Friday, November 2, 2012

Ellie Mae (Nasdaq ELLI ) -- Big Growth in a Declining Market

Ellie Mae (ELLI $22.50) reported excellent better than expected Q3 results.  Earnings zoomed ahead by 320% to $.21 a share (fully taxed).  Revenues advanced 87% to $27.5 million.  Ellie Mae is the leading provider of mortgage origination software.  Its technology is used by regional and local banks to produce loans cost effectively.  That segment, along with independent mortgage brokers, who also rely on the technology, represent 50% of the entire market.  The rest is handled by the top 20 banks.  Ellie Mae has deals with Wells Fargo and Citibank to use its software to facilitate their operations.  Revenue per loan from the company's full service customers is about $100.  The big banks will retain most of the revenue on the deals they produce, since they use their own software for a lot of the work.  But $25-$50 a loan appears realistic.  Ellie Mae's system is becoming an industry standard.  The large banks love the idea of having data providers, like income verification and appraisals, using a consistent format.

Regulatory headwinds could impact mortgage activity in 2013.  The mortgage rules have made it more difficult for people with average credit to qualify for mortgages.  Most forecasters predict a decline of 10%-30% in mortgage origninations next year as a result. 

Rising average order size and market share gains are likely to sustain growth at a superior level.  Contributions from the large banks could provide a little kick.  We estimate income will rise 23% to $.80 a share on a 30% increase in sales.  More shares outstanding will offset the likely improvement in margins.  The long term outlook remains bright.  Ellie Mae basically has no competition and it participates in a gigantic market that is in an early stage of recovering.  In 3-5 years earnings could reach $1.50-$2.50 a share.

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