Value in a 131-Year-Old Industry
Our take on the three players that dominate the title insurance business.
Not that many industries can trace their origins back 131 years. While it might be hard to believe, title insurance actually predates the invention of the automobile, radio, motion pictures, airplanes, and many other things we take for granted today. Of course, any industry that has been around that long will experience constant change and adaptation, and the title insurance industry is no exception.
Prior to the late 1970s, issuing a title policy was a labor-intensive process that required the expertise of title searchers familiar with massive volumes of public records. Technological advances, however, changed the industry dramatically. Title companies began to computerize county records, resulting in increased efficiencies that, in turn, considerably increased productivity. What's more, these advances paved the way for new products that evolved from the huge database that the real estate records produced. Title insurance companies began to realize the wealth of data they possessed. From a sleepy, esoteric industry that specialized in producing a virtually unknown product, title insurers woke up one morning sitting atop a mountain of information data.
At Morningstar, we cover the three largest title insurers, which responsible for about 75% of all title insurance written in the United States. In order of size, they are First American (FAF), Fidelity National Financial (FNF) and LandAmerica (LFG).
|Title Insurance Titans|
| Morningstar |
|Moat Rating|| Risk |
|First American (FAF)||Narrow||Average||$5 billion|
|Fidelity National (FNF)||Narrow||Average||$5.7 billion|
|LandAmerica (LFG)||None||Average||$1.4 billion|
|Data as of 05-17-2007|
From a pure title insurance standpoint, market leader First American has shown that it can expand its business profitably. It has increased its market share from about 23% in 2003 to almost 30% last year while maintaining a respectable 92% combined ratio. But of greater importance over a long term is that First American has leveraged its unique control of real estate information into products that are ancillary to its main product line. Years ago, it would have only received a title premium on a real estate transaction. Today, the firm is apt to be compensated for appraisal, credit reporting, tax services, and other services.
Yet all of this revenue is tied to real estate transactions, an extremely cyclical and sometimes volatile business. This is where the benefit of the firm's information database helps. First American, through its majority owned subsidiary, First Advantage Corporation (FADV), sells information acquired through a variety of databases to non-title insurance customers. First Advantage is growing rapidly and profitably. While only 10% of First American's revenue, the company accounts for 15% of pretax income.
Fidelity National Title
Once the behemoth of the industry, this firm has seen its market share whittled away. In 2003, the company commanded a 31.5% market share, but it has slowly eroded to about 29% in 2006. There is no doubt that Fidelity National's quest for better margins had a hand in this decline.
Fidelity's margins have historically exceeded those of First American. The combined ratios for title operations over the past three years were almost 84%, which is far better than First American's combined ratios. But title insurance results don't tell the whole story.
Fidelity embarked on a series of reorganizations and spin-offs over the past three years that had everyone, including us, trying to figure out what it was trying to accomplish. Like First American, Fidelity saw value in the raw data accumulated in title plants. The firm also branched out into ancillary and banking services. In the end, though, we think Fidelity only succeeded in destroying a sound strategy that would have made it a formidable competitor for title, ancillary, and information services. Now that the dust has settled, Fidelity is a title insurer with a couple of specialty insurance subsidiaries, and its past relationship with Fidelity National Information Services (FIS) is at arm's length. This is not enough, in our view, to match the capabilities of First American.
If there is one thing you can say about LandAmerica, it is that the firm has a very consistent and steady approach. LandAmerica has made it clear that it intends to operate as a title company with only minor emphasis on ancillary products. The company produces average margins for the title business--about 9% over the past three years--and has even gained some share through acquisitions and a strong commercial market presence. Management is extremely focused on enhancing shareholder wealth through share repurchases. For example, the $230 million pretax takedown of excess reserves that LandAmerica will garner over the next couple of years is mainly earmarked for share repurchases. This may be a sound strategy in the short term, since the company currently sells just above book value. Over the longer term, though, LandAmerica isn't investing back into the business, and this will eventually put the firm at a severe disadvantage to competitors who develop the products and services the market demands.
Value in Title Insurance?
Our pick in this sector is 4-star-rated First American. We believe that companies should invest for the long haul by building a strong moat that acts as a barrier to competition. First American has accomplished this feat by reinvesting returns from title insurance into information services that add incremental revenue to its main product line while also opening doors to other markets. First Advantage has developed products that are sold to entities like automobile dealerships that prequalify potential buyers, apartment owners screening prospective tenants, and more.
Over the long term, companies like Fidelity and LandAmerica should do fine. After all, we think the title business is as healthy as the real estate markets they depend upon. Population and household growth will continue, and an adequate replacement for the service title insurance companies provide has yet to be found. In addition, the cyclicality of the business doesn't really bother us; even Warren Buffet has acknowledged that he would prefer better returns from a lumpy business than lower returns from a steady one. That said, looking beyond this or the next housing cycle, we think it is wise to invest in companies that build a moat. First American is leveraging its ample technology and information base into a variety of businesses and services that the consumer and companies want and will pay for. We'd put our money on First American.
Jim Ryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.