Exchange-Operator ICE Acquires Ellie Mae for $11bn to Drive Mortgage Automation

Acquisition Summary

Stock-exchange operator Intercontinental Exchange (ICE) has made a gargantuan $11bn acquisition of Ellie Mae, a software company driving automation of the mortgage industry. The cash-and-shares transaction is one of the latest mega-deal in the US since the beginning of the summer, after the coronavirus pandemic brought dealmaking to a sudden halt. Apart from the favourable financing conditions due to robust equity valuations and cheap borrowing, the deal reflects ICE’s desire to consolidate its position in the growing digital mortgage industry. Supplementing the expertise it gained through the acquisition of MERS and Simplifile to enhance its mortgage-related offerings, adding Ellie Mae to its portfolio could also help it modernise the mortgage market by becoming the first fully-automated firm servicing the entire mortgage product chain.

Founder, Chairman and CEO of Intercontinental Exchange Jeffrey C Sprecher commented

“ …we are pleased to announce the acquisition of Ellie Mae, which will help us […] transform the mortgage marketplace”

Deal Structure

This $11bn transaction is the largest deal undertaken by NYSE-owner Intercontinental Exchange in its 20-year history. The shares-and-cash purchase is set to be particularly lucrative for Thomas Bravo, the private equity firm which currently owns Ellie Mae, as it paid a mere $3.7bn to acquire it in 2019. The vast majority of the purchase price (84%) is set to be paid for in cash, with the remaining 16% being constituted of newly issued ICE shares.

The deal value also represents a sizable premium to Ellie Mae’s key 2019 financial metrics. For instance, the $11bn purchase price is nearly 24x the company’s adjusted EBITDA and approximately 12x revenues. Such exuberant spending may be partly driven by the fact that ICE’s current mortgage business has been its best-performing division in the 3 months to July.

ICE Overview

The Intercontinental Exchange (ICE) is a US-based Fortune 500 firm which operates clearing houses and global stock exchanges and also provides mortgage-related services. In total, the $52bn financial-markets behemoth runs 12 regulated exchanges including the NYSE, the Liffe futures exchanges in Europe, and other futures exchanges in Canada and the US. Additionally, the firm is also the proprietor and operator of 6 clearing houses in locations ranging from the Netherlands to Singapore.

Ellie Mae Overview

Founded 23 years ago, the California-based Ellie Mae provides credit unions and non-bank lenders with technology to help them originate residential mortgage loans. The software firm currently processes 35% of US mortgage applications, recently with the application of machine learning and AI. The company operates with a software as a service (SaaS) business model; it automates the process of funding and originating new loans while also facilitating regulatory compliance. More specifically, the firm connects mortgage lenders, investors and internet-service providers and aids with valuation, risk analysis and fraud detection.

Industry Insight

The mortgage industry in the United States, which gained particular notoriety after the Global Financial crisis of 2007–09, is a financial sector of significant size. This partly reflects the federal government’s plethora of programmes and entities to encourage the ownership of homes, house construction and mortgage lending. These include Fannie Mae, a government-sponsored enterprise (GSE) tasked with increasing lending in the mortgage market, and Freddie Mac, another GSE also intended to raise the quantity of financing available for home purchases. Partially as a result of such schemes, the earliest of which date back to the New Deal of the 1930s, the size of total mortgage debt in the US amounts to $16.01tn, a staggering 75% of US GDP in 2019.

In the US, “origination” is the process through which a borrower secures a mortgage. The borrow must, in turn, submit a loan application as well as a record of their financial and credit history to the underwriter, which is typically a bank. A third-party mortgage broker may also be involved. Credit scores, and other metrics, are often used by whatever entity originates the loan to review a number of lenders and select the ones which they believe best meet the customer’s needs.

In terms of recent trends, the coronavirus crisis has created significant shockwaves through the mortgage industry. As investors fled to the safety of bonds, yields fell and sparked a surge in refinancings, a process which allows homeowners to take advantage of lower interest rates. As a result, mortgage applications increased to their most elevated level since 2009, with the value of the total annual originations expected to reach $2.61tn in 2020. Lower-credit homeowners have also been affected particularly adversely by coronavirus-related vicissitudes. According to a Mortgage Bankers report, nearly twice the percentage of borrowers from Ginne Mae, a state-owned corporation catering lower-credit homeowners, demanded forbearance on loans compared to conventional ones. Greater forbearance and delinquency rates raise the risk of loan defaults and adds additional pressure and uncertainty to the precarious US mortgage market.

Why did ICE acquire Ellie Mae?

There are arguably 3 primary driving forces behind this acquisition for ICE. Firstly, and arguably most significantly, is the desire to consolidate its established position in the lucrative mortgage market, after similar acquisitions in the industry from 2016. Additionally, the deal will likely generate efficiency gains through automation of mortgage origination, a service Ellie Mae specialises in. Lastly, strictly financial motivations are contributing to the transaction as well, with synergies and accretive EPS prospects looking increasingly attractive in the current low-rate environment.

Strategic Rationale

The principal aim of ICE’s acquisition is arguably to consolidate its existing position in the fast-growing US mortgage market. The mortgage business of the exchange operator has been the fastest-growing segment of ICE since May, primarily due to the surge in mortgage refinancing as interest rates plummeted to 0. Given the Federal Reserve’s announcement that this ultra-low interest rate environment is likely to last until the end of 2023, ICE likely viewed now to be an opportune time to enter and capitalise from growth in this sector. The acquisition also allows ICE chief executive Mr Sprecher to pursue his vision of creating “the clearing house for the mortgage industry”. Having already entered the mortgage market through acquiring electronic mortgage registrator MERS in 2018 and service-management firm Simplifile in 2019, this deal will likely grow ICE’s market share as a key provider of end-to-end electronic workflow solutions and generate sustained revenues in the future.

President and CEO of Ellie Mae Jonathan Corr remarked:

“We are excited to be joining the Intercontinental Exchange family and having the opportunity to work closely with Simplifile and MERS in helping our industry to realise the true digital mortgage.”

As well as consolidating its position in the mortgage market, this transaction will also help ICE and Ellie Mae automate the industry and hence capitalise on efficiency gains. Along with ICE’s in-house expertise, Elie Mae will be better able to provide technology services to participants in the mortgage supply chain through its Digitial Lending platform. A way in which this could occurs is through the transaction supplementing ICE’s trading and bond data business and allowing it to profit from the trend towards digitisation in the traditionally paper-based mortgage market. The deal will also, according to President and CEO of Ellie Mae Jonathan Corr, be conducive to allowing the electronic mortgage processor to “help[] our industry to realise the true digital mortgage”. In particular, Mr Corr argues that operating under the ICE umbrella will better allow Ellie Mae to achieve this goal due to the parallel route ICE has been pursuing in global exchanges. Lastly, modernisation is likely to benefit many customers and stakeholders of both groups. Chairman and CEO of ICE Mr Spercher argues that many of its own products are highly complementary to that of Ellie Mae, resulting in valuable knowledge spillovers from its proven expertise in operating marketplaces and networks which will drive value creation for the foreseeable future.

There are also technical driving factors behind the transaction: notably, the prospect of synergies and an accretive EPS outcome. For instance, the run-rate synergies of between $50 and 60m before 2023 will look particularly favourable as robust equity markets and cheap borrowing rates offer few financial hindrances to the acquisition. Furthermore, the deal may be attractive for shareholders given its expected accretive effect on ICE’s adjusted EPS in the first full year of ownership. Given that the exchange operator’s trailing EPS has been lingerting relatively unchanged between $3.40 and $3.85 since Q4 2018, this transaction may look particularly lucrative in the short term.

Long-Term Prospects

As mentioned before, this transaction is likely to automate the entire mortgage product chain; the origination phase in particular. Historically, the entire mortgage industry depended on manual and document-heavy processes, all the way from generating leads, to applications, pre-closing, closing, and post closing. While the acquisition of MERS in 2018 allowed ICE to automate the post-closing process, the addition of Ellie Mae to its portfolio will likely see the digitisation of the origination space as well. This transaction, therefore, represents a step towards creating a company which could revolutionise the traditional mortgage market; a fully automated and vertically integrated mortgage business.

More specifically, Ellie Mae’s application of AI and machine learning will likely enhance the efficiency of the mortgage manufacturing process and its other technologies are set to boost consumer interaction too. The technology solutions which Ellie Mae provides allows clients to attain greater levels of engagement with customers, hence enabling more effective communication and a greater degree of reliability in terms of payments. Furthermore, the company’s recent introduction of artificial intelligence and machine learning may have momentous effects on how customers’ credit is evaluated. Ellie Mae’s new AIQ Credit Analyzer will be able to automate due diligence reviews and credit evaluations when underwriting a new loan. By allowing underwriters to only focus on exceptions, this technology will result in an almost 80% reduction in time spent to manufacture each loan, hence saving on staff costs and significantly bolstering the new entity’s bottom line.

Written by Alexander McFadzean (Oxford University)