Black Knight Stock: Merger Or No Merger, Stock Buy (NYSE:BKI)

Real estate, keychain with house symbol. Key with finance blank.

Evkaz

Much has been written about the merger (great article here: Black Knight: Merger Arbitrage With An Asymmetric Risk/Reward); however, this article will work on analysing the merits of Black Knight (NYSE:BKI) as an individual business.

Business Overview

Residential real estate is the primary focus of BKI’s business in the United States. Black Knight’s ecosystem provides customers with different digital channels tailored to certain market niches via which they may have access to through a full suite of integrated software and workflow management solutions. The ecosystem, which is bolstered by large mortgage-specific datasets and powerful proprietary analytics, allows BKI to be a reliable partner to their customers by delivering cutting-edge solutions on a consistent basis.

Mortgage servicers, mortgage banks, and home equity loan providers can all reap the benefits of the company’s suite of eleven integrated software solutions for the mortgage industry. These systems provide the core data processing infrastructure that is required to handle all elements of a loan’s life, including its origination, pricing, servicing, trading, and defaulting, among other things. Data and Analysis, sometimes known as a Business Intelligence (BI) department in its most basic form. BKI provides its customers with residential real estate data and analytics solutions, with the goal of assisting those customers in making informed business decisions. These solutions allow customers to obtain insight into their customers, their portfolios, and the market.

BKI has competition mostly from a small number of other businesses in the market for software solutions. Mortgage Technology by Intercontinental Exchange (ICE), and the systems that lenders and servicers have developed on their own are some of its competitors.

The Integration

A pivotal consideration is that once BKI’s software is put into action, the software is indispensable to the operation of mortgage lenders. The process of transitioning to a new system is typically extremely involved and might take anywhere from 12 to 18 months to complete. This provides BKI with a competitive advantage and helps to assure that its consumers will not leave the company unless there is an extremely compelling reason to do so. Due to the fact that BKI’s software is mission-critical, mortgage lenders and servicers are not likely to switch to a solution that is less well-known and has not been tested. This is mostly because of the substantial switching expenses that are associated with making such a changeover. The mortgage lender or servicer that poses the most conceivable threat is one that has developed high-quality software in-house and is considering licensing it to other businesses in the industry. Even if we make this assumption, there would still be significant expenses associated with switching.

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Company Presentation

Due to the SaaS nature of the software, there is a recurring nature to the revenue and therefore indicates that the income is consistent and not as susceptible to changes in market conditions. As a result of the fact that the Data business at BKI is based on licensing and subscriptions, it is able to bring in a consistent cash flow for the company.

Taable

Author

There is a clear distinction between the software market and the data market; each of these marketplaces has its own distinct set of competitors and a distinct set of products or services to offer customers.

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Company Presentation

When it comes to data, BKI goes up against a variety of competitors, the likes of which include CoreLogic, First American Financial Corporation (FAF), and even BKI’s very own in-house databases of mortgage loan market participants. BKI has a strong competitive advantage over its clients in the software business, which is one of the industries in which it operates. The market knowledge and statistics provided by BKI are beneficial, but they are not mission-critical for the majority of businesses. In addition, the cost of switching to a different service provider might range from being modest to inexpensive, depending on how important the service is and how well it connects with the various tools that are available. Creating a new database does take an investment of some time and money, but it is not a hurdle that cannot be overcome. This means that the entry barriers are not overly difficult to overcome. When compared to software, the reduced complexity and risk associated with such a project makes it more probable that people will convert, given that the pricing is comparable and the quality is equivalent.

Financial State Of the Company

BKI has shown exemplary strength through COVID but has fallen victim to much of the restrictive inefficiencies that are the product of inflation. This is evident in the 17% and 30% decline in Operating and FCF margin at the onset of inflation in 2021.

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FactSet

Due to the nature of the software operating model, BKI’s operating margin has enjoyed relatively high levels compared with different financial technology companies. This is effectively the reason that I have decided to source more ‘software heavy’ companies for the relative valuation.

BKI’s industry leading Net Margin is amongst the highest within its peer group. Interestingly enough, from a valuation scope, the price/sales, price/cash flow and EV/sales, are all below their respective peer group median values. I view this with an observant eye, given the market and macro environment investors are forced to be observant. BKI, however, is showing consistent signs of mispricing on a relative basis.

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FactSet

Relative to where BKI has historically traded over the last 5 years, it currently exhibits the characteristics of an underpriced stock. This discount to historical is due to many reasons, one being obvious, the merger may not go through. Though this does bode well in terms of probabilities, I would also suggest that much of the discount is also factoring in the deterioration in consumer confidence and credit. Thus, directly affecting BKI.

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Bloomberg

Final Thoughts

BKI is a well performing business which is structured to implement its software within the weeds of a business and their processes, making it a sticky component in their workflow – in a period of consolidation. The large discount to the acquisition price is also a risk to be considered, however, for the long term investor I believe that the valuation and the inductive pricing of BKI are favourable for those who can stomach the volatility.

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