FNF to Underperform

We are maintaining our Sell (under-perform) recommendation on Fidelity National (FNF - Snapshot Report). The company is effectively eliminating the holding company structure, merging FNT with FIS. Shares rose 20% after the announcement, eliminating much of the holding-company discount. Nevertheless, the company’s mortgage operations comprise 70% of the company’s revenue and we believe that mortgage rates will continue rising and will accelerate the current slowdown in home sales, shrinking revenue, and earnings. Therefore, we believe FNF shares will under-perform the overall market. Despite Fidelity National’s ongoing success in diversifying its revenue stream, it still derives about 70% of its revenue from the title insurance business. This has significantly negatively impacted revenue and earnings growth as the mortgage market has been continuously declining from 2003 levels, albeit at a slower rate than we anticipated. Long-term interest rates and, hence mortgage rates, have not risen in line with short-term rates (the yield curve has flattened) and therefore Fidelity’s revenues have not declined as much or as quickly as we initially expected. Moreover, we expect the anticipated revenue slowdown to have a disproportionately greater effect on margins, which have remained under pressure as costs remain high. During the first quarter, expenses rose 8% year-over-year. Although the company is making strides in bringing expenses in line with the current operating environment, we nevertheless believe margins will continue to decline as revenues shrink.