Ellie Mae (NYSE:ELLI) – market cap as of 21/02/2018: $3.46bn

Introduction

On February 12, 2019, Ellie Mae, the leading cloud-based platform provider for the mortgage finance industry, announced that it has entered into a definitive agreement to be acquired by Thoma Bravo LLC, a leading private equity investment firm, in an all-cash transaction that values Ellie Mae at an aggregate equity value of approximately $3.7 billion. The acquisition looks to take advantage of the digitalization trend progressively shaping the mortgage industry, of which Ellie Mae is a market leader.

About Thoma Bravo LLC

Thoma Bravo is a leading private equity firm, with more than a 30-year track record, focused on the software and technology-enabled services sectors. With a series of funds representing more than $30 billion in capital commitments, Thoma Bravo partners with a company’s management team to implement operating best practices, invest in growth initiatives and make accretive acquisitions intended to accelerate revenue and earnings, with the goal of increasing the value of the business. Representative past and present portfolio companies include industry leaders such as Blue Coat Systems, TravelClick and Veracode. The firm has offices in San Francisco and Chicago.

About Ellie Mae

Founded in 1997 by Limin Hu and Sigmund Anderman, and headquartered in Pleasanton (California), Ellie Mae is a leading cloud-based platform provider for the mortgage finance industry. Ellie Mae handles the technology that underpins the entire-home-loan origination process, and its services are used, in particular, by loan officers who work at nonbank mortgage lenders. The company’s mission is to automate everything automatable for the residential mortgage industry.

As rising mortgage standards increase the amount of verification information behind a loan, and borrowers and lenders move online, Ellie Mae is increasingly becoming the reference IT system provider for the industry. With its end-to-end service, Ellie Mae counts 2,300-plus lenders as customers, and its network is around a quarter-million users strong. The stickiness of the business, embedded in banks, credit unions and online originators systems, means retention rates exceed 95%.

Industry Overview

The 2008 subprime crisis transformed the structure of the mortgage industry and triggered substantial regulatory intervention and consolidation. These events, in combination with the low-margin nature of the business, caused the largest banks, which initially dominated the $1.5 trillion industry, to progressively exit the market and create space for new entrants. These include online mortgage lenders, marketplaces and brokers as well as non-bank lenders.

Although the health of the lending business improved in recent years, due to rising housing prices and low interest rates, many traditional lenders still face challenges in providing their services at low cost and high convenience, especially during the loan origination process. Layoffs, sales and closure among these firms have thus been common. The remaining companies started to invest heavily in technological infrastructure to accelerate the delivery, quality and usability of their offerings. For example, by allowing customers to individually upload documents online, the time and cost of every origination is significantly reduced. Additionally, machine learning is anticipated to help lenders in analyzing customer data more effectively and contribute to the development of customized loan conditions. Experts believe that this approach will prove to be increasingly successful and important, as more technologically conscious millennials begin to penetrate the international real estate market.

Online mortgage lenders have been highly successful in driving traditional players out of the industry. For example, Quicken Loans has become one of the largest mortgage lenders in the United States. Online mortgage marketplaces, such as Zillow and LendingTree also successfully act as middlemen using their fast and reliable algorithms. In comparison, non-bank lenders often service low-rated individuals, to which JPMorgan Chase or Bank of America would not extend credit.

Given the aforementioned trends and developments, several private equity funds and financial institutions have lately acquired innovative online platforms. In 2017, Goldman Sachs purchased Genesis Capital, in addition to launching their no-fee personal loans and high-yield online savings platform called Marcus. Earlier in 2018, Thoma Bravo also bought the loan origination and new account opening platform MeridianLink.

Deal Structure

As specified by the takeover agreement, Ellie Mae shareholders will receive $99 in cash per share, which represents a 47% premium to the 30-day average closing price. Thoma Bravo is paying an EV/Sales of less than 7x Sales, in line with firms like Microsoft and Salesforce, but below Adobe. For a technology company, it looks to be a quite reasonable acquisition multiple (even though profitability is still not optimal).  

The company’s Board of Directors has already unanimously approved the transaction and has suggested that stockholders also express their support. The acquisition is subject to regulatory approval and it is projected to close in the second/third quarter of 2019, and is not linked to a financial condition.

Ellie Mae possesses a 35-day period, which allows the firm to consider any superior acquisition offerings, thus potentially escaping Thoma Bravo’s agreement. Should the company prefer an alternative acquiror, Ellie Mae would incur a $55 million breakup fee.

Deal Rationale

Ellie Mae’s acquisition is only the latest of a series of transactions that have heated up the financial services industry over last months and comes immediately after Morgan Stanley’s $900m Solium Capital acquisition.

Last June, the tech specialized private equity fund itself completed the acquisition of MeridianLink – another player in the mortgage software industry – and it is now approaching the next steps of its digital mortgage strategic plan. Many analysts speculate the possibility of generating synergies amongst these two companies for Thoma Bravo.

The potential upside of this deal lies in the fact that Ellie Mae’s market share is expected to boost subject to a recovery of the mortgage market from its current stagnation and many analysts expect a substantial volume rebound in the near future. Moreover, the software house can lever on its high-end technology, which is widely recognized by industry operators – mainly smaller banks in need of a technology to assist them originating loans – as an absolute reference point.

Moreover, Ellie Mae has a very valuable and reputable customer base, its loan origination software is used on approx. 40% of U.S. mortgages and its partners include Equifax Inc, Genworth Mortgage Insurance, Fannie Mae and Freddie Mac.

In light of the facts mentioned above, Thoma Bravo could profit from the investment once its expectations over Ellie Mae’s market share growth turn into reality and as the company eventually captures the benefits of a more attractive interest rate environment and a subsequent repricing wave in the mortgage market.

Lastly, although the Thoma Bravo is acquiring the company for a 47% premium to the last 30-day average, the $99 per share acquisition price still represents a 15% discount to the company’s mid-year highs, suggesting the P.E. firm completed the acquisition for what looks to be a great price. Furthermore, the valuation of Ellie Mae looks to have suffered excessively from the October general market sell-off, and now that interest rate increases seem to be out of investor’s short-term radar (which would have implied a slowdown in lending and mortgage generation), considerable value may arise. 

Market Reaction

On Tuesday 12th, Ellie Mae’s shares – which had been falling nearly 30% since their June all-time high – went up approx. 21% in early trade following the news, seeing their price aligning to the one paid by the tech-focused private equity fund to secure the ownership.

Advisors

Ellie Mae is advised on the transaction – which is likely to close on Q1-Q3 2019 – by JPMorgan Chase and the law firm Cooley, while Jefferies and the law firm Kirkland & Ellis are acting as Thoma Bravo’s advisors. Jeffries is also providing Thoma Bravo with financing for the deal.


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