The private equity acquisition of the fintech vendor Ellie Mae comes amid a significant decline in mortgage volume and consolidation among lenders that have made shareholders nervous and its stock price volatile.
Its $3.7 billion sale to Thoma Bravo will alleviate some of those pressures and give the Pleasanton, Calif.-based technology developer some breathing room to more aggressively pursue a strategy to advance its digital mortgage capabilities.
During the company's third-quarter earnings call, President and CEO Jonathan Corr dealt with questions regarding seat count, lower-than-expected results on revenue per loan, growth rate, revenue headwinds and expense control.
But as a private company, Ellie Mae has a lot more freedom.
"You're not distracted by being on the road every other day, trying to cater to investors and having to do quarterly reports, and putting your feet to the fire on margins and even on targets for the year," said John Campbell, managing director at Stephens.
Here's a look at five pros and cons of the deal, which is expected to close in the second or third quarter of 2019.
No pressure to meet targets
"Part of the reason why Ellie Mae's stock price is where it is today is because they started to feel the pressure from the industry," Campbell said. "This is an indirect impact of consolidation in the channel and the market changing."
As a private company, "it has the ability to reinvest and spend, and not have to cater to consensus estimates and Wall Street estimates and having to toe the line," he said.
Ellie Mae reported net income of $100,000 off revenue of $116 million for the fourth quarter of 2018, compared to net income of $9.9 million off nearly $113 million in revenue a year ago, the company reported Feb. 14. In light of the pending acquisition, Ellie Mae canceled its earnings call with analysts.
The fourth quarter 2018 results include adjustments for acquisition costs related to its Velocify acquisition and one-time costs for the restructuring of its technology group. For the year, it earned net income of $22.6 million off $480.3 million in revenue.
"While revenue came in higher than expectations, margins pulled back quite a bit to 22% (down from 25% in the year-ago period). Adjusted EBITDA of $25.5 million was about 14% below our estimate, and below management's guidance of $28.8 million-$31.3 million," Stephen Sheldon, an analyst at William Blair wrote in a Feb. 14 note.
Ellie Mae could move into other products
Thoma Bravo has investments in a number of fintech companies, including three with a presence in the mortgage industry: MerdianLink, whose technology includes the LendingQB loan origination system; Kofax, which offers document capture software; and Hyland Software, which does electronic document management technology.
There might be "grander aspirations" for the company to offer more of a fintech solution and not just mortgage, Campbell said. The Ellie Mae platform could grow to include other forms of lending such as automobile and student loans, he said.
Ellie Mae "rolled out a lot of next-generation stuff in the last couple of years," Campbell said, noting it opened up its application programming interfaces and created more modularity with the system and that could lead to those other products being added.
Thoma Bravo may be paying too much
The $99 per-share price shocked analysts. "The fact that someone would pay 20 times 2020 EBITDA or higher for a business that is going to grow revenue 3% to 5% a year was surprising," said Henry Coffey, a managing director with Wedbush Securities.
But even though there is a go-shop period, a higher offer is unlikely, he said.
"You got everybody in the mortgage industry saying that mortgage tech needs to evolve for the next generation; that's an expensive process," Coffey said. "And someone just paid 20 times EBITDA for this company."
But the price may indicate Thoma Bravo is taking a long-term approach with Ellie Mae.
"The valuation was big in my view, but if you have a four- or five-year view, and you view some of these industry trends on the health of the channel as temporarily cyclical, you come out at a better end," Campbell said.
However, analysts at William Blair were not taken aback by the offer. "We believe the multiple paid is either fair or attractive. We note that the average 2019 adjusted EBITDA multiple for other real estate technology/information services firms we cover is about 22 times, so this multiple seems relatively in line with the broader group," the firm said in a report.
It eases the minds of Ellie Mae's partners
"Anytime one of our partners is set up for growth, that's a good thing for us," said Rajesh Bhat, CEO of the mortgage fintech Roostify. In November, the two companies announced a bidirectional integration allowing the sharing of information. Roostify now has integrations with 10 loan origination systems, although not with LendingQB, operated by MeridianLink, another Thoma Bravo investment.
"In our view, this transaction is going to allow Ellie Mae to have more flexibility to focus on growth and to accelerate truly connecting the ecosystem and allowing our shared customers a more full-scaled digital experience," he said. "To a certain degree they can think more about the long term as a private company."
The challenges now fall on Thoma Bravo's shoulders
There are two facts of life Thoma Bravo has to deal with, Coffey said. First, mortgage originations are expected to stay flat for the next two years, with lenders looking to cut costs by reducing headcount. Then there is the current state of mortgage technology.
"We still are in an industry where costs have gone up and up, we're up to $8,000 to $9,000 per unit on the retail side," said Garth Graham, senior partner at Stratmor Group. "Less than 10% of revenue on a mortgage is spent on technology, and 50% to 80% is spent on people."
But consumers are demanding better technology options, and the industry is just realizing that.
"That less than 10% has doubled in the last two years," Graham said. "As an industry for years we underinvested in technology. There's so much headroom for growth."
But these upgrades won't be cheap. "You got everybody in the mortgage industry saying that mortgage tech needs to evolve for the next generation, that's an expensive process. And someone just paid 20 times EBITDA for this company," Coffey said.
The Financial Stability Oversight Council said the mortgage giants may need a bigger capital cushion than their regulator has proposed, but stopped short of designating them as “systemically important financial institutions.”