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 are a tailwind for Rocket as it accelerates mortgage refinancing. 

But the real value creator is for Rocket to continue its technological leadership which could be greatly accelerated with the assistance of artificial intelligence. There are two kinds of AI beneficiaries – the technology enablers (such as Nvidia, Amazon and Salesforce) and consumer class companies with business models that can be fundamentally improved through AI integration. As the market and technological leader in a highly fragmented industry, Rocket is well positioned to supercharge its already best-in-class mortgage assembly-line process by integrating AI to boost operational efficiency, profitability, and further expand its current pricing and timeline advantages over peers. Traditional banks should also have an easier time using AI to close the gap, as they have vastly more room for improvement than Rocket. However, AI is much more likely to be quickly adopted by companies like Rocket – companies that have embraced technology and the digital age – as opposed to older institutions that have historically been reluctant to adopt any sort of technological innovation. Throughout the AI revolution, we have observed across other consumer-based industries that the businesses that are already tech native (such as Tesla, Amazon and Spotify) are far better equipped to integrate AI in ways that meaningfully transform their businesses, and Rocket is in the driver’s seat to be this player in the mortgage industry. Moreover, Rocket has a relatively new CEO who wants to dominate the mortgage industry and is not afraid of technology, previously working at Intuit, PayPal, Groupon and Microsoft. If these value levers are properly executed, Rocket’s high single-digit share of the mortgage market should be able to grow to 15% to 20% organically and potentially higher if coupled with some accretive mergers and acquisitions. In the longer term, there’s no reason why this industry should remain so fragmented. Most digital consumer business markets eventually consolidate to a few major players with the winners commanding 30%-plus market share, and Rocket has a clear path to victory.

This is not ValueAct taking a “flyer” on AI. First, ValueAct is a very thoughtful and diligent investor and doesn’t take “flyers.” Second, ValueAct has extensive experience from both sides of AI. The firm has been in the boardroom at companies like Microsoft and Salesforce, two of the largest developers of AI. And ValueAct has been active shareholders at companies like Spotify, The New York Times, Expedia and Recruit (Indeed.com) – some of the largest users and beneficiaries of AI. So, when ValueAct invests in AI, it isn’t just spitballing. Rather, the firm thoroughly understands AI and how its customers can use it. ValueAct makes investments like this because it likes the company for all of the reasons stated above. The firm takes board seats in approximately half of its core positions but does not go into an investment “needing a board seat” or even necessarily wanting a board seat. Moreover, as a sub $200 million investment, this is very small for ValueAct. But as the float increases and it grows its position – and as management gets to know the company better – we think with ValueAct’s financial expertise and AI experience, it would be natural for the firm to be invited on to Rocket’s board.  

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.