Friday, August 9, 2013

Ellie Mae ( Nasdaq - ELLI ) -- Builds Momentum

Ellie Mae (ELLI $30.00) reported excellent on target Q2 results.  Earnings advanced 33% to $.24 a share (fully taxed).  Revenues gained 45% to $34.3 million.  Average shares outstanding increased 21%, mainly as a result of last year's public offering.  Margins improved despite accelerated spending on sales, technology, and customer support.  Ellie Mae originally had planned to add resources evenly throughout the year.  It decided to speed up the program to reinforce the company's competitive advantage.  Ellie Mae is the industry leader by a substantial margin.  It's market share is continuing to widen as existing customers add more users and new customers are acquired from competitors.  Financial performance is being bolstered as more services are provided per loan, and users of the company's legacy on-site products switch to superior on-demand versions, which generate higher margins.  Even if total industry mortgage volume declines in upcoming periods Ellie Mae is likely to maintain a superior rate of growth.  Market share gains combined with rising revenue per loan promise to keep performance intact.  The company also is developing relationships with large banks to create a standardized format for handling mortgage applications.  Those banks will continue to perform the actual processing.  But Ellie Mae will earn usage based fees on that order flow.  As the big banks force their constellation of data providers to use Ellie Mae's format, the company's software customers will more easily integrate with those providers, as well.

Our 2013 estimates are unchanged.  We estimate income will reach $1.00 a share (+33%) on revenues of $135 million (+33%).  Next year earnings could attain $1.35 a share on sales of $175 million even if industry volume contracts in response to higher interest rates.  In 2-3 sales could reach $250-$300 million as average revenue per loan expands to $250 from $125 today.  That probably would require some acquisitions of data providers, like appraisals.  Most of that information currently is purchased separately by the company's customers who generate the complete mortgage application.  Ellie Mae has ample cash reserves to make several deals like that.  The company could establish royalty arrangements instead, reducing risk but also limiting profit potential.  Assuming the royalty strategy is the dominant one, margins probably would remain similar to where they are today.  In 2-3 years income could hit $1.75-$2.25 a share under the latter scenario.

Ellie Mae's leading market share in mortgage origination software might leverage a larger corporation's performance.  The company has been approached on a regular basis in the past by banks, data providers, servicing companies, and technology suppliers as a prospective acquisition target.  In light of the company's low risk profile, high cash generation, and international potential Ellie Mae could command a price of as much as $50 a share, in our view.  Rumors are circulating that the process might be underway.

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