AAMC - Buy Altisource Asset Management Ahead Of Massive Growth

2023-04-19 08:00:00 ET

Summary

• Altisource was for many years a cash shell company that traded at a discount to net cash as it slowly leaked value for almost a decade.
• The value proposition radically changed when a decision was made to hire CEO Jason Kopcak to use AAMC assets to create a low risk loan origination "flow" business.
• Kopcak has succeeded in this endeavor twice before, first at Nomura, and then at Morgan Stanley. His chances of success here are excellent in my view.
• The company has almost $30 a share net cash, and should hit a run rate $10 EPS by YE 2023, and $22 in 2024.
• The earnings ramp from there is likely to be substantial, with $50 EPS plausible by 2026.

Altisource Asset Management ( AAMC ) is an ultra fast growing mortgage originator and reseller with almost $30 a share of net cash and, conservatively, a $10 EPS run rate by YE 2023. I expect them to grow rapidly from there, with $22 EPS in 2024 and $50 by 2026. The business model is low risk - I will explain momentarily - and, in my view, highly likely to succeed. Liquidity is an issue, so I suggest limit orders, and not market orders, for those who choose to buy AAMC stock.

AAMC's history as a cash shell company

AAMC was a cash shell company for many years. It spun out of Ocwen after that mortgage giant blew up in 2015, and Ocwen's founder, Bill Erbey, owns 40% of the outstanding AAMC shares today. Erbey is not allowed to sit on the board or hold a management position with any public company due to a legal settlement related to Ocwen.

The company just sat there for years, slowly leaking cash. As of Q4 2022 they had almost $30 a share of net financial assets. The hope with this sort of company is that eventually a real business would emerge. And that is exactly what happened.

Pivot to a real company

AAMC made a decision to turn into a real business. Perhaps related to Erbey's background in mortgage origination - and his AAMC holdings amount to 1/3 of his wealth, so he's going to want this to work - the BOD hired Jason Kopcak as CEO. Kopcak has a lot of experience in mortgages, recently at Morgan Stanley, and Nomura before that.

On the Q3 2022 call Kopcak laid out his vision. He would turn AAMC into a mortgage origination "flow" business, which will hit a $1B origination run rate by 2h 2023, and then ramp from there. The idea is to originate loans and then sell them with an extremely rapid turnover to end customers in pre-arranged agreements. The hold time they are targeting is three days; that's why it's a "flow" business, and also why it's low risk to AAMC. The buyers are in place ahead of time, so the only risk is execution. As long as AAMC can deliver the product to spec - all the documentation in order, that sort of thing - then the buyer has already agreed to buy the loans.

Kopcak then summarized the business model in a tremendously clear way on the Q4 2022 earnings call (emphasis mine):

Our strategy which is unique in the industry is that we are capital light originator of private credit products . These products include both short duration, high yielding fixed income assets, secured by one to four single family residential or multifamily residential properties going through value improvements, also known as residential transitional loans or RTLs, as well as long duration interest only secured by income producing residential properties, also known as DSCR loans. Such products are distributed to institutions with permanent capital, such as insurance companies, pension funds and endowments.

I have 15 years of unique experience relationships with these institutions. Unlike our peers, we do not use loan securitizations as an exit for our loans. Instead, we establish individual criteria, or a Buy Box, to sell loans to insurance companies or other funds that are backed by endowments and pension funds. These institutions have large stable cash that needs to be invested in fixed income products. We then go to market to originate these loans via our three channels: direct to borrower, wholesale, [and our] broker direct channel...

Insurance companies, pension funds and endowments have potentially over a trillion dollars allocated to be invested in alternative fixed income assets...

AAMC is facing a unique opportunity right now in alternative mortgage origination. They have a legacy processing operation, left over from their Ocwen days, combined with CEO Kopcak's experience as a mortgage originator, and his connections to natural buyers of packaged "Buy Box" alternative mortgage products. This is a niche business, and right now AAMC is the only operator filling it.

Off to a good start

Management has guided to $600M of originations in 2023, mostly in 2H, as they are ramping the business now. And they are going to absolutely blow that number away. From the Q4 call :

we're sitting at $50 million to $60 million direct to borrower... I'd say that's from like, three days. I think you can extrapolate the ramp should be pretty strong...

The business in 2024

Management has discussed expectations of hitting perhaps $200M to $300M of monthly originations relatively soon. At the midpoint, this is $3B annually - a drop in the bucket of the $1T larger alternative lending market - that they expect to hit as a run rate before the end of next year. This converts to EBITDA of more than $40M and earnings per share in excess of $22. Here's how I get that.

To begin with, I assume revenue of 350 basis points on loan originations. This is consistent with guidance:

Our expected gross revenue per loan for RTLs is a range between 300 basis points to as high as 450 basis points. Our term or DSCR loans have a range between 200 basis points and 350 basis points. The above ranges reflect the all-in annualized revenue expected to be received from originating the loans consisting of origination fees, gain on sales and interest strips.

From there, assuming a 40% EBITDA margin, 1.4% of originations convert to EBITDA. $3B of originations - the midpoint of their $200M to $300M monthly target for the DSCR and RTL products they have launched so far - works out to $42M of EBITDA as a run rate in 2024.

They also generate net interest income. And here they are actually in a nice position, since the interest rates they receive are relatively high:

Typical metrics include shorter duration originations with a range of 10.5% to 12% gross weighted average coupon... with a one a two year term.

But the credit risk is actually quite low! There are multiple reasons for this, including the relatively quick turnaround between origination and sale to the end buyer. The loans simply do not have time to go bad while AAMC holds them for a week. AAMC currently has, according to their 2022 10K , roughly $55M of net financial assets, mostly loans held in excess of debt, while other loans can be held using their $100M warehouse facilities. The company can safely earn net interest income in the high single digit millions of dollars per year as a result.

Including both fees and net interest, this works out to pre-tax earnings of perhaps a bit more than $50M. The company is domiciled in the USVI - another legacy of their Ocwen days - and can expect a tax rate under 15% as a result. With 1.9M fully diluted shares (this assumes the conversion to 116k shares of common stock of legacy preferred shares), fully taxed earnings work out to a $22.80 per share run rate in 2024.

The company in 2026

CEO Kopcak is not going to stop at RTL and DSCR loans. The alternative lending space is wide open, demand is high, and other products are coming. I see no reason the company can't double in size from the 2024 level. What's more, they are going to use all that cash they are generating on behalf of shareholders. Stock buybacks are on the table, and the incentive is certainly there given the low valuation today. But special dividends or a larger loan portfolio are certainly very reasonable options too. Put it all together and a $50 EPS in 2026 seems completely plausible to me.

Valuation

My price target for 2024 is $175. With the demand for alternative loan products as strong as it is, it's plausible that one or more of AAMC's lines of business will be acquired by one of their customers. This has taken place in the past at 10 to 12 times earnings. What's more, the business will be growing fast, Kopcak will be announcing new growth initiatives, and after succeeding in RTL and DSCR he will have a great deal of credibility in the market. I see no reason the company can't trade at a high single digit PE or better. With a $22 EPS, and an 8 multiple, that works out to a $176 price target.

Risks to the Thesis

By far the biggest risk is execution. The company has big plans, and they are off to a great start, and CEO Jason Kopcak has done this twice before. That sounds great, but they have to actually execute. If something goes wrong, then they will be falling back on their roughly $30 a share of net financial assets. The stock could easily trade under that if the current business plan doesn't pan out, as indeed it has in the past before they announced their new business plan.

There is also clearly a "key man" risk. None of this works without Kopcak. He's not old - only 50 - and appears in robust good health to me. And I think he is highly motivated to stay at AAMC, to take advantage of the incredible opportunity right in front of him. So I don't think the key man risk is a high probability. However, it might be ugly for AAMC shareholders if, for some reason, Kopcak could no longer serve as CEO.

Conclusion

AAMC has $30 a share of net financial assets on the balance sheet and is ramping to a $22 EPS run rate in 2024, and to perhaps $50 in 2026. The ramp is dependent on execution, but CEO Jason Kopcak has done this twice already. The stock is $69 as I write this, a 3.0 PE on next year's earnings, and a 1-handle within a few years. The current sub $70 price is absurd, and the stock should be bought.

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