The logic behind a Black Knight takeover

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Top mortgage lending software and analytics provider Black Knight is reportedly exploring a sale following takeover interest from several private equity firms. But don’t misread the situation – a potential deal reflects an opportunistic move rather than an act of desperation, analysts who cover the company told HousingWire.

Black Knight’s stock has been punished due to the company’s exposure to the mortgage business – after reaching a record of $4.4 trillion in 2021, origination volume is expected to decline in the coming years as interest rates eclipse 5%. 

The stock had lost 30% of its value from December 31, 2021 through April 1, 2022, down to a market capitalization of just under $9 billion. The performance, however, does not reflect Black Knight’s current financial situation or the opportunities in front of it, analysts said.

“The company’s financials are in excellent shape; it is not having problems,” said one analyst, who requested anonymity because he was not permitted to publicly discuss rumors of a potential deal. “The potential sale appears to be a case when private equity is opportunistic because Black Knight’s stock has underperformed relative to expectations. There’s still long-term value in the company.” 

Black Knight did not respond to a request for comment. 

The most recent earnings report revealed that Black Knight notched $386.2 million in revenue from October to December, an increase of 13% compared to the same quarter of 2020. The company also recorded $1.48 billion in revenue in 2021, a 19% jump compared to 2020. 

Software solutions for servicing and origination represented 84.7% of the revenues last year, with an operating margin of 46.6%, compared to 46.5% in the previous year. The remaining revenue comes from data and analytics, a segment with an operating margin of 28.7% in 2021, compared to 25% in 2020.

According to analysts, investors are missing a nuanced – but critical – detail: even though Black Knight is exposed to the mortgage industry, the share of its revenues related to loan originations is smaller than other business segments. 

“Black Knight sells software used to either service mortgages, to originate mortgages, and then data and analytics,” said the same analyst. “So, roughly 55% of revenues are related to servicing mortgages, 30% are related to originations activity for mortgages, and then the remaining is data and analytics.” 

Black Knight’s stock closed Friday at $68.02, down 0.26% from the previous day, but up 15% since the potential deal was first reported by Bloomberg on April 5. However, analysts have a target price for the company in the next 12 months over $80, an upside of around 18%. That’s the potential that private equity investors are taking into account. 

For a potential buyer, the deal could be a way to replicate another success in the industry: the acquisition of Ellie Mae, a company founded in 1997 to automate and digitize the residential mortgage industry. In April 2019, private equity investment firm Thoma Bravo bought Ellie Mae, a cloud-based platform provider for the mortgage finance industry, for $3.7 billion. 

Shareholders received $99 in cash per share, a 47% premium to the company’s 30-day average closing share price. After the transaction, the technology company was no longer listed on the New York Stock Exchange. As a private company, Ellie Mae could foster innovation and growth of the Encompass Digital Lending Platform. 

The strategy worked pretty well. In September 2020, Thoma Bravo sold Ellie Mae to Intercontinental Exchange, one of Black Knight’s fiercest rivals, for $11 billion. ICE’s stock closed at $129.9 on Friday. 

“Maybe that’s one way the Black Knight deal will shake out,” said another analyst who also requested anonymity. “If a company needs to put a lot of money into improving infrastructure and increasing technology efficiency, it may be easier to do that if it is not constantly scrutinized by investors quarterly.”   

Founded in 2014, Black Knight says it has the leadership in the mortgage loan servicing software solutions market, with a market share of 56% as of December 31, 2021, an increase of 2 basis points in comparison to the previous year, according to a 10k document filed with the Securities and Exchange Commission (SEC). But competition has been more intense over the last few years, another reason for a war chest. 

Another competitor, the mortgage servicing software provider Sagent, announced in March that it had extended its software partnership with Freedom Mortgage for another five years. In February, Sagent announced that it had inked a deal to create a cloud-native servicing platform for Mr. Cooper, which has $710 billion in servicing UPB. The software company also has a mortgage servicing deal with Mike Cagney’s Figure Technologies to power Figure’s mortgage servicing and help accelerate its “blockchain vision.”

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