Description

Ellie Mae (NYSE: ELLI) - LONG

Ellie Mae is a leading provider of loan origination software to the US mortgage industry

Market Statistics                                                          

Price: $25.75                                                                 

Market Cap: $724mm                                                     

Enterprise Value: $590mm                                              

P / EPS: 26.3x (14E), 20.3x (15E), 15.1x (16E)              

EV / EBITDA: 14.8x (14E), 10.5x (15E), 8.0x (16E)       

Dividend Yield: 0.00%

Trading Statistics

3 Month ADV: 478k

Short Interest % of Float: 17.9%

Short Ratio: 8.4

Major Shareholders

PRIMECAP (10.4%), management (8.6%), Tremblant (8.0%), Macquarie (7.5%), Frontier (6.7%), BlackRock (5.6%), Vanguard (5.4%)

5 Year Returns

IRR: 17%, MOIC: 2.4x

Year 5 Target Share Price: $63

Street View

ELLI is a short because 2014-2015 mortgage origination volumes will collapse and the Company’s revenue model depends on Success Based Pricing (“SBP”)

My View

1. Instead of focusing on declining origination volumes, the market should really be thinking about how the US mortgage industry is changing in a way that allows ELLI the opportunity to grab market share and grow its user base
• The traditional loan process is infamous for manual data entry and very little collaboration – characteristics that lead to overall loan quality issues, fraud and defects and, eventually, buy-backs or lawsuits 
• Customers today are focused on (1) simple, convenient, end-to-end solutions and (2) managing regulatory complexity
• Conversations with industry participants suggest that competitor products are not as robust and adept at understanding complex mortgage workflow.  Many have said that ELLI's products are the most comprehensive and best end-to-end LOS
• Management believes the Company has a long run way for market penetration.  Total addressable market is big (management estimates at $5bn).  The Company has recently had success with signing some top 10 lenders in the country, though it has historically focused on small-mid sized mortgage lenders that do not have the capacity to develop in house  

2. Rather than being discouraged by projected declining originations, investors should be excited about the fact that ELLI's moat is getting wider from market dislocation.  Customers are migrating to ELLI's platform and the Company's products are hard to displace once customers are integrated (takes 4-7 years to switch).  Industry volumes have been falling since 2012 but ELLI user accounts have been consistently growing from customer migration!
• Industry wide origination volumes decreased by ~15% over the past year but total contracted SaaS users grew 43% from 68.9k to 99.1k.  
• Per conversations with management, 16.6k of these users came from new bookings!

3. ELLI is a cyclical stock.  Intrinsically, the Company should be worth more today than ever before because the franchise has been successfully growing accounts through the cycle, which makes profitability much more levered to a rebound in the mortgage origination markets
• We are investing at a 15 year trough cycle for US mortgage originations
• We are buying a leading player that is very well positioned to capture a trough cycle rebound
• ELLI's business has very nice operating leverage, which makes capturing the cycle rebound even sweeter.  Management has guided Adj EBITDA to expand from 31% in 2013 (at $128mm revenues) to 35-40% at $200mm revenues.  I believe future revenue potential for this business is much higher than $200mm.

4. Near term revenue growth will be driven by new account growth, converting customers to SaaS, and implementing recently booked users.  The Company has seen its revenue become less sensitive to changes in origination volume over the past several quarters as overages have fallen rapidly.  Trailing LTM revenues do not reflect forward run-rate potential
• In Q1-14, 90% of SaaS revenue came from base fees ($70/user) as overages have rapidly declined.  In aggregate, 70% of total revenue in Q1-14 is contracted (non-volume sensitive) 
• Converting on premise users (~27,500) to SaaS would increase revenues by ~$50mm
• Upgrading customers from the Del Mar DataTrac acquisition to SaaS (5000-7000 customers remaining, based on my discussions with management) would (i) increase revenues by $16mm and (ii) allow ELLI to sell additional ancillary / Ellie Mae Network products into this group
• Implementing recently booked users will drive up revenues.  Active Encompass users increased 14.3k and active SaaS users increased 19.3k over the past year
• These users are currently paying base fees but will begin paying for other services once fully integrated in the next 6-12 months

6. In addition to recapturing Success Based Pricing when the origination cycle turns in the future, ELLI is well positioned to sell ancillary products into this entrenched customer base, further boosting future profitability from a market rebound
• As the origination process becomes increasingly automated in the future, ELLI believes it can extract up to ~$500 of value for each loan vs. $260 today 
• This is still a relatively small amount in the context of the total cost of originating a loan today (Average ~$6,000)
• Management commented that it is already seeing originators adopt its Total Quality Loan (“TQL”) services.  With the increasing scrutiny of mortgages and the need to speed time to funding, originators are proactively adopting TQL as the higher cost associated with the services are far outweighed by the benefits from having the TQL stamp on the loan

Summary Financial Projections / Assumptions

• Mortgage origination volumes reach $2.1 trillion in 5 years (Based on 15 year average from 2000-2015E)
• Total Active Encompass users grow to 160mm (9-10% CAGR), Active SaaS users reach ~145mm, or 90% of Active Encompass user base.  Increasing SaaS penetration to come from a combination of (i) adding new users, (ii) Conversions and add-ons (new seats @ existing customers and DataTrac conversions), and (iii) upgrades from on-premise Encompass
• Fee per mortgage file under SBP: $130 to ~$145, Transactions per loan file: 6-7, Average revenue per transaction: ~$5
• Estimated mortgage files per month per user: ~1.5

Catalyst