Chit Chat Stocks - FICO (Ticker: FICO) with Buyback Capital

Episode Date: February 16, 2023

FICO or Fair Isaac Corporation, develops analytic, software, and data decisioning technologies and services. The company's products and services help businesses make more informed decisions by analyzing consumer credit data and providing credit scores and predictive analytics solutions. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of Buyback Capital's work? Check out their Twitter here: https://twitter.com/Larryjamieson_?s=20&t=gJKWa75W6sj1WCoixTULoA Contact us: [e-mail] Timestamps FICO | (2:51) Competitive Advantages | (19:20) Big Risks | (46:36) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chitchat Money. My name is Ryan Henderson, and I am joined by my co-host, Brett Schaefer. Today is our Thursday deep dive episode where we interview an analyst to discuss a single stock. And today we have on the show Buyback Capital to talk about Fair Isaac Corporation, otherwise known as FICO, probably a name a lot of people are familiar with. As far as our guest goes, I'm a big fan of Buyback Capital. I've been following him on Twitter for a long time. I think we have very similar investment ideologies and philosophies. I think his knowledge and his depth as an investor will shine through in this episode as he digs through FICO. But anyways, before we get to the interview, I want to talk about

our presenting sponsor, which is Stratosphere. Stratosphere is our investing home screen for fundamental research. You guys see us, our listeners see us using Stratosphere all the time and we genuinely use it as our daily dashboard. It lets you easily track all your investments, track any stocks you're researching. It's got this nifty news feed. It's got SEC file aggregation tool, a number of, I find new tools every day. There's a fundamental charting tool. And then perhaps my favorite, they've got tons of company specific data where you really can't get anywhere else, at least not in one seamless place. There's plenty more. Stratosphere is free. Go ahead, check it out. Stratosphere.io. That is Stratosphere.io. And if you want to use

any of their paid plans, use promo code CCM and you get 15% off. And if you're more interested in the Stratosphere platform, go ahead and stick around after the episode. There's a three-minute interview we did with Stratosphere's founder, Braden Dennis. But without further ado, let's get to the interview with Buy Back Capital. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other

podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. All right. Welcome in. Today, we are joined by Buyback Capital. It's his first time on the show, hopefully not the last. We met through Twitter, through a recommendation of a previous guest, Philip Martinelli. I think Martinelli. He said, we got to get Buyback Capital on the show. And so, I reached out and we're happily joined by him today. And we're talking about FICO. So kind of, I guess maybe before we talk about what FICO is, how did you like stumble across this as an investment?

Yeah, thanks guys for having me on. It's awesome. Yeah, look, I came across the company. I've known about it for a long time. When I was in law school, I probably the only class I remember really being engaged in was consumer law. There are different regimes in the Western world, but one of the most striking things about consumer law is the focus on various interest rates that can be charged on short term money, auto loans, etc. These are things that are fairly well regulated.

And I was struck by the fact that in the United States, unlike other places in the Western world, there's a fairly uniform and strict regime about credit ratings. And so you hear about the FICO score, you hear about it in movies, banks refer to it, subprime auto lenders refer to it. So it was a bit of a cognitive referent for me to begin with. um in the summer of 2021 so the end of 2021 in australia um there was a fairly large drawdown in the shares of the company um and at the time this was being driven by you know question marks around a software business and potential new competition from the likes of upstart um when you dig kind of you know even on a very cursory look at the financials you can tell that this is um a fantastic uh company it's not usually you need to dig a little bit deeper to get you

know that kind of insight this is something where you can basically just pull up the income statement and you're um you know kind of lost for words so it was a company that was trading at a you know kind of high teens forward multiple um you know kind of ticked all the boxes it looked attractive compared to the 10-year i think if you remember at the time the 10-year was about 1.6 percent something like that uh you know very strong earnings growth long-lived franchise that kind of thing so it was a drawdown in the general market um a guy that i follow deb Cantus area, it's his largest position. So it was kind of an alignment of the stars, if you will. Right. And it's a term I imagine a lot of people are familiar with, but can you maybe go into like

how they actually make money? Cause that doesn't seem, that's maybe not super intuitive. So like who are their actual customers? And then I know they have two elements to their business. So can you talk about the non-scores as well. Yeah, sure. So just like you say, in terms of revenue, they really have... And this used to be different. And we might talk about their other businesses that they pursued over the years. But in terms of actual incremental operating income that contributes significantly to the company, they run a scores business, just like you've like you've said this is primarily broken down into b2b and b2c primarily they distribute the score so we talk about the score the score is an algorithm that's run on top of credit bureau

data so you've got the three big credit bureaus they own the data the fico score is run is an algorithm that's run on top of the data that comes out of the bureaus um and so the primary that the primarily the b2b customer base are the credit bureaus um and to you know a lesser extent you know lending institutions um and what have you so fairly consolidated base of customers um every time a pull is made so they pull a score uh fico will charge the credit bureaus or the financial institution um a fee for doing so and typically in most circumstances that fee for running the score will be passed along to the lender during the whole lending process. If you ever bought a house or you bought a car or something like that, you'll know that there

are closing costs. Some minute portion of that, depending on what you purchased, is your FICO score that's been fed down the value chain. On the B2C side, FICO also makes your individual FICO score available to you through a platform called MyFICO. And so any individual consumer I can, you know, open an account with them and check their FICO score. And that's quite good for many, many. And that's, you know, a relatively new innovation for them. This is a company that's been around since the mid-50s. And the, you know, MyFICO platform or the ability to check your own credit score has only been around for less than 20 years, I believe.

So that's 25% of the score's revenue. on the software side um they did divest um a business there primarily what they do is they have a platform called decision management um and you know it's in the middle of a transition to the cloud so you know as probably most people will be aware you know last 15 years many software companies have been moving from a license model to a software as a service model and there's all kinds of good stuff and you know uh difficulty in the you know reporting the financial reports So, that traditional accounting doesn't deal with it so well. But the essence of the decision management platform is that it services, you know, the 200 largest financial institutions.

And it's a money saver. So, that's really, it's, you know, a platform that a company can use to analyze their own data when they're making, you know, credit decisions. The company, you know, alludes to the fact that this software could be used for, you know, many other use cases in many other industries. And we're kind of very early days there. and uh so the money they make on the software side is you know part of that is traditional licenses there's people who are using versions of the platform that are you know decade plus old and then there are new signups that are you know going straight onto the sas model and then there's a big swathe in between of people who they will eventually you know renegotiate to you know sas

monthly fees um for doing so all right yeah we're going to talk about the software company in more detail later as it's getting to be a larger portion of this business uh and you mentioned a bit of the history but i want to talk about just for context for the listeners how did they end up becoming and i wrote monopoly provider here but i think they're probably the duopoly provider you mentioned they have one big competitor what is any relevant history to kind of get people up to speed and how they got to where they were say 50 years ago to where they today? Yeah, awesome question. The history is not so different than the history of sort of Moody's and S&P in the credit rating world. We're talking more about the consumer credit rating world. So

famously, the company was started in 1956 by Bill Fair and Earl Isaac, I believe the names. They both you know invested four hundred dollars uh into the business and that's pretty good um pretty good return for them um uh you know the early days were a very hard slog so basically you know two years after the company was created they came up with this idea of a credit score the philosophy of the company you know is not dissimilar from the philosophy of like almost every fintech today which is we're going to you know digest data to make uh financial and credit decisions more efficient and rational and so that was the initial rationale you know 70 odd years ago two years into the company they came up with the score they took the score to 15 financial institutions and kind of

had a very slow um slow progression from then the original traction for the idea is that it was actually quite innovative the um the score was um a way to you know judge credit worthiness of an individual borrower um in a way that was much more efficient than had been done before because a normal human lender will have all kinds of biases and um you know even bringing a tiny bit of of data analytics to your decision making can be quite a big delta really what got them to the unusual market position that they are in in today um is the advent of securitization so you know in the last 70 years or so there's been this huge move away from um the instant the financial institution that originates the loan in the old days would hold on to the loan now today that's

actually very uncommon most people who originate loans will resell loans to investors and so this creates an odd nexus um it creates three parties uh to a transaction so you've got the borrower the lender and the investor who will eventually buy the um the loan from the lender and so when you have this kind of multivariate um scheme you need a standard to coalesce around you need a kind of shorthand way to assess uh the riskiness of any loan and so investors who are purchasing these loans they need a way to you know assess their riskiness quickly like you know these huge portfolios it's not they can't really go down the line and you know analyze every single securitized loan within you know a particular mortgage-backed security or a you know a loan-backed security

product so that's you know kind of the gist if there were a big breakthrough you know most people point to 1995 when fannie mae and freddie mac um took the fico score um as a way to determine who would and who would not qualify for a fannie and freddie um guaranteed loan and obviously the you know the u.s 30-year mortgage regime is completely supported by that so that's kind of the that's another onus where you know these the government and a quasi-government institution came to the party they also needed a way to make sense of you know this vast market with all these loans being made and so you have this very odd circumstance in the wake of 2008 so obviously a lot of mismanagement and misallocation of resources went on before this

the government once again sort of stepped in and needed a way to rationalize markets So, in the period since the GFC, the FHFA, so the agency that regulates mortgages in the United States, they basically mandated a FICO score for, first of all, securitization of mortgage products, but also those mortgages that would qualify for a 30-year. So part government, part historical kind of accident, if you will. well who i guess who are their competitors because i know in the last two years uh and kind of with the the rise of upstart it made it seem like fico was maybe dying when that doesn't seem to be what's played out so like are there some true competitive threats kind of on the horizon and then um who would they be right yeah so the um um i tweeted a little bit about this but i think uh calling upstart a competitor um is perhaps mis-sequencing markets just a little bit

um upstart is a very large fico customer so one of the things that um fico mentions is that you know this move away from or what people interpret to be a move away from purely using the FICO score is not detrimental to the company just because a lending institution wants to implement many inputs into their credit decision doesn't really mean that the FICO score is under threat so upstart phenomenal company they have a philosophical difference with the FICO score which I think is sort of playing out. You can see it in their reported numbers now where their idea philosophically

was that we're going to find the diamond in the rough. So we're going to find the guy with the 600 FICO score who should be 800. And, you know, we're going to make money because he's, you know, we'll be able to lend money to him and he can actually repay better. The FICO model, this philosophical model is to try and, you know, cut out bad risks.

so they're more on the side of um you know harshly grading people so some people who may actually be you know 100 points whatever it is greater than they are they may be harshly graded but the kind of outcome is that's a more sustainable model over time so that's kind of like a heuristic that they operate by um in terms of competitors exactly right so um in the positioning that we talked about before the main customer for FICO is the credit bureaus the three large credit bureaus and naturally there's a tension between those two guys because the credit bureaus in some sense you know they are an oligopoly but they also do you know they are charging closing fees on top of a loan and so there's a little bit of competition there about how cost effective they can be

compared to their competitors, even though they do raise prices over the years. So there's a natural tension there because they are effectively on passing the FICO score cost to the customer. So they banded together a few years ago and they created what's called Vantage Score. Vantage Score, once again, is the public propaganda, if you will, is that it's a lot more inclusive than the FICO score.

um and you know it opens up uh you know lending to to more people really what the credit bureaus were trying to do two things they wanted to be able to lend to more people so where the fico score might be harsher it would stop them from lending out you know as as much as they might like to so they would be able to circumvent the fico score and you know lend to their heart you know, issue more loans or be the catalyst for more loans, if you will, and then also to save their costs. So they could, you know, instead of paying $10, $7, $3, whatever the score pool might cost, you know, they could just have it in-house with their own little score.

That's actually turned out to be a kind of disastrous strategy for them. there was a recent FHFA decision around mortgage which essentially you know created this duopoly status now so in the past the bureaus only had to pull a FICO score for a mortgage and now they have to pull a Vantage score and a FICO score so they've kind of doubled up and they used to be called tri-merge so you'd go to all three credit bureaus and they would all run one FICO score and then you'd have a conforming mortgage. Now you only need two of the credit bureaus and you need two scores.

So they've introduced competition for themselves. So, you know, one third of the credit bureau is going to be cut out of every decision and they are now mandated to pull a FICO score as well. So it's kind of like maybe five years of, you know, unlimited pricing power there where the FICO guys can really push. The other competitive threat is really a bit of a trend

it's not a huge trend, but this has popped up a little bit where some lending institutions have moved away from the score and have been able to securitize without it. So this is probably a handful of banks, usually regional, not large. And they usually make a big song and dance about leaving the FICO score, but you never really hear about if they're using it again. So it's a bit unclear how that is. In the vast majority of cases, to be able to sell securitized loans, it does need a FICO score so that's something else you'd really need to keep your eye on over the years and and the other thing that I would say about that is that FICO is continually upgrading the algorithm so they're onto version I can't even remember it's something like 15

so they have different iterations of the score over time and they're opening it up and they're doing certain things so they were one of the first people to not take race or gender into into decisioning of credit and um you know that was i think 40 years ago so um they're innovative they keep they keep updating it but um yeah there's a few there's a few hair you know there's hair on this and you you mentioned i think i don't want to call it regulatory capture but maybe a regulatory competitive advantage is that why they are so difficult to displace and do you believe they have any other competitive advantages because kind of personally i think the fico score Or while you may not think about this at first glance, it kind of has a pretty good branch.

I don't know. Do you agree or disagree with that? It does have... You're 100% right. So it has this cognitive referent thing where it shows up in movies. So if you watch the big short, they're talking about FICO scores 650, da-da-da-da-da. So it shows up time and time again. And it shows up in unrelated earning reports.

So you'll hear large banking institutions, which aren't technically customers, they'll talk about the score. You have this kind of cultural pervasiveness, which is a very positive thing for the company because it means most people will identify with it. So on the customer's side, they identify with, you know, when they think about their credit score, they're thinking about the FICO score. it's going to be very difficult for you know the public consciousness to think about vantage score when i think about vantage score i think about like it sounds scammy to me i don't know it's

new i don't understand it you know why is it even here very hard to kind of have that um you know mind share as buffer would say um you're 100 right on the regulatory capture thing so in the mortgage segment which is a very important segment for the company they do have regulatory capture they are mandated by the government it's a man a government mandated uh duopoly now so that's obviously a very strong part to the thesis um some things which are less well understood generally is um a lot of these financial institutions they run off very old coded software called cobalt so you guys might be familiar with this this was a um uh popular programming language in the 60s 70s kind of when a lot of these uh financial institutions were um you know building out

their computer infrastructure fico's kind of built into this so you know i i've heard computer program computer programmers say like the number of people who can really um competently code in cobalt now you can kind of like count them on one hand or something like that so the ability for these banking institutions to change their internal infrastructure would you know the pain point would just have to be so high um for them to to really do anything about this there's a way where they're kind of woven into the financial fabric um of society as well and you know finally i would just say it's a good product they're um they're the philosophy we talked about is a long lived philosophy so if the fico score has been around you know almost 70 years there's a reason

for that and the reason for it is is that it's a risk averse approach so the upstarts of the world and whatever i'm fairly confident um if not already but these guys will find themselves in very uh hot financial water um if you know you know in a very adverse credit regime and they're already starting to see it and i mean you know what do we have like eight rate hikes or something but i understand that it's the worst bear market in rates ever but a lot of these people have built no margin of safety into the lending practices. And in an 08, I mean, they finished the toast. So the fact that the FICO score has been able to thrive and survive,

part of that reason, it's not just regulatory capture. It's that it actually is, you know, rating credit scores in an efficient, you know, margin of safety type way. You may have already mentioned this. I apologize if I'm asking it twice, But why is the FICO score mandated on the mortgage side? What was the incentive from the governments to make that a part of the mortgage application process?

Yeah, right. So the, and I might have historical facts a little bit wrong on this, but the broad general narrative is that it's really in the government's interest to have an orderly mortgage market. So, you know, going back to first principles, the 30-year mortgage regime is like, if you don't live in America, someone tells you that you can get a 30-year fixed mortgage. It's like, you know, your mind kind of explodes. You're like, how is that even possible? And it's possible because it's a government-sponsored program, right? You have the Fannie Mae and Freddie Mac guaranteeing these loans, insurance on these loans, and there's a whole infrastructure built up there to support this regime. And it's a fantastic deal for the American citizen, you know, like you can buy a house, you can lock in an attractive rate for a long time.

If you want to refinance when rates go lower, that's very easy. If rates go up, you've still got a great rate, you know, and it's this way to have a very, long-lived tax basis, you know, cheap housing, you know, the whole thing. So I'm generally very supportive of it. But the government does need a way to kind of make sense of this market and make sense of it in a very rational way. And so if you had 35 different standards by which people were issuing loans and this kind of thing, it would be very chaotic

and it would probably be impossible for this regime to exist. if there were very large portions of the market that were non-performing um you know it would it would be kind of a societal disaster like what we saw in 2008 so i think the government recognized the score is quite a good way a risk averse way to do this it's a way for um everyone to be on the same page if you can if everyone knows how they can build their credit right if you've got all these different scores and they've all got a different way that you know a different path to building your own credit, how are you supposed to make a decision about that?

So it's kind of the investors, the lenders, the borrowers like it for the most part, and the government sees it as a way to rationalise the market. The new trend that we're seeing, you know, probably since the advent of Obama and, you know, kind of the woke crowd kind of getting more involved and millennials becoming a bigger part of the consuming public is that you have this greater push for inclusion so the um the the traditional um the criticism of the FICO score is that um it doesn't include enough people so

um typically you see certain demographics so for instance you know the black community certain other minority communities um appear to be penalized uh quite difficult uh you know in a that they're penalized quite harshly by the FICO score. I don't think that's a racist thing. I just think some communities are disadvantaged and the scores will interpret the data that way. So that's kind of like a forward-looking thing that scores probably need to become more inclusive

to keep up with societal trends. But yeah, it's a good product, a risk-averse product and worked for a long time. No, it's a great overview. And let's go to the second part of the business, which is software. where I just generalized this as their new business lines, but how has this gone?

How many years have they been at this? And what potential do you see with the stuff that is the non-credit score area of the business? Right, yeah. So full disclosure, when I first bought the business, I was not very focused on software. One of the general characteristics of a wonderful business is that eventually the CEO can't sit still.

He's got this thing which is just generating like ungodly amounts of profits. And eventually they get bored and they think we should be doing something else here. I've been such a genius with this government mandated monopoly. Surely I can take this into a different business line and be just as successful.

That is typically not the case. And that's something that's played out with Moody's as well. So there's been different iterations of the software over the years. Like I mentioned, they had the original license scores, which some are sorry the original license product um which has been around for uh many years and there are people using quite old versions of this which they cannot transfer to the new decision management cloud which is what they call it um the essence of the business like i mentioned before is

really that it's a it's a way for companies to make sense of their data so that it's obviously a you know general trend um in uh cloud computing towards this so the likes of snowflake you know being able to take all your data lakes and you know the terabytes and terabytes of data that you've got and visualize it make sense of it um get gain insights from it and that's really um what the decision management cloud is uh all about so the main customer base like i mentioned before it's about the 200 largest financial institutions um and um from all reports from the company you know they mentioned this in the last earnings call that um you know the software kind of pays for itself in less than a year and it's paying for itself because more efficient

decision making um is able to be made i'm not going to profess to know all the nitty-gritty details on it because i simply don't know i've never used the software before i probably need a few hundred mil to uh to get a copy um but the financial performance has been um fantastic So if you go over the last, if you have a look at the share price over the last year or so, it's done really well in part because the company has been able to grow their bookings, revenue and margins, the operating margins very nicely in an environment where other technology companies have had their costs sort of blown out as they've tried to keep up with their revenue numbers and whatnot. So, you know, from looking at the financials, it looks really good. I mean, it's a company which is in an odd happenstance where you look at the scores business and you're like, wow, this is amazing. And when you compare the software business to the scores business, you're like, you know, what's this pathetic thing that they're doing on the side? But it's got 30% operating margins.

If it was a standalone company, you'd be kind of blown away by it itself. um but yeah their ability to manage the costs on it is um breathtaking yeah they've done a very good very good job of managing it um they they did have a divestiture one of our less promising business lines uh in the end of 2021 into 2022 another software business so they are very realistic in their investments if they don't see returns on it they're they're willing to kind of spin those out divest them shut them down and they've done that with other business lines as well you know the infamous example is they used to have a collections business anyone who knows anything about debt collection will know that that is a really tough business and it's really

got to be the sole focus of what you're doing it's kind of like the reverse opposite of issuing scores and you know that they've shut that down they used to do consulting professional services that's low margin anyone who knows in software knows that if you're selling training that's people intensive time intensive you're trying to do the least amount of training the customer's trying to get the most amount of training out of you um and so that you know that they've stopped that as well so it's very promising the consensus um amongst people i respect um is that the the growth story will probably be a five to ten year um kind of time frame and because it does have this cost-saving element, there's probably tremendous pricing power in there. As loan

volumes trend up over time, they'll be able to raise their prices because the value between the money they're saving and the money they're charging kind of grows. So very promising. It was an option. It seems to have worked out. Yeah. Seems like there's some uncertainty there, but lots of upside if they continue to execute. You talked about the competitive advantages and it's pretty clear that they have pricing power over at the score segment. And it's likely because like you talked about, it's a small piece of the overall pie of the whole credit score and loan supply chain. I think the big question though is how much can they raise prices? So I guess maybe some context, I don't know if you have the exact numbers, but how often do they

raise prices and what do you think they could reasonably take prices to this decade without losing customers? Is it inflation rate? Is it double the inflation rate? What are your thoughts there? Yeah, great. So the dynamics of pricing, for many decades, they actually did not raise the price on the scores at all. So up until about 2018, they were not raising prices. So we're in year five or six of this. And if the price hadn't been raised for 30 years, there's a tremendous amount of economic uh goodwill there to put the scores into perspective um so this um they have um they have cpi plus special pricing so obviously the the cpi i think it's calculated in like september october every year so that year gets carried forward for the next year gets

calculated um the year after that and so on and they also have special pricing now they are very cagey about um how they are raising prices so i think for probably since they started the normal the what they call the special pricing um regime in 2018 it was probably quite discretionary and there was a lot of um uh experimentation going on you know what can we push in auto what can we push in mortgage what can we push in consumer so and um will lansing the ceo you know he's brought a lot of science to that whole um process and so the special pricing is kind of calculated at the same time and it seems that they are migrating most of their clients over to a um tiered structure so they'll kind of have the people doing the most amount of volume they'll kind of have you know 10

15 maybe 20 depending on what the deal is um they'll be in that range and then as you get to the second and third tier um when you get to the second and third tier financial institutions like the numbers are crazy it's like 100 to 400 they're going to raise in the next year i think over you know the historical period where they had the special pricing increases uh you know the special price increases have probably been something like 15 if not higher um and this is a little bit different depending on the exact um loan that they're making So, the place where they definitely have the most pricing power and potentially maybe unlimited is mortgage because you will not be able to get a mortgage without the score. To put that into perspective, let's take a half a million dollar loan, which I think is pretty reasonable.

That loan would have about $3,000 worth of closing costs. So, that's insurance, credit bureau, blah, blah, blah. maybe there's some local taxes thrown in there. So there's $3,000 worth of closing costs. The credit bureau's portion of that is about $92 at the moment. So normal mortgage, $92 on $3,000 on a mortgage of half a million. The FICO score, depending on the information that you get, if you just take the number of scores they run out of the year and you divide it by the scores revenue, it looks like $13, which is quite high than what the company has actually reported. The company in earnings reports has said that the average mortgage score pool is

something like $7. It can be something as low as like, you know, 50 cents for a personal loan. So let's say something like $7 to $13 on 92 for the Bureau on 3000 of closing costs on half a million mortgage. Where does that become cost prohibitive? Your guess is really as good as mine. My general feeling is that could be many orders of magnitude higher. Yeah, there's no reason anyone would give it up or stop getting a mortgage if it was $50, if that closing cost went from $3,000 to $3,050. It's a great point. And I wanted to make sure we add it on here because we talked before about hitting this point in case you forgot.

And it is the potential inflection in volumes for mortgages over the next few years. Is part of the thesis on FICO that we're in a slowdown in the mortgage market right now? Or how does that relate to their business? Because I know the volume, if it decreases, their volume is going to decrease. Ryan, do you have something to add there as well? Yeah, I'll just maybe tailor that into the valuation discussion, which is like, is that are they under earning right now? And then maybe could you give some context around valuation for the listeners? Yeah, no problems. So going back to the first question. Okay. So really one of the

largest macro themes it's been playing out over the last kind of, you know, since the beginning of our rates going up at the end of 2021 has been this massively precipitous drop in mortgage volumes. And most people will be aware of this. The typical 30-year mortgage has gone from like 1%, 2% to 8%, which is an enormous delta in a typical borrower's ability to service a mortgage. And you've seen incredible declines. So the company's really been reporting you know 40 50 percent declines in in mortgage volumes and mortgages really um it's a it's probably the most important part of um of their scores business because you know it's a regulated monopoly this is a huge market people are buying houses every year and there's always been a trend

towards you know very high levels of ownership in the west so um we're in a massive trough and For the company's perspective, those huge declines in a very core portion of the scores has been made up primarily in credit cards, so consumer loans, and a pretty healthy auto market, irrespective of a similar dynamic playing out there. so um really what we're seeing is a normalization of the of the mortgage market and eventually this is going to you know these volumes will uh normalize if rates come down it's going to be you know an even better boon for the company the other place where you see this um general dynamic playing out is in their b2c business so naturally when you're not able to get a mortgage or service a mortgage to buy the house you want, you're probably not that interested in your FICO score. So you're not on there checking your FICO score every three days, whatever it is.

So that's kind of affected it as well. There will be a normalization period and there will be a trend to normal eventually, especially if you assume that the credit markets kind of normalize in the next couple of years. And that will kind of be a catalyst in two ways. Obviously, the increased volumes that's just all incremental it really doesn't take much capital at all to produce a score and secondly it will probably be a um a catalyst for the ceo to go to his sales people to much more aggressively push the um the price hikes and the other kind of icing on the cake there is it appears that the bureaus are kind of coming to the party they're going to be you know pushing their prices as well so this will be kind of like an industry accepted um

trend. And probably everyone will do quite well out of it. So that's a silver lining on the horizon. What I mentioned before is that really, the precipitous decline in mortgage volumes has not really affected their financial performance very much, simply because the company has so much pricing power. So on the valuation point, Will Lansing, the CEO, he has come out in some earnings reports when analysts have questioned guidance and he's more or less said you know the company has such tremendous pricing power that you can pretty much rely on our guidance because you know this is a company that kind of can make its own income statement up if they if they you know they could they're pretty good at forecasting what volumes are going to be because you can

correlate them to where interest rates are and so they can say oh you know mortgage is at eight we reckon that's going to have you know x so much impact on volumes we're going to raise prices like 30 this year or something like that not saying that's going to happen i'm saying that's a scenario that can play out especially in this environment where you've got high cpi numbers as well you have to remember that's being added on so last year they probably had pricing seven or eight 20 you know on the average and so that can make up for a lot of volume declines you have to remember that these pricing escalators they're staying there so when volume comes back you know the these higher prices are going to apply to even more volumes so you know the business risk and their ability to

manage you know their earnings cash flows is very high and that's why you see a very high valuation for the company at least now so if you look at a stock chart i didn't see what it closed at today, but it's something like, you know, 45 times last 12-month earnings. And that's a price that is reflecting a kind of, you know, their ability to manage their numbers despite what would otherwise be quite adverse circumstances. It's reflecting, you know, an inflection point in the software and, you know, its ability to add incrementally to operating income and cash flows. um and you know there's probably a forward-looking element in there where they're seeing you know the market is kind of discounting a more normalized lending environment um and the fact that the

competitive threats are not uh they didn't materialize as many investors would have thought they would um so it's a very very high price i'm certainly not buying um the shares back the company themselves have continued to use their free cash flow pretty much all of it to repurchase shares um last year so 2020 and the year before that 2021 they borrowed a lot of money to retire shares um because they thought that the share price was very low um compared to what its future position would be and that would be a point i would generally agree with um i think they've probably done the right thing uh to not borrow any more money to repurchase shares at these at these levels. Yeah, that was a great job answering kind of a hodgepodge of four different questions

we threw at you. But I guess then this question might be kind of difficult to answer, but is there any point when like, I hear about those price hikes and I know it's still like if that $13 or whatever the price was on a $500,000 loan, I know that's low, but is there ever a point when And the price hikes kind of hit a wall where customers are just looking to get away from this. And it kind of either invites competition or invites pushback from customers. Could you see that kind of coming up at all? Yeah, I'm not so sure about the customers really being the adverse party here.

When you go and get a mortgage, you have the amount that you'd like to borrow. The house that you're buying is probably not an economic decision in the vast majority of cases. You know, you've got a family, your wife likes the house, the kids like it, you're buying it. You know, that kind of dynamic is playing out. When they get the closing cost bill, it doesn't say you've got $13 from FICO. It says, you know, you've got $3,000 from your mortgage broker or, you know, whatever it is. So, customers are probably not naive, but just generally, you know, the association of FICO and the increase in what their closing costs might be, you know, not quite apparent to them. This is also, you know, a fairly irregular decision.

You know, you buy a house once every, well, some people buy one house in their life and, you know, you buy a car every five, six years, something like that. So really the customer's sensitivity to this is, you're 100% right, there is some price somewhere where it does become, the closing costs would become a little bit prohibitive. But in a sense, you are making this non-economic decision. The place, the risk for the company, in my opinion, would be both regulatory and the relationship with the bureaus. so if the government were to come in and um you know pick another provider that they were going to exclusively accept you know conforming fannie and freddie mortgages from that would be naturally a catastrophic outcome um for the company in one of their reporting lines and the other thing would be um investors losing faith in the standard so if a large number of in you know large institutions

were willing to buy securitized loan products that did not have a fico score that would also be fairly catastrophic um event for the company and like they have made it through so many um like i you know probably we you know chances are we don't see an outcome like 2008 again where every institution on the lending food chain was acting poorly and all these standards came out stronger on the other side of it you know even that's kind of like mind-blowing so it's hard to envisage a scenario where a multitude of these parties to the standard lose faith in it and you know potentially move to a different standard or move away from standardization altogether I think it's unlikely. It's not impossible, but unlikely.

That kind of answers my last question, which I wanted to end with, which is the pre-mortem. Aside from some sort of regulatory change, is there any big risks you see here that could cause this to be a poor investment from here over the next, say, however long your time horizon is? hopefully it'll be forever hopefully they return more money to me every year that would be ideal but um but the main risks i really see for it apart from the you know clear regulatory um and you know just basic business positioning dynamic um would really be a move away from will lansing's regime so will lansing came into the company as a ceo in 2012 he had a private equity background he's a very level-headed individual he has a very clear plan for value creation and his strategy has been a very strong total stock return you know more volumes more pricing more share of

purchases and will leverage the balance sheet when it's appropriate to do so and that has been a spectacular you know value accretive event for all the shareholders in the company he has done a very good job in managing expenses um this has basically been you know very little change in the SG&A over the past four years, which, you know, you guys are an investor in some other technology companies and, you know, they have not, they have had explosions in their cost basis. This is a company that basically, you know, it doesn't own a lot of, it doesn't have a lot of PP&E. It has one, $2 million in CapEx every year. Like you can't even see CapEx on the free cashflow statement. It's a very well-run, efficient company. The risk in my mind

is that uh uh mr lansing is um he's not a spring chicken so late 60s 70s i believe he's been at the company now for 11 years and um my impression from some of the other executives at the company is that they are very flashy sales type people um and a serious concern of mine would be that some moron takes over as ceo and decides to the usual maligned um you know ceo path of m&a new business lines uh you know doesn't focus on the scores business um you know tells the sales guys to you know get out on the road every week all the kind of things that investors don't like that would really be um a very bad outcome for the company especially at its current valuation um and it would really damage you know the kind of total stock return thesis with the company

um that would really be um you know a very big risk the other risk is just clearly valuation um uh it's probably fair to say that the company is quite fully valued at the moment people understand that the bull case with the company is kind of being appreciated by the market and um you know significant deteriorations in in other uh scores sectors like you know auto personal loans what have you the things that are holding up um the revenues and earnings at the moment if there were a very large collapse in that that could have you know serious multiple compression you have to remember that during the gfc this is a company that was trading on like nine ten times eps which would be a very large re-rate but um probably not impossible you know

given a very adverse um circumstance but having said that um it's a company you have you can have a lot of faith in where their numbers are going under current management want to add that um and so you know the business risk is quite low valuation is quite high but you know if they continue to kind of pump out 20 percent ish you know free cash flow growth retire a bunch of shares uh that's a that's a recipe for a decent stockholder return all things being equal okay Okay. Last, last question. You mentioned the buyback program. Do you like that at these prices or would you rather see them just go invest it into T-bills or something while it's elevated? I know it sounds like management has plans to increase that E in the PE, but

is there any other way you'd like to see them allocate that capital? i'm generally very supportive of of what they of what they have been doing so this is one of the few examples where you've seen what what i've seen what a management have done i thought oh this is great and then you know usually management keeps doing what they're doing which is um you know that's where you can get frustrated because you want management to do something else uh despite the history so i think their capital allocation policy is very rational um it makes a lot of sense to reinvest capital in very high returning business lines which is essentially what they're doing in the buyback um program the alternatives yeah like keeping it on

the balance sheet or potentially doing a dividend um i think just from a pragmatic standpoint that is not um that's uh even though you know there might be a level where that's you know mathematically rational you have to remember that people purchase these companies for certain reasons and so if you um you know purchase a company under the assumption that it's going to repurchase the shares and then they pay a dividend instead that will attract different kind of investors and it's kind of like you know you're holding a warehouse door and a ballet recital at the same time and that can cause a lot of chaos in the um in in the shareholder base which i'm actually not very supportive of people buy to this company because they know they're going to repurchase the shares

and they have a high returning enough business lines to do that um so very supportive very supportive of them raising what is relatively low-cost debt to repurchase shares at what they deem to be low prices. I think they have a very rational perspective of what the value of their business is. And if it continues on, even a modest amount in relation to its last five-year business performance, repurchasing the shares is not a silly thing to do. I think somebody asked the same question to Buffett about Coca-Cola in 1999 or 98 when the shares were like 40, 50 times earnings. And I don't want to be immodest here. I'm certainly not comparing myself to the great man in any respect. But he said that that was not a stupid thing for the

company to do if you think the franchise is going to be better 10, 20 years from now. And so I kind of think along the same lines here. Okay. Well, I think that's all the questions we have unless Brett's got any others. He's shaking his head. So that's going to do it. Where can people keep up with you? What's your Twitter handle? What's the, what's the Substack called? Yeah, great. So the name on Twitter is Buyback Capital. The handle is at Larry Jamison underscore and the Substack is buybackcapital.substack.com. You can find the link on my Twitter page as well. Perfect. We'll link to that. That is going to do it, though. We want to remind our listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Money is not

formal advice or a recommendation. We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thank you again, Byback Capital, for coming on the show, and we will see you all next time. Okay. I'm welcomed by the founder of our exclusive sponsor, Stratosphere.io, Brayden Dennis. Brayden, welcome. I wanted to basically give listeners that are interested in Stratosphere more context around what the platform is. So let's start there. What is Stratosphere? And then why did you decide to start it?

Yeah, thanks for having me. I appreciate it. And I'm glad to be sponsoring the podcast as a listener myself. I like the deep dives. I like the different guests, the different perspectives on some interesting companies. So I think it's a good concept for a podcast, which is kind of what led me down to making Stratosphere in the first place, which was I was making content online and frustrated with the tools that were available to me. So I started building a very scrappy version of the product just for free, just to figure out like, how can I overlay 10 years of financial side-by-side up to 35 years we have now, and how can I actually build out a proper database of company KPIs that are not just revenue, but like if you're looking at like Costco, like how many warehouses do they have? How many paid members are are in like our costco members or you know if i want to do a comp against like the streaming like how many netflix subs versus uh hbo plus discovery plus no disney plus like how do i build up proper comps of those because those are the metrics that actually move the

business those are the ones that actually move the needle more than any like gap financial metric you'll find and so it started off as just purely a passion project and i figured let's just make Take the leap into entrepreneurship and see where it goes. And, you know, it brought us here today. Yeah. And like you mentioned, it is the stuff that you can't find anywhere else, at least not now. I mean, you could find it page by page on their financials. You can go through 35 PDF filings and find it.

Be my guest. And that's basically what we did for a long time. So what do, I guess, maybe describe the pricing model so people know. But you're going to say there's a free platform. What do free users get? Yeah, good thing. Because our mission was to always build a free platform. And so we really kept true to our mission and give like an amazing platform for free,

which gives you 10 years of financial statements on 40,000 global security. So we don't list you just to US securities. It's on global stocks. We give you a watch list, the screener, comparisons on competitors, fundamental charting up to 10 years, filings, transcripts. You can look at the press releases right inside the app, news, ETFs, funds, super investors, hedge fund letters, investor holdings, and financial calendars. Those are all the features you'll get on the free tier. Now, on the middle tier, the personal tier, you're going to unlock up to 35 years of financials and just kind of like nice to have, like quality of life, like notifications being built in, price targets for building models, like business owner mode where you can hide prices. Like kind of like just that next level for, for individual investors who want to level up. And then the top tier is for like investment teams and professionals who want to unlock that KPI data and request KPI coverage as well. Like a firm will be like, here, we want these 10 names in our coverage and in your coverage. And then you'll have basically our, our entire universe that we're looking at, which is great, right?

Because like earning season comes around and we have it updated within 15 minutes when Netflix comes out with their net subscriber ads, like it's right there in one place, especially easy to handle around the peak of earning season. That matters a lot for these people. And so we have a premium tier for that as well. That's the three plans that are available today. And now a perfect time to shameless plug our code. If you use CCM, you get 15% off any of the paid plans. But I think that covers it pretty well. If you're interested, please go ahead and check out stratosphere.io.

We'll have a link in the description as well. But thank you, Brayden, for joining us. Ryan, keep it up. I really like what you and Brett are doing, and I'll be listening along. This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hurricanes. Don't know the net?

Then Google us. From the underworld of Guy Ritchie. Do you want to step up the ladder? I want Comet dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren. Do I have to do everything myself? You want to vote? I'll give you a vote! Mobland. New season hits September 18th on Paramount+.