Intercontinental Exchange (ICE +3.10%) added another piece to its mortgage business recently by buying Ellie Mae from private equity firm Thoma Bravo. While Intercontinental Exchange is known primarily for owning the New York Stock Exchange, it has been increasing its footprint in fixed-income trading and the mortgage business. Intercontinental Exchange sees the mortgage business as the fastest-growing part of its verticals, and the company now has an end-to-end offering in the space.
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The analog-to-digital conversion in mortgage origination
Ellie Mae is a software-as-a-service company that helps mortgage originators automate the origination process. Costs to originate have been climbing as Washington adds more layers of compliance. The company estimates that the cost of originating a loan has doubled in the past 10 years. The next phase of cost savings will come from digitizing the mortgage experience. The Ellie Mae offering includes processes to streamline tasks like underwriting and processing, and it allows users to connect with different vendors, from mortgage insurance companies to title companies, via its systems.
With Ellie Mae, Intercontinental Exchange will be able to touch the mortgage loan throughout the entire process. During the origination phase, Ellie Mae's Encompass system handles the files. During the post-closing timeframe, Simplifile streamlines the process, and then the transaction is recorded in MERS (the Mortgage Electronic Registration System). Intercontinental Exchange believes the mortgage business is a $10 billion addressable market that can grow 8% to 10% a year for the next decade.
Intercontinental Exchange is paying up for this asset
Ellie Mae was taken private in 2019 by private equity firm Thoma Bravo for $3.7 billion. Intercontinental Exchange just paid $11 billion for Ellie Mae, of which 85% is in cash and 15% is in stock. The transaction is expected to close in the fourth quarter after the receipt of antitrust approval. The cash portion will be funded with newly issued debt, and Intercontinental Exchange will issue 1.75 million shares to Thoma Bravo as well. While Intercontinental Exchange intends to maintain its dividend (which yields about 1.2% as of Tuesday's close), buybacks will be put on hold until debt comes down.
The fact that Intercontinental Exchange is paying basically three times for Ellie Mae as much as Thoma Bravo did raised some eyebrows. That said, Thoma Bravo did not simply fire a bunch of people and flip the company; while private, Ellie Mae increased headcount and transitioned to the cloud. So while the price tag did increase, the company is better off than it was a year ago.
Ellie Mae's pro forma 2020 earnings before interest, taxes, depreciation, and amortization (EBITDA) is expected to be about $470 million. Intercontinental Exchange is paying over 23 times that amount, which is a pricey multiple. The company does expect to see cost synergies of $50 million to $65 million per year, but even at the high end of synergies we are looking at 20 times EBITDA.
Intercontinental Exchange also envisions the possibility of revenue synergies with the sheer amount of data Encompass generates. This could be helpful in making industry forecasts and could possibly help create new indices and data sales possibilities. The company expects the transaction to generate a 10% internal rate of return, and Intercontinental Exchange expects to be able to issue debt at around 1.6%. If Intercontinental Exchange can bump up the revenue growth for Ellie Mae, the transaction could end up being a winner.
