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On Dec 3, we downgraded our long-term recommendation for business services provider Lender Processing Services, Inc. from Neutral to Underperform. The relegation was primarily driven by downward fiscal earnings estimate revisions amid a challenging macroeconomic environment. However, if the company can tide over the current negative investor perception, it can expect a steady reversal of fortunes in future.    

Why the Downgrade?

Lender Processing was spun off from Fidelity National Services in July 2008. The company completed just four years of independent operation and is continuing to integrate the additional expenses associated with replicating systems, infrastructure and personnel as a standalone company. Moreover, an increased amount of debt post spin-off and its associated interest payment will continue to put pressure on the company’s earnings and cash flow.

The company’s business model is highly sensitive to government regulation, political risk and litigation. Any unfavorable legislation and/or lawsuits will likely impact the housing, origination and foreclosure business, impairing the overall growth of the company.
    
The continued underperformance in the company’s Default services business remains a cause of concern. Hit by lower transaction volumes, the Default services revenues continue to experience challenging market conditions, which call for new regulations and process changes related to foreclosure activity. Providing cost-effective services to clients’ needs for regulatory compliance has become difficult for Lender Processing in the recent quarters.

However, Lender Processing has historically maintained a balanced operating model that is designed to provide a natural hedge during fluctuations in the real estate market. Given the scope of the services provided, the company stands to maintain revenue strength at both ends of the mortgage cycle. While the loan facilitation services along with various data and analytics segments stand to generate higher revenues when interest rates are low and the residential housing market is strong, the company’s default management services are positioned to generate higher revenues when the residential real estate market is particularly weak and foreclosures are numerous.

Moreover, despite the substantial regulatory and market challenges that Lender Processing and the entire mortgage industry is facing, the company has not lost any major customer as well as new business opportunity in the recent past. The unique combination of scale, expertise and innovation continues to position Lender Processing as a leader in technology-driven solutions for the evolving mortgage industry.

Other Stocks to Consider

Lender Processing has a Zacks Rank #5 (Strong Sell). Other players in the industry worth considering include Global Payments Inc. (GPN - Snapshot Report), Higher One Holdings, Inc. (ONE - Snapshot Report) and Xoom Corporation (XOOM - Snapshot Report), each carrying a Zacks Rank #2 (Buy).

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