Intercontinental Exchange (NYSE:ICE) just made a huge bet on providing software for the residential housing market. The company closed its $11 billion acquisition of Ellie Mae in September, which sets it up to dominate the market for mortgage software used by mortgage originators, lenders, and record keepers.
The acquisition of Ellie Mae is remarkable for more than just its sheer size. Intercontinental Exchange is the owner of financial exchanges including the New York Stock Exchange, and the company has a track record of creating liquid financial markets and then making a killing by monetizing the data assets. Is Intercontinental Exchange preparing to transform the mortgage market too?
The acquisition of Ellie Mae
Intercontinental Exchange completed its acquisition of Ellie Mae earlier this month. The $11 billion deal was structured as a cash and stock transaction, with 84% being paid from cash holdings and 16% from issued stock. By paying the vast majority of the acquisition cost in cash, Intercontinental has reduced the amount of a share dilution that comes from issuing a large amount of stock.
What is Intercontinental getting for its $11 billion? An electronic home mortgage platform.
Ellie Mae is a digital platform that serves many of the mortgage industry participants and is a critical player in nearly half of residential mortgages in the United States. Ellie Mae's flagship product is a platform called Encompass, which serves as a single record-keeping system. Additionally, it serves as a marketplace for connecting customers with additional Ellie Mae services provided by other third-party vendors.
Intercontinental's rationale for making the acquisition is straightforward, although not obvious. The company sees a huge opportunity to make the mortgage market more liquid and exchangeable, similar to how investors use the NYSE to buy and sell stocks and other financial products. Through its platform, Intercontinental can streamline the process of originating mortgages and standardize the terms so that mortgage loans can be more easily traded. This is similar to how Intercontinental has worked to create liquid exchanges in the energy and bond markets, which historically were more illiquid.
The mortgage market is large and growing, which makes it an extremely attractive market to enter. The market is estimated to be roughly $10 billion in size. Furthermore, there is a ton of friction in the market today due to compliance costs, origination backlogs, and a lack of liquidity and transparency. In other words, there is a massive opportunity for a company like Intercontinental to radically improve the way things are currently being done and capture value in the process.
Building on prior acquisitions
Ellie Mae isn't Intercontinental's first foray into the mortgage industry. The company made its first investment in 2016 with the purchase of the Mortgage Electronic Registry System known as MERS. MERS serves as a database to track the ownership and servicing rights of outstanding mortgages in the United States.
Then, in 2019, Intercontinental Exchange acquired Simplifile, an electronic mortgage settlement network. Simplifile acts as the backbone for the electronic closing and post-closing process. Ellie Mae was the final piece of the puzzle. Intercontinental can now bring together all the key players needed to go from origination to the final settlement of an electronic mortgage, all in one digital ecosystem -- creating an end-to-end platform maximizing efficiency.
The long-term vision in mortgage software
Intercontinental Exchange has a 20-year history in which it has mainly focused on targeting markets or assets that were primarily analog and were in the process of moving to a more digital platform. The company has shown success with this model with the experience of operating network marketplaces and reducing inefficiencies in their ecosystems.
The U.S. residential mortgage industry is a clear example of this. Intercontinental's ambition in the industry is commendable, because transforming such a large and established industry surely won't be easy. This is why making such large investments and acquisitions is necessary -- to piece together a large enough platform to gain traction.
Today, only a small fraction of mortgages are originated and recorded electronically. This is a clear indication of the opportunities at hand for future growth and the potential for Intercontinental Exchange to generate a meaningful new business to complement its financial exchanges business.