ELLI looking good

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Here are my notes on Ellie Mae’s most recent quarter. This company remains one of my highest conviction long-term investments.

  • Despite 27% decline YoY in mortgage originations, ELLI grew revenues by 30%. They continue to consolidate their position in the industry, and existing customers continue to increase the amount of business they’re doing with ELLI.

  • Revenue per user increased 17% YoY despite lower volume. Average number of transactions per loan application is up to 6 and continues to rise. Users are embracing the benefits of both automation and the Elli-Mae Network.

  • Users up 11% YoY. Backlog and pipeline are healthy.

  • Consumer Direct just launched last quarter and seeing early success. Pipeline is filling up as planned.

  • Seeing solid interest in TQL (Total Quality Loan) product, with revenues about doubling YoY.

  • Great sales traction in enterprise – ELLI will be continuing to invest heavily for the next year in support staff, data centers, security, etc. to make it possible to really service these enterprise customers. From the CC:

We have also continued to see the expansion of our market opportunity to larger enterprise size lenders adding clients we considered beyond our reach just five years ago.

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What we are doing as we are seeing the opportunity is, investing in supporting the success in the enterprise segment and it’s one of these things where you have to invest in certain levels of baseline talent across your support organization, your services organization, et cetera to be able to service that customer segment well.

I expect that the profitability is going to be similar, but we are going to sell a lot more, I think there is a lot more opportunity at the enterprise and lot more opportunity to help them automate.

We just think it’s a great opportunity for us to aggressively invest to put us over in a position to win more of this business.

  • Management sees margins returning to normalized levels exiting 2015, and on nicely higher revenues:

we are continuing to make very significant investments this year. I don’t expect that these are run rate investments for three, four, five years beyond. So I think we will see return to margins very nicely as we exit 2015.

  • AllRegs acquisition closed Oct 1st. “Regulatory tsunami” continues, pushing originators and lenders to ELLI. AllRegs acquisition fits perfectly into this and will allow ELLI to not only cross-sell, but enhance existing products and create new ones.

AllRegs acquisition should be accretive by the time we exit this coming year, late in 2015… and should be starting to contribute very nicely to margins.

  • Mortgage market should continue to improve:

The forecast by Fannie Mae, Freddie Mac and the Mortgage Bankers Association projects only a slight decline in mortgage volumes for 2015. We are happily looking forward to getting out of such drastic headwinds and having clear air to sail through. Given the current origination forecasts and our business momentum, we expect 2015 revenue growth to be above our long-term target of 25%.

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I think all predictions look towards a pent-up demand that’s going to take place over the next four, five years. I definitely see lenders having strengthened themselves having acquired smaller players and I think we will continue to see that and that’s our customer base. So we are definitely catering to that segment.

Overall, I’m very pleased with how ELLI continues to position itself, consolidate the industry, and widen its moat. Yes, we have another year ahead of heavy investment, and that will continue to temporarily impact EPS, but the next 4-5 years should be very rewarding.

Neil
Long ELLI

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Neil, I love ELLI and their moat. However what disturbs me is that, if you look back at their reports in 2012 and 2013, they kept saying each quarter that they were investing a lot but it would be finished “in two quarters”, “by the second half of the year”, “by the end of the year” etc and that margins would return to normal. Now, I hear from you that they are promising the same thing “by the end of 2015”!!! Maybe they will, but they have lost credibility with me. Sorry.

Saul

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Maybe they will, but they have lost credibility with me.

I think that’s totally valid, Saul.

This is just a guess, but I suspect that the enterprise market is just a completely different beast than what management was used to or expecting, and they grossly underestimated what it would take to genuinely win and service those customers. With companies that size, there are a lot of other internal considerations beyond just procuring the best product or service that’s going to lead to the best return on investment: there’s a massive amount of politics as manager and departments vie for influence, people are obsessed with career-risk and avoid any kind of change, buy-in is likely needed from many different departments or organizations that all have their own agendas, etc. This not only makes for a very long and complicated sales cycle, but also often results in a huge number of inane demands that have to be met (many thrown up as roadblocks by various people who want to protect their own influence). So it wouldn’t surprise me at all to find out that management based its original timeline on what a rational person would expect to deliver to a very large client, but the enterprise procurement process is anything but rational.

I also suspect that after all the high-profile hacking scares lately, ELLI is plowing a lot of money into security – and I’m sure their enterprise customers, especially, demand that. They mentioned a little bit about security investment on the CC, but I think it’s probably a much bigger deal than they’re letting on – they work with very sensitive personal and financial data, after all.

I hear you, though. Still, looking ahead 5, 10, 20 years: I think that ELLI is going to be a huge force that will earn its cut of most mortgage applications and most of the accompanying services as well via the Ellie Mae Network – and maybe even on both sides of the deal as they go after investors too. If they are successful breaking into enterprise, then it doesn’t really matter in the grand scheme of things if it’s 1 year or 3 years of investment. The mortgage industry isn’t going away, and unless ELLI is bought out first (which I think is actually the most likely outcome) I think it’s becoming increasingly clear that they will come to dominate.

I do wish management had a better handle on what it will actually take (maybe they do now, maybe not). But enterprise is a new area for them, and they seem to be completely credible and competent in their traditional business. So I’m willing to cut them a little slack as they learn the enterprise ropes.

Neil

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