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LPS a Good Long-Term Pick

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( MagicDiligence) -- Lender Processing Services (LPS) is the largest mortgage processing provider in the U.S. The company offers services that cover the entire span of a mortgage loan, from origination through service of existing loans and even handling defaults. Examples of services provided include title search, closing, lien recording, appraisals, flood zone certification, foreclosure, property inspection, and so forth.

LPS was spun off from Fidelity National Information Services (FIS) in 2008 and has an attractive business model. LPS is an outsourcing solution for lending institutions, primarily large banks. Revenue is dependent on the volume of mortgages coming through the pipeline.

One nice thing about the business is how it is set up to thrive during boom or bust periods for real estate. When the housing market is strong, LPS earns increased business on its loan origination services. When it is extremely weak, mortgage default volumes skyrocket and LPS earns the dough providing foreclosure and other end-of-life functions. LPS also has an attractive Technology, Data, and Analytics segment, about 10% of the business, that provides software, data management, and analytical services to lenders.

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There are three things I really like here. One is that LPS has a fairly consistent revenue stream. While mortgage origination, refinance activity and foreclosures will obviously ebb and flow in a normal market, there is a predictable channel of activity instead of a heavily cyclical boom-and-bust behavior (the last three years are a historical aberration).

Second is that LPS has high switching costs. Once a lender decided to utilize LPS for services, switching away can be costly and difficult. Third, and related, is that LPS has an outstanding competitive position, with its technology handling over 50% of residential mortgages by volume and processing about 80% of foreclosures.


So how does such an attractive business get into Magic Formula Investing, with a 14% yield on both operating earnings and free cash flow?

Over the past year, Lender Processing has faced a number of issues that have given the firm a black mark. First were allegations of questionable signing and notarization processes within its Default Solutions segment -- commonly called "robo-signing." This, of course, led to a flood of lawsuits from state attorneys general, an FDIC lawsuit against the firm, and a consent order issued in April that forced the company to do an independent audit of their processes, develop new controls and potentially provide monetary restitution from victims who suffered from their practices.
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