Altisource Asset Management (AAMC) – A $2 Billion Dollar Parasite

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Bill Erbey’s empire is a complicated web of companies with inter-related interests. The history first:

AAMC Corporate Structure

 

The Host-Parasite Relationship between RESI & AAMC

The focus here is on RESI and AAMC’s parasitic relationship – here’s how it works:

With shared upside, no bills and no downside, the question is:

Is AAMC disproportionately benefitting at the expense of RESI shareholders?

The conclusion from Glaucus Research is an emphatic YES. RESI massively overpays AAMC.

RESI pays AAMC over 7x what similarly situated mortgage REITs are paying for internal asset management.

AAMC v Internal MgrsSource: Glaucus Research

If you widen the comp set to include twelve externally managed mortgage REITS, RESI pays AAMC around 4x more than the amount paid to external asset managers.

AAMC v External MgrsSource: Glaucus Research

Looking at these charts, it should be clear to you that AAMC is unjustly benefitting at the expense of RESI shareholders. What’s interesting is that not only has Bill Erbey been getting away with it, but as the largest shareholder of both companies he’s been a massive beneficiary as the sell-side plays buffoon. The valuation of these companies makes no sense – I’d go so far as to say AAMC is one of the biggest mispricings I have ever seen, internet bubble included. Take a look at the numbers and decide for yourself:

P to NAVSource: Bank of America Merrill Lynch

The numbers tell the story: the market is – arguably – fairly valuing the host (RESI) and it’s – rather remarkably – rewarding the parasite (AAMC).

So we have a strange public market situation where 2 interrelated companies are engaged in a massive siphoning of money from one (RESI) to the other (AAMC) while overvaluing the pair by $2 billion. Ok, good to know. But what’s the catalyst for shorts? Well, absent the market miraculously waking up from its stupidity-induced coma, there’s one other catalyst on the horizon: June 24th. You see, Glaucus has written letters to independent RESI board members attempting to get the current Asset Management Agreement replaced with an at-market rate (thereby eliminating the massive value transfer from RESI to AAMC) and June 24th is the last date the independent directors must give notice to terminate or replace the contract.

If they are successful at achieving even a 50% decrease in AAMC’s incentive fees (which would still leave its overall compensation structure significantly above market for an asset manager), AAMC’s stock price will likely get cut in half – and that assumes AAMC continues to trade at an absurd and unsustainable multiple (Glaucus est).

But what if they aren’t successful? Then you still have a combined RESI-AAMC pair trading at an internet bubble-like valuation and a blood sucking parasite (AAMC) realizing 35% – 50% of the gains from RESI’s portfolio.

And so I propose a slightly modified pair trade from the one Glaucus mentions in their report: short them both. If the management contract gets ripped up and replaced, AAMC will tumble dramatically and you’ll lose some money as RESI rises. Net-net, you likely win.

If the management contract doesn’t get torn up, RESI will likely fall (why should RESI be priced at NAV considering they are giving away 35% – 50% of the ups to another company?) while AAMC may remain extremely overvalued. Net-net, you likely win.

Either way Bill Erbey remains a diabolical genius.

Critical Questions for Management

Addendum: Thoughts on the recent capital raise

In March, existing investors gave the company $250MM which the company is using to buy back $300MM in shares (source). This is strange to me… why would AAMC institute a buyback program given that it’s a brand new spin-off trading at an internet bubble-like valuation and is beginning to face negative headwinds from a no-longer-severely-distressed single family home market (see Blackstone’s comments here)?

This transaction smells funny to me. Why would existing investors put in new capital given the above? Is it to buy them enough time to get out of their positions? I’d love to be a fly on the wall at AAMC, but here’s a scenario to ponder… funds like Luxor, Long Pond, and SAB all got their shares in the Dec-12 ASPS spin and have lucked into a large fortune. They get a massive drawdown in 1Q13 (AAMC was down big intra-quarter) impacting their performance so before the quarter ends they propose this deal with the Company, making their quarter look better. This wouldn’t surprise me one bit. And with management’s restricted stock grants tied incredulously to AAMC’s share price, AAMC is equally incentivized to do everything they can to keep their share price high (hence the buyback announcement).

The investors that bought into this deal got convertible preferred stock that has free upside and no downside (they can put these shares back to the company at par and get upside if they convert over $1,250 / share). This is a risk-free trade to participating investors with principal protection. And the simultaneous buyback announcement creates the perception that there is a floor under the shares. At its core, for investors that sell their non-convert stock holdings (we’ll see over the coming months whether or not they start selling), this is merely an exchange of “at risk” money for principal protected money with a 6 year lock-up. A trade I’d do any day especially if I thought my shares were worth 90% less than what they were trading at.

One final note: If Glaucus is successful in getting the management agreement torn up, the buyback could be moot (there’s ~$260MM left) as AAMC may have to keep a lot of that cash to cover the “put” held by convert holders.


2 Responses
  • energybev Reply

    Great call on the OCN complex of names……what are your thoughts on them here? Is AAMC a zero?

    • analyst Reply

      Safe to say their business model is dead.

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