Mortgage servicing company Black Knight (BKI 1.34%) saw its stock price fall 7.5% in the trading session after its third-quarter earnings report. The reason had a lot to do with a lawsuit filed against it by one of its clients. The stock has since recovered, and it's up more than 40% year to date -- which isn't too surprising, because Black Knight is a leader in its space and there's a lot to like about it. But there are some concerns on the horizon. Let's take a look at why Black Knight dropped, why it recovered, and where it's headed.
Lawsuits prompt drop
Black Knight provides data and analytics and software to automate processes for mortgage companies and the real-estate industry. It has grown its market share from 49% in 2010 to 63% now, and its loan servicing platform accounts for 70% of its revenue.
On Nov. 6, Black Knight was hit with a lawsuit by one of its clients, PennyMac Financial Services, alleging that Black Knight "uses its market-dominating LoanSphere MSP mortgage loan servicing system to engage in unfair business tactics that both entrap its licensees and create barriers to entry that stifle competition." PennyMac claims Black Knight is in violation of the Sherman Act, the California Cartwright Act, and California's Unfair Competition Law.
Black Knight countersued PennyMac, claiming that the former client broke its contract by instituting "a secret project to create a copy of the MSP System for its own benefit in lieu of the MSP System."
Black Knight's move
On the third-quarter earnings call, Black Knight CEO Anthony Jabbour went into more detail.
"In my second week at Black Knight, PennyMac Loan Services notified us that they were working on an MSP replacement," said Jabbour, who became CEO in April 2018. "Soon after, we noticed some anomalies in the usage of MSP and began a more in-depth review, which uncovered actions by PennyMac that show their improper use of the MSP system to unfairly accelerate the development, testing and implementation of PennyMac's system."
Jabbour said Black Knight tried to reach an agreement with PennyMac but couldn't. "As a result, yesterday we filed a lawsuit against PennyMac for breach of contract and misappropriation of trade secrets." It is seeking $340 million in damages.
These actions caused the stock price to fall nearly 8% on Nov. 6. But the stock has recovered as investors' attention has shifted from the lawsuit to another strong financial performance.
Black Knight's revenue increased 6% year over year, while net earnings fell 13% year-over-year to $37.3 million (that's due to last year's buyout of Dun and Bradstreet). Earnings per share by generally accepted accounting principles dropped a bit year over year, from $0.29 to $0.25. However, adjusted net earnings were up 7% year over year, while adjusted earnings per share (EPS) increased 6% to $0.51.
Further, EBITDA climbed 8% to $149.8 million year over year, with the EBITDA margin up 11 basis points to 50.1%. An increasing EBITDA margin means the company's operating expenses are lower in relation to its revenue.
In addition to maintaining its lead in mortgage servicing, Black Knight is also seeking continued growth in home equity servicing. Its market share here has grown from 6% in 2010 to 19% now, and it continues to add new clients in both areas. It is also seeing growth in its data and analytics business, which represents 14% of revenue. The company saw 9% growth here in the third quarter. "The fundamental underlying strength of the core business hasn't changed," Jabbour said.
Headwinds in 2020
While its stock price has recovered, Black Knight faces some headwinds heading into 2020. Specifically, Jabbour said the company is expected to take a 5% revenue hit next year due to the loss of some clients, including PennyMac. PennyMac alone generated about $33 million in revenue for Black Knight through the first three quarters.
These defections will cloud what is otherwise expected to be a strong year. But the company is working on several fronts to offset them.
"We're looking at sort of every pocket that we can to increase the efficiency of the organization in light of some of these headwinds," said CFO Kirk Larsen on the earnings call. "And so it's really across the board around streamlining facilities and in a variety of other actions that I think you would expect that we would take. But it's something that certainly we didn't just start last week, but it's been something that we've been working on over time to protect our margins."
Investors don't like uncertainty, and that's what Black Knight is confronted with heading into 2020. But this is a market leader that has been beating its competitors, and with strong fundamentals, it should continue to do so. Watch the lawsuits, of course, but Black Knight still looks like a good long-term investment.