Nastassia Samal
Background
Black Knight, Inc. (NYSE:BKI) is a number one supplier of software program, information, and analytics options for the mortgage and actual property industries. The corporate gives expertise options to assist lenders, servicers, and buyers handle and optimize their mortgage and residential fairness portfolios.
Intercontinental Alternate (ICE) is a world monetary providers firm that operates a community of regulated exchanges and clearinghouses for varied financial and commodity markets, together with inventory and bond buying and selling, power and agricultural commodities, currencies, and derivatives. ICE gives a number of information providers, analytics, and expertise options for market contributors and buyers.
Arbitrage Alternative
Merger arbitrage is an funding technique that entails shopping for and promoting the shares of firms concerned in mergers or acquisitions. The thought is to revenue from the distinction between the present market value of the goal firm’s inventory and the worth provided by the acquirer.
I consider the merger between Intercontinental Alternate, Inc. and Black Knight, Inc. gives an unusual however welcome alternative for merger arbitrage for potential buyers. The $13.1 billion money and inventory transaction values Black Knight at $85 per share, a major premium to its present buying and selling value of $57 per share.
Apart from the arbitrage alternative, holding on to BKI shares after the deal closes in Q3 2023 may be justified by the synergies this acquisition will create for ICE’s mortgage expertise enterprise. A few of these synergies embody:
- Incorporating BKI’s expertise options, actual property and mortgage-related information property, top-notch analytics, and a workforce {of professional} mortgage and expertise professionals into ICE’s portfolio.
- Enhancing automation and effectivity within the mortgage lending course of will decrease the price of acquiring a mortgage and assist present householders scale back their month-to-month funds.
- Complementing ICE’s present mortgage servicing enterprise, offering a complete end-to-end answer for the mortgage manufacturing and servicing ecosystem.
Each boards have unanimously authorized the merger of administrators. The merger has an anticipated cut-off date within the first half of 2023, topic to regulatory approvals, BKI stockholder approval, and customary closing circumstances.
A notable threat concerned within the merger arbitrage technique for the BKI-ICE deal is the potential of ICE shares declining submit merger, which might have an effect on the worth of the inventory portion of the acquisition value. As a result of BKI shareholders can select to obtain both money or inventory, which might be topic to proration, in addition to the worth of the money election and the inventory election made equal at closing, a decline in ICE shares would cut back the general worth of the deal for BKI shareholders who select the inventory election or who’re topic to proration. The decline in ICE shares may occur for varied causes, corresponding to market circumstances, regulatory points, integration challenges, or lower-than-expected synergies from the merger. Due to this fact, buyers who make use of the merger arbitrage technique ought to take into account the volatility and efficiency of ICE inventory in addition to BKI inventory when evaluating the potential revenue and loss from the deal.
On this technique, buyers buy shares of Black Knight at its present market value of $57 in anticipation of the inventory value will increase to the acquisition value of $85 upon the completion of the transaction. Given the strategic and synergistic nature of the acquisition and the approval of each firms’ boards of administrators, the chance of the deal falling via is low, making this a low-risk funding alternative for merger arbitrage.
Antitrust Regulators Unlikely to Block Merger of Black Knight and Intercontinental Alternate
I firmly consider the merger between mortgage software program suppliers Black Knight and Intercontinental Alternate is unlikely to be blocked by antitrust regulators. Though the Federal Commerce Fee (FTC) has launched an inquiry into the deal following a criticism from the Group House Lenders Affiliation (CHLA), which represents small- and mid-sized mortgage lenders, there’s little proof that this merger would hurt competitors or customers. One cause is that BKI’s mortgage servicing software program primarily serves massive mortgage suppliers, corresponding to banks and government-sponsored enterprises. Due to this fact, ICE’s acquisition of BKI wouldn’t create important market energy within the small- and mid-mortgage servicing phase, certainly one of CHLA’s main considerations.
One more reason is that BKI’s mortgage servicing software program doesn’t instantly compete with ICE’s mortgage origination software program. As an alternative, they complement one another by providing completely different providers alongside completely different phases of the housing finance continuum. This implies there is no such thing as a important horizontal overlap between their merchandise, a vital issue that antitrust regulators take into account when evaluating mergers.
In accordance with my evaluation, this merger may benefit prospects and shareholders by lowering prices and growing revenues. In accordance with ICE’s estimates, this merger may remove double marginalization by decreasing software program product costs by as much as 10%, creating value synergies of $200 million over 5 years via operational efficiencies, and elevating ICE’s recurring income share from its mortgage expertise phase from 40% to 60%.
Total, I strongly consider the dearth of serious horizontal overlap and the potential advantages to customers of the merger makes it unlikely that antitrust regulators will block the merger and that any try to take action would probably fail on the identical grounds.
Strong Funding Whatever the Merger
Even with out this deal, BKI seems to be buying and selling for lower than its intrinsic worth primarily based on its earnings, money circulate, property, and development potential.
As of December thirty first, 2022, Black Knight had complete property of $5.83 billion and complete liabilities of $3.21 billion, leading to a complete fairness of $2.62 billion. The corporate had a present ratio of 1.11 and a debt-to-equity ratio of 1.02, indicating an unusual capability within the business to satisfy its short-term and long-term obligations.
Black Knight generated $582 million of free money circulate in 2022, representing a free money circulate margin of 42%. This displays the corporate’s robust money technology and low capital expenditure necessities. The corporate additionally returned $186 million to shareholders via dividends and shared repurchases in 2022.
Black Knight had a web revenue margin of 29% and a return on fairness of 17.5% in 2022. These metrics are nicely above the business averages of 12% and 10%, respectively. This displays the corporate’s excessive profitability and effectivity in producing shareholder returns.
Black Knight’s valuation multiples are additionally engaging in comparison with its friends and the business. The corporate’s trailing P/E ratio is nineteen.1, decrease than the business common of 23.4. The corporate’s trailing P/S ratio is 9, decrease than the business common of 11.6. The corporate’s trailing P/FCF ratio is 32, decrease than the business common of 36.8.
One other issue that makes BKI a beautiful funding is its excessive return on fairness of 15.6% in comparison with its business common of 11.8%, indicating that it’s environment friendly and worthwhile in utilizing its shareholders’ capital which is one other credit score to the administration.
I might contend that BKI holds a considerable aggressive benefit in its area of interest market with excessive obstacles to entry and switching prices for patrons, making it much less susceptible to disruption or competitors.
Moreover, I consider that BKI holds a dominant place in its core markets, accounting for over 60% of U.S. mortgages by quantity. This offers it a big and dependable buyer base with excessive retention charges and the potential for cross-selling. The corporate maintains a constant historical past of paying dividends and growing them over time, offering revenue and stability for buyers.
BKI generates income from varied sources, together with recurring software program subscriptions, transaction-based charges, information licensing, {and professional} providers, making a diversified income stream that reduces the chance of dependence on any single supply.
My evaluation exhibits that Black Knight’s robust steadiness sheet and monetary place assist its development technique and worth proposition. The corporate has low debt, excessive money circulate, and excessive profitability in comparison with its friends and the business.
Lastly, BKI has a constant historical past of spectacular development and profitability, evidenced by its 10% YoY income enhance to $1.3 billion in 2022 and an adjusted EBITDA margin of 54%.
Michael Burry’s determination to open a place in BKI
Michael Burry is a well-known investor recognized for his profitable guess towards the subprime mortgage market in 2007-2008, depicted within the ebook and film “The Massive Brief.” He’s the founder and supervisor of Scion Asset Administration, a hedge fund specializing in worth investing.
Within the fourth quarter of 2022, Burry purchased 150,000 shares of BKI.
This was a brand new place for Scion Asset Administration, which allotted 19.90% of its fairness portfolio to BKI. The inventory traded for a mean value of $60.78 per share through the quarter.
Burry’s funding in BKI is important for a number of causes:
Michael is taking his traditional contrarian stance on BKI, which has underperformed its friends and opponents relating to inventory value efficiency over the previous yr. I consider it signifies that he sees worth and development potential in BKI’s enterprise mannequin, which gives end-to-end options for mortgage originators, servicers, buyers, and regulators. I might additionally presume he expects BKI to learn from the merger take care of ICE, which goals to create synergies between ICE’s information, expertise, and market infrastructure enterprise and BKI’s software program, information, and analytics options that serve the housing finance continuum. He’s probably assured that the merger deal will undergo regardless of potential regulatory hurdles from the FTC, which can have considerations about market focus and competitors.
Conclusion
The merger between Black Knight Inc. and Intercontinental Alternate gives a low-risk funding alternative for merger arbitrage, with potential good points of 32.5% if the transaction closes on the present value. In my opinion, this inventory is a purchase at its present value of $57 and is a worthy funding underneath $65. The synergies that this acquisition will create for ICE’s mortgage expertise enterprise make holding on to BKI shares after the deal closes in Q3 2023 justifiable. Moreover, BKI seems to be buying and selling for lower than its intrinsic worth primarily based on its monetary well being and aggressive benefit, making it a beautiful funding whatever the merger. Famed investor Michael Burry’s latest determination to open a place in BKI additional confirms its potential. The deal is predicted to shut by June thirtieth, 2023, making any investments in BKI, and this evaluation’ timing is vital. Total, the merger gives a uncommon alternative for buyers to revenue from the distinction between the present market value of the goal firm’s inventory and the worth provided by the acquirer whereas additionally benefiting from the long-term development potential of BKI.
