Could Optimal Blue sale tip scales in favor of a ICE-Black Knight merger?

A possible sale of Black Knight's product and pricing engine unit Optimal Blue could be the key that unlocks the Intercontinental Exchange transaction, said Ryan Tomasello, an analyst at Keefe, Bruyette & Woods.

The Federal Trade Commission's two-pronged opposition to the deal hinged on anticompetitive practices in the loan origination system and product and pricing engine businesses. Black Knight and ICE are looking to resolve the former by selling the Empower LOS to Constellation Software for an undisclosed amount.

"While the closing probability under the status quo appears balanced, we believe divesting Optimal Blue is a feasible path to guarantee the deal's approval, which is most likely to occur leading up to the July 24-26 trial," Tomasello wrote. "As we've stated previously, we believe ICE is open to divesting Optimal Blue as it is not a critical component of ICE's strategy."

Optimal Blue is considered to be the most used PPE in the mortgage industry. The Encompass LOS that ICE Mortgage Technology acquired in the Ellie Mae deal in August 2020 has its own PPE built in, but that is considered to be less robust.

The Encompass PPE does not offer "post-lock automation, dynamic markups with custom margins, instantly available historical pricing, pricing concession approvals, and custom fields," a June 30 ICE and Black Knight federal court filing for "proposed pre-hearing findings of fact" stated.

Furthermore, post-deal, ICE Mortgage Technology will operate both products, according to the filing. It should be noted that at the time the deal was announced, ICE executives said they wanted to keep both Empower and Encompass.

The July 24 trial Tomasello refers to will take place in the Federal District Court for the Northern District of California. That court wants to rule on the preliminary injunction prior to the FTC's internal hearing on this matter.

As a result, the FTC will not start its own proceedings until Sept. 25, filings on the agency's website state.

If Optimal Blue were to be sold, the chances of the deal being repriced again are low, Tomasello said. After the Empower sale was inked, the consideration was dropped to $75 in cash and stock per each Black Knight share from the original $85.

Selling Optimal Blue is a "silver bullet" for the deal, Tomasello said, noting that ICE could build a similar system organically or go out and buy a smaller competitor.

"In terms of potential buyers [for Optimal Blue], Constellation Software seems the most natural suitor, although we do not think the asset would have difficulty drawing interest in a competitive process (we believe there were several serious bidders when GTCR sold the asset in 2020)," he wrote.

The FTC in its own June 30 legal filing argued that a Constellation-owned Empower would not be able to compete without Optimal Blue, stating "Constellation will be unable to offer the single point of contact for pricing, contracts, and vendor management." But Black Knight and ICE said Empower users can use other PPEs such as Polly in their filing.

A fire-sale price for Optimal Blue could be in the $1.5 billion-to-$2 billion range, versus $2.9 billion that the September 2020 transaction was valued at. Black Knight partnered with Cannae Holdings and Thomas H. Lee to get Optimal Blue but by April 2022 had bought out their interests in the subsidiary used to acquire the PPE.

While a sale before the Federal District Court hearing is ideal, "it is theoretically possible to divest the asset post-trial but before the judge's ruling (which should take several weeks)," said Tomasello. "The divestiture could take place as part of a settlement that is negotiated directly, or under the advice of the district court judge."

The KBW report came out on July 6. Black Knight's common stock closed that day at $58.85 per share. It opened lower on the following morning at $58.66, but was priced at $59.58 at 11:30 a.m.

Even with the divestiture of Empower and proposed sale of Optimal Blue, many deal opponents have expressed concern regarding breadth of the combination. In particular, they are worried about Black Knight's MSP servicing technology, which holds a dominant market share in that portion of the business, combining with Encompass, the leading LOS.