by contributor Dan Freed | Published April 1, 2015 at 9:41 AM
The complex web of companies tied to Atlanta's Ocwen Financial Corp. (OCN) is proving difficult to unwind, and may threaten the proposed $1.3 billion acquisition of Home Loan Servicing Solutions (HLSS) by New Residential Investment Corp. (NRZ), a REIT managed by hedge fund giant Fortress Investment Group (FIG).
On Feb. 22, HLSS agreed to sell itself for $18.25 per share, or about $1.3 billion, to New Residential in an effort to diversify its funding sources as at least one major debt holder, Blue Mountain Capital Management, claims the mortgage servicer is in default on certain of its debt issues.
While HLSS shares traded at a slight premium to that price for some three weeks after the deal was announced, they started slipping on March 17 and hit a post-merger announcement low of $16.23 on Friday. They were quoted at $16.39 Tuesday afternoon.
At least three industry watchers expect the deal will still go ahead, though Compass Point analyst Jason Stewart on March 23 cited additional fees and a delayed 10-K filing with the Securities and Exchange Commission as factors that "bias our price expectations lower." Stewart nonetheless retained his $18.25 price target on HLSS.
Further complicating the deal is the fact that many HLSS shareholders also own shares of Ocwen and/or Ocwen spinoff Altisource Portfolio Solutions (ASPS). Both Ocwen and Altisource could be negatively impacted by the HLSS acquisition if New Residential cancels contracts between HLSS and Ocwen.
Indeed, in a little-noticed March 12 filing, hedge fund Luxor Capital disclosed that it had suddenly become the largest shareholder in HLSS with a 9.8% stake.
"We believe Luxor is looking to protect its stake in Altisource Portfolio Solutions," wrote Piper Jaffray analyst Michael Grondahl in a March 13 note. As of its most recent filing, Luxor owns 2.38 million shares of Altisource for a nearly 12% stake worth roughly $30 million. Its stake in HLSS is worth about $115 million.
Grondahl believes Luxor is worried New Residential could gain control of mortgage servicing rights owned by Ocwen and shift them to Nationstar Mortgage Holdings Inc. (NSM), a competing mortgage servicer controlled by Fortress. Mortgage servicers are essentially debt collectors. Mortgage servicing rights (MSRs) refer to the contracts assigned to mortgage servicers which pay them a fee in return for administering the debt payments. Grondahl also referred to "noted opposition" to the deal from Kingstown Capital Management LP, a hedge fund that owns about 5.1% of HLSS and 9.5% of Ocwen.
Kingstown stated in a 13D filing Feb. 24 that it opposes the deal because it believes New Residential's bid is too low based on historical trading multiples for mortgage servicing assets. Kingstown argues HLSS is best served by "continuing its servicing relationship with Ocwen Financial Corporation, completing refinancing initiatives recently highlighted by management and executing the Issuer's growth initiatives as its financing and operations normalize in due course."
Kingstown and Luxor's combined ownership of HLSS, totaling roughly 15% "have clearly raised the bar" for the proposed acquisition by New Residential, according to Grondahl's note. Shareholders holding 67% of HLSS need to approve the deal for it to go forward.
One investor who has followed the Ocwen saga closely said he did not believe Kingstown and Luxor were necessarily opposed to the deal.
"They just want it spelled out in writing that Ocwen and ASPS contracts are going to be maintained for a long time," he said. It could not be determined if this investor had spoken to Kingstown or Luxor directly. The investor would not discuss his positions, though according to the latest regulatory filings he has shares in HLSS and Altisource and/or Ocwen.
Indeed, the question of whether New Residential will transfer servicing away from Ocwen was the very first question to New Residential management on the Feb. 23 conference call following the deal's announcement.
"We are not contemplating transferring any servicing," was the response of New Residential CEO Michael Nierenberg.
Despite that comment, Compass Point analyst Kevin Barker downgraded Ocwen to sell from Neutral on Feb. 27, citing the sale of HLSS to New Residential as the primary reason.
"After further review of the [New Residential]-HLSS acquisition, we believe the increased cost of maintaining the relationship with HLSS, combined with operational changes required by regulators, will have a material adverse impact on [Ocwen]'s servicing margins over the long-term. In addition, we believe the risk of having servicing pulled on private label trusts or transferred by New Residential is high. If this were to occur, it would have a serious adverse impact on the sustainability of [Ocwen]'s business model," Barker wrote.
Among those pressuring HLSS to sever its relationship with Ocwen is HLSS shareholder Mangrove Partners. The hedge fund wrote to HLSS' Board of Directors Feb. 9 asking it to terminate the company's relationship with Ocwen "without delay." Mangrove is concerned Ocwen's difficulties with regulators exposes HLSS to "grave risks," according to the letter from Mangrove portfolio manager Nathaniel August.
Calls and email messages to Mangrove, Luxor, Kingstown, HLSS and Altisource weren't returned. New Residential investor relations officer Mandy Cheuk declined to comment, as did spokesmen for Nationstar and Ocwen.
Despite the potential investor opposition from Luxor and Kingstown, Piper Jaffray analyst Jason Deleeuw believes announcements by Ocwen and HLSS that they would have to delay 10-K filings are the main reason shares have dipped below the agreed upon $18.25 price.
"I think the highest probability outcome is that the deal goes through as is--at the $18.25 price," Deleeuw said in an interview. He notes HLSS CEO John Van Vlack said the company had received "inquiries from multiple parties regarding strategic alternatives" and that New Residential's offer was the best "from multiple standpoints, including valuation and certainty of execution."
Other analysts, however, contend New Residential has HLSS over a barrel and could lower its price.
Sterne Agee analyst Henry Coffey noted in a March 18 report that the merger agreement allows New Residential to walk away if HLSS receives an opinion from its auditors indicating doubt about HLSS's ability to continue as a going concern. In delaying its 10-K filing March 18, HLSS stated it "requires additional time to prepare information related to its ability to operate as a going concern."
New Residential, Coffey contends, could use a negative auditor opinion "to negotiate a better deal for the company than the proposed $18.25 per share in cash, but we think it goes ahead with the acquisition."
Advising New Residential on the acquisition were Bank of America Merrill Lynch and Credit Suisse as financial advisers and Skadden, Arps, Slate, Meagher & Flom LLP, Sidley Austin LLP, and Maples and Calder as legal advisers. Advising HLSS on the transaction was Citigroup as financial adviser and Weil, Gotshal & Manges LLP and Walkers as legal advisers.