Tuesday, February 28, 2012

Ellie Mae ( Nasdaq - ELLI ) -- Meet HAL, Your New Mortgage Broker

Ellie Mae (ELLI $8.25) reported better than expected Q4 results.  The company is the leading independent provider of computerized mortgage origination services.  Results topped our estimate due to a pick-up in overall mortgage activity in the December period.  Ellie Mae's market share widened, as predicted, which amplified results further.  Still, non-GAAP earnings declined year over year to $.07 a share despite the sequential improvement in mortgage volume.  Compared to the year before industry activity still was down on the order of 20%.  Revenue advanced 48% to $18.8 million, enhanced by the company's acquisition of its closest competitor.  Costs jumped, however, as Ellie Mae integrated the new operation.  Shares outstanding also rose as a result of the company's IPO earlier in the year.

Reported earnings are as depressed as they can be.  Interest rates have been steady for a while and are unlikely to go down further.  So refinancing activity is dormant.  Resales are perking up, but they remain far below normal levels.  New housing is trying to rally but that still is a tough go with the foreclosure market hanging over the industry.  House prices declined again in January, moreover.  Despite all that Ellie Mae is poised to expand sales by 26% in 2012 to $70 million.  Faster gains are possible if the market improves.  The key is computerization.

Ellie Mae spent 23.4% of revenues on R&D in 2012.  The previous year the company developed a cloud computing software service that provided lenders with a variable "success based" pricing model.  Before that Ellie Mae sold its technology as a perpetual software license.  The new format charges customers each time they write a mortgage, aligning costs with revenue.  Recorded revenues suffered during the transistion process, since the company used to collect more money up front.  That process is continuing but more than 50% of sales now are coming in from the recurring revenue model.  The 2011 R&D program expanded the number of services Ellie Mae could offer.  Average order size widened as a result.  That trend is likely to continue as more parts of the mortgage process are automated.  Ellie Mae currently is pulling in about $200 per mortage.  That figure could climb to $300-$400 over the next few years.

Demand is rising at short-handed banks.  Approximately 50% of the mortgage market is off limits to Ellie Mae.  That part is controlled by the nation's 20 largest banks, which perform their own automation services.  (Ellie Mae is working with Wells Fargo on a pilot program.  So it's conceivable the company will break into the major market, as well.)  At this point, though, regional and local banks are the company's primary customers.  Many of those instuitutions have laid off a large part of their work force since 2008.  If volume expands they'll have few alternatives beyond computer automation to satisfy demand.  Ellie Mae's service guarantees they'll get the work done, and earn a profit on each transaction.

We estimate income will advance modestly in 2012 to $.25 a share (fully taxed).  Longer term, margins promise to expand meaningfully as volume grows.  Higher revenue per transaction could generate further leverage.  In 2-3 years income could attain $.75-$1.00 a share on sales of $125-$150 million. 

( Click on Table to Enlarge )


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