PHH Corporation (NYSE:PHH) may face increased criticism from shareholders concerned over its decision to pursue a sale of the company despite a poor valuation. Pennant Capital Management disclosed a 7.8% stake in the company and issued a letter to the board outlining their belief that the company's shares could be worth as much as $51/share - significantly higher than the current buyout premium of $31.50/share.

The outsource provider of mortgage and fleet management services issued their proxy statement on June 18th that paint a picture of a seller in panic mode as bidders were dropping out and even Blackstone blinked at the eleventh hour. Interestingly, the issues that caused the panic were all irrelevant or self-inflicted and temporary; the two main concerns were of the sub-prime meltdown and the inability to file financial statements on time. These factors led to a proposed buyout of just $31.50/share.

Pennant believes that the real value of the company can be pegged closer to $51/share within two years. The New Jersey based hedge fund proposed that the company separate its mortgage and fleet management segments via a tax-free spin-off, which could alone bring the stock price close to $36/share. Using deferred tax liability related to mortgage servicing rights, the company could also prevent around $10/share in tax leakage that they would experience in the event of a sale of the company.

PHH also reported better than expected results for full year 2006 and the first quarter of 2007. Using a 15x to 17x multiple of free cash flows, Pennant estimated that the fleet segment alone is worth between $17 to $20 per share. Incredibly, this valuation implies a sale of the mortgage segment at approximately 0.7x tangible book value! Meanwhile, the hedge fund values the company's mortgage business at $26 to $34 per share, which is an 8x to 10x multiple of the combined servicing and production after-tax earnings. Combining these two numbers, Pennant believes the company is worth $51 to $68 per share and could realize that value over the next two to three years.

In the end, Pennant believes that the proposed sale of the company is being conducted at a price far below the true value of PHH. Additionally, the company's preliminary proxy statement fails to address many critical issues including the benefits of rejecting the proposed sale of the company. Consequently, the hedge fund demanded that the company immediately amend its preliminary proxy statement to reflect these sentiments and give shareholders a fair view of the transaction. Combined, these factors make PHH a stock worth watching!

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