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Why the Mortgage Choice Limited (ASX: MOC) share price crashed 23% lower today

Mortgage broker franchisor Mortgage Choice Limited (ASX: MOC) lost nearly one fourth of its market capitalisation on Tuesday morning’s trade, down 23% to $1.46.

The Mortgage Choice share price has been very volatile recently, amid concerns that broker fees would be a subject of regulatory scrutiny after coming under the spotlight of the Banking Royal Commission.

However, today’s sell-off was triggered by negative media coverage on a different issue. A joint investigation by Fairfax and ABC’s 7.30 reveals that the company’s franchisees are facing financial distress, and as many as 173 of them, about half of the Mortgage Choice’s network, could be ready to take legal action to force the franchisor to improve their conditions.

Criticism over the mistreatment of franchisees recently hit other ASX-listed companies, including Retail Food Group Limited (ASX: RFG) and Domino’s Pizza Enterprises Ltd. (ASX: DMP).

The main difficulty for Mortgage Choice’s franchisees lies in the way they are paid. Brokers typically receive commissions from lenders, with the franchisor retaining a share of the commissions. During the GFC, the company introduced a performance-based model that links brokers’ margins to their success in meeting a monthly target of new loans, which has led to the erosion of brokers’ income.

On Monday, Mortgage Choice reported ongoing consultations with franchisees to review the remuneration model, in order to grant brokers a higher and more stable income. The review won’t affect FY18 cash results. The company expects to finalise the new model in July 2018 and implement it on an opt‐in basis across the network in August 2018. Any legal action from franchisees might be put on hold until the review is complete.

Foolish takeaway

Given today’s tumble you might be tempted to buy Mortgage Choice while it is in the bargain bin, as the stock trades at just 9x earnings, with a 15% grossed up dividend yield.

However, considering that the company’s business model has come into question with respect to both the fee structure and the treatment of franchisees, I doubt they will be able to keep their earnings and dividend payout unchanged, and I wouldn’t buy even at the current price.

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Motley Fool contributor Tommaso Autorino has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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