholder emphasis.

In my previous article , I argued that the Black Knight (BKI) and (ICE) merger presented a compelling buy opportunity as the leading provider of software and data solutions for the mortgage industry. I highlighted the company's strong competitive position, robust financial performance, and attractive valuation. I also discussed the pending acquisition by Intercontinental Exchange (ICE), the owner of the New York Stock Exchange, which offered a significant premium to BKI shareholders. This article is meant to serve as a brief update on the events that have occurred since my last article and my new recommendation for investors to maximize returns.

The Story

The Merger encountered an obstacle in March 2023 when the Federal Trade Commission ((FTC)) filed a lawsuit against it, alleging that the transaction would stifle competition and hinder innovation in the mortgage software market. The FTC claimed that ICE and BKI were competitors, in product areas including loan origination systems, product pricing and eligibility engines as well as title and closing services. Furthermore, the FTC argued that the proposed divestiture of BKIs Empower loan origination system was inadequate to address the concerns regarding competition.

Since then, ICE and BKI have made several concessions to address the FTCs concerns and salvage the agreement. In May 2023 they reduced the value of the deal from $13.1 billion to $11.7 billion by lowering their offer price, per share from $85 to $75. Additionally, in July 2023 they reached an agreement to sell BKIs product pricing and eligibility engine for $700 million to Constellation Software, a Canadian software company.

These moves seem to have paid off, as the FTC announced on August 7th that it has withdrawn its lawsuit against ICE and BKI, signaling a possible resolution of the antitrust dispute. However, the deal is not yet done, as the two parties continue to negotiate with the FTC and seek its final approval. The deadline for reaching an agreement is August 25, otherwise, the deal could be terminated.

What Now?

On one hand, the decision to withdraw the FTC lawsuit is a step. It increases the chances of the deal being finalized. Removes an element of uncertainty. However, there are still risks and challenges that need to be addressed for the deal to be successful. These include obtaining approval, from jurisdictions meeting closing requirements and meeting shareholder expectations.

As of August 16th shares of BKI closed at $74.51 below the revised offer price of $75. This suggests that there is still a level of uncertainty priced into the market regarding the completion of this deal. If everything goes as planned, BKI shareholders will receive a laughable premium of 0.7%. Additionally, they will also receive ICE shares as part of their compensation, which could potentially provide growth in the run.

Alternatively, if the deal falls apart due to regulatory or other reasons, BKI shareholders could face some downside pressure in the short term. However, I believe that BKI's intrinsic value remains intact regardless of the deal outcome. The company has a solid track record of revenue growth, margin expansion, cash flow generation, and shareholder emphasis. It also has a loyal customer base, a diversified product portfolio, and a strong innovation pipeline. Regardless, the near-term emphasis on the deal would pressure the stock downward if in fact the outcome was a failed merger.

Updated Strategy

I will provide investing strategies for a variety of investors, as that is our audience here on Seeking Alpha. In my view, there are two investing philosophies that could find value in BKI. One is the arbitrage school of thought; the other is the classic "buy and hold". Really though, as always, it boils down to short, and long-term investing. I will provide a brief update to each strategy and assert my views on its pragmatic application.

Short Term: The investing strategy I outlined in April has materialized. Investors who listened returned 30% with simple arbitrage. The deal is nearly brokered and has few barriers in its way, but the anticipated return has been secured. There is no need for short-term investors to take the risk of some unlikely but possible erasure of gains. Thus, because my arbitrage strategy succeeded, for short-term investors, I assign a "sell" rating.

Long Term: Though the arbitrage was successful, BKI and ICE are not disqualified as strong potential investments. The FTC's decision to drop its lawsuit is a positive sign for the ICE-BKI deal, which could offer some long-term benefits to BKI shareholders. If the deal does materialize, two synergistic entities will become one mortgage technology powerhouse. Even if the deal does not materialize, I think BKI has enough fundamental strengths to overcome any temporary setbacks and continue delivering value to its shareholders. Thus, for long-term investors, I assign a "Hold" rating.

Conclusion

BKI and ICE made all the necessary moves to complete their merger. The FTC dropped the lawsuit and surrendered, just as I suspected. The story of this arbitrage is in my view over. I am downgrading my bullish view on BKI as an Arbitrage strategy. Why? Because the investing strategy here was to arbitrage the 30% price differential, and if you listened to me, that's exactly what you got. That downgrade doesn't mean the future isn't bright for these two. Look at the downgrade as the end of one investing strategy, and the beginning of another.

For further details see: