Fidelity National Financial Inc (NYSE:FNF), the country’s largest title insurer, split up its empire last decade in a bid to simplify operations and increase shareholder value. The spinoff unit, payments technology provider Fidelity National Information Services (NYSE:FIS), subsequently completed its own spinoff in 2008, floating its mortgage processing and technology subsidiary Lender Processing Services, Inc. (NYSE:LPS), based on the same shareholder value rationale. However, with yields on its fixed income portfolio low and the housing market rebounding, Fidelity National Financial sees value in the processing business, offering to acquire Lender Processing Services for $2.9 billion in May 2013. So, should investors follow the title insurance giant into mortgage processing?
Lender Processing Services, Inc. (NYSE:LPS) is one of the big providers of technology, data, and processing services to the mortgage industry. It focuses its sales efforts on the largest mega-banks, including Wells Fargo & Co (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM), which can provide a huge installed base for the company’s mortgage technology platform and the potential for ancillary services. Lender Processing Services also has a large default services unit that has been pressured lately by foreclosure moratoriums and settlements with state attorneys general.
In its latest fiscal year, Lender Processing Services, Inc. (NYSE:LPS) had a weak financial performance, especially in light of the strength in the domestic housing market. For the period, it reported increases in revenues and adjusted operating income of 0.8% and 5.3%, respectively, versus the prior year. While revenue in its origination area was up 20%, the gains were offset by double-digit revenue declines in its default services business. In addition, the company incurred higher technology costs as it continues to try to transition its large customer base to its new cloud computing product offerings.
Fidelity National Financial Inc (NYSE:FNF)’s core title business has rebounded sharply lately, in line with higher housing purchase and refinancing activity, approaching its segment sales peak in 2009. In its latest fiscal year, the title segment reported increases in revenues and operating income of 18.2% and 47.7%, respectively, compared to the prior year. The unit’s operating margin spiked due to both higher production volumes and a greater percentage of business from its internal sales force versus independent agents.
As a title insurer, though, Fidelity National Financial Inc (NYSE:FNF) needs to earn a decent return on its large investment balances to offset potential claim losses on its policies, a difficult task in the current rate environment. Consequently, the company has been taking a page from Warren Buffett’s playbook by buying controlling stakes in operating businesses, like auto parts maker Remy International and restaurateur J. Alexander. The title insurer’s management obviously sees the acquisition of Lender Processing Services, Inc. (NYSE:LPS) as a solid investment value, with the potential to cross-sell technology processing and title insurance products.
While an investor could buy Fidelity National Financial Inc (NYSE:FNF) to gain exposure to Lender Processing Services, Inc. (NYSE:LPS)’ future profit stream, only about 22% of the combined company’s revenue base will come from the mortgage processing segment. A better approach would be to buy competitor Ellie Mae Inc (NYSE:ELLI), a mortgage technology and processing company that has a leg up on Lender Processing Services in the cloud computing area with over 41,000 current active users. The company’s technology product offers compelling automation capabilities to mortgage professionals, leading to greater assurance that government regulations are being adhered to.