Near-Duopoly In Title Insurance Presents an Opportunity in Fidelity National Financial

Shares of Fidelity National Financial sold off today following news of the departure of its CEO, Alan Stinson. He will be replaced by COO George Scanlon who acted in the CFO capacity for Fidelity Information Services after its spin-off from Fidelity National Title.

Stinson did a heck of a job navigating the rough waters of 2008 and 2009 following the real estate meltdown. Under his leadership, Fidelity National brought its share of the title insurance market near 40% today, following the acquisition of LandAmerica Financial in bankruptcy court. Stinson will stay on board as a vice president, and Fidelity’s solid management team will keep the house in order. Incoming CEO Scanlon successfully orchestrated the sale of Fidelity Information Services to Metavante only a year ago. The sell-off is overdone, in our opinion, and shares are ripe for the picking.

Fidelity National provides title and specialty title insurance, claims management and information services throughout the United States. It currently holds the largest market share in the title insurance market, at 38%, with First American holding another 27%. The remaining title insurance market remains fragmented and with many under capitalized and underdeveloped competitors. Many smaller banks have created title insurance arms to enter the lucrative title insurance market, but state regulation remains tight with increasing scrutiny over claims processing.

More recently, mortgage companies have come under fire for automatic signing procedures and lack of safeguards in the foreclosure process. Almost all mortgage contracts mandate title insurance coverage and, as a result, title insurers are on the hook for liability stemming from a defective title transfer. Large mortgage companies, including Bank of America and its legacy Countrywide financial, have agreed to indemnify Fidelity National for liability for improper documentation procedures in the foreclosure process.

Shares are worth $22 apiece using a discounted cash-flow analysis. Title insurance premium growth will likely remain strong due to bursts of refinancing and foreclosure sales. Average premiums topped $6,600 per filing in the latest quarterly report, and growth should pick up once household formation picks up and consequently, real estate sales rebound over a multi-year period. Margins will benefit from Fidelity’s further use of cost-cutting technology, and should remain around 9-10% as a result.

Fidelity’s dividend expectations going into 2011 approximate 30% of cash flow, resulting in a dividend rate around half of the current yield of 5%. The cash freed up due to the dividend cut will be used by management to repurchase shares, effectively putting a soft floor on the price. Shares trade at 13.20 today.