ValueAct takes a stake in Rocket Cos. How the activist may help lift shares

Company: Rocket Companies Inc (RKT)

Business: Rocket Companies is a financial technology company consisting of mortgage, real estate and personal finance businesses. Its segments include Direct-to-Consumer and Partner Network. In the Direct-to-Consumer segment, clients can interact with Rocket Mortgage online, as well as with the company’s mortgage bankers. Rocket markets various brand campaigns and performance marketing channels to clients through its Direct-to-Consumer segment. It also includes title insurance, appraisals, and settlement services. Partner Network segment leverages its client service and brands to grow marketing and influencer relationships, and its mortgage broker partnerships through Rocket Pro third-party origination (TPO). The company’s personal finance and consumer technology brands include Rocket Mortgage, Rocket Homes, Amrock, Rocket Money, Rocket Loans, Rocket Mortgage Canada, Lendesk, Core Digital Media and Rocket Connections.

Stock Market Value: $25.4B ($12.68 per share)

Activist: ValueAct Capital

Ownership: 9.99%

Average Cost: $12.37

Activist Commentary: ValueAct has been a premier corporate governance investor for over 20 years. ValueAct principals are generally on the boards of half of ValueAct’s core portfolio positions and have had 56 public company board seats over 23 years. Additionally, the firm is a long-term, thoughtful and diligent investor known for creating value behind the scenes. ValueAct has previously commenced 106 activist campaigns and has an average return of 52.60% versus 21.27% for the Russell 2000.

What’s happening

ValueAct has taken a position in Rocket Companies (RKT).

Behind the scenes

Rocket Companies is a financial technology company consisting of mortgage, real estate, and personal finance businesses. In a highly fragmented industry, Rocket has steadily gained market share and is now the No. 1 originator of mortgages in the United States. This position has primarily been driven by a technology-first, assembly-line approach to mortgage processing. Unlike industry legacy methods where people and technologies are stretched over the entire process, Rocket has broken down the workflow into distinct stages and has dedicated people and technologies at each step. As a result, the company can originate a loan at about one third of the cost of peers and close loans in an average of 21 days versus 45 days for its competitors. However, the company’s share price has yet to reflect this clear competitive advantage, as shares are down over 29% since its initial public offering in August 2020.

While Rocket is a great company, it is not a great stock. The primary reasons for this are its small float, controlled ownership and unnecessarily convoluted share class structure. Rocket’s founder Dan Gilbert retains over 80% of voting power through a preferred share class. The current public float of the company is only about 7% of the total voting power. Further complicating matters is that Rocket’s ownership has been spread across four different share classes – though in March, the company said it would reduce its share classes to two. These factors made the stock difficult to buy, leaving its investor base absent of many long-only institutional investors that are typically sought after by companies of this size and stature. The valuation gap that has resulted from this is clear, while Rocket trades at a single digit price-earnings multiple, comparable businesses like Schwab trade closer to 20 times.

The float issue is in the process of being remedied, however. Rocket’s public float is set to increase to 35% from 7%, because of the company’s pending acquisitions of Redfin and Mr. Cooper. Additionally, the company will be collapsing its share structure from four to two. This will still leave it a controlled company with Dan Gilbert owning approximately 65%, but controlled companies do not scare ValueAct. On the contrary, the firm has delivered strong returns investing in many controlled companies such as Liberty Live Group, Meta Platforms, Martha Stewart Living, The New York Times, 21st Century Fox, Spotify and KKR. In these situations, ValueAct has delivered an average return of 96.15% vs. 21.12% for the relevant benchmark. While the significantly increased float and simpler capital structure should attract the broader base of long-term institutional investors who have thus far been sidelined, this is just a tailwind for stockholders, not a value-creator. Likewise, declining interest rates…