Ellie Mae: A Leader in the Shrinking SaaS Market

| About: Ellie Mae, (ELLI)

Ellie Mae (proposed ticker is ELLI) is scheduling a $75 million IPO with a market capitalization of $204 million at a price range mid-point of $10, for Friday, April 14 2011. The full IPO Calendar lists seven other IPOs for this week.

SUMMARY -- Ellie Mae had a high 15% after tax profit margin for the December 2010 quarter, revenue was up 7% over the September quarter, gross margin was 75% and the after tax profit margin was 15%, the same as the September quarter.

In Fast Growth SaaS (Software as a Service) revenues, ELLI generated $5 million SaaS revenues in 2010, up from 0 in 2009. SaaS companies generally sell at very high earnings multiples and often increase in price on just breakeven earnings. The best known SaaS company is salesforce.com (NYSE:CRM). A number of SaaS companies are also moving into cloud computing, which may not be as important in ELLI’s marketplace.

VALUATION -- On an annualized December quarter basis, ELLI would sell for 27 times earnings at the price range mid-point of $10. If Elli can continue to produce 15% after tax profit margins on increasing revenue, the stock appears attractive at $10.

Industry P/E multiplies, however are low. Annualizing the December quarter, to compare with ELLI, Lender Processing (NYSE:LPS) multiple is 10. MGIC Investment (NYSE:MTG), mentioned as a competitor in the S-1 filing, is currently losing money, with a P/E ratio of –3.

ELLI Valuation Metrics

BUSINESS -- ELLI hosts one of the largest electronic mortgage origination networks in the United States. The Ellie Mae Network electronically connects 51,000 mortgage professionals to the mortgage lenders, investors and service providers integral to the origination and funding of residential mortgages.

In 2010, over 2.0 million residential mortgage applications were initiated over the Ellie Mae Network. ELLI believes this represented 20% of the total U.S. residential mortgage market.

COST REDUCTION MARKET OPPORTUNITY -- It is estimated that electronic processing of mortgages would reduce origination costs by $700 per loan. In 2009, less than 1% of residential mortgage originations were processed completely electronically.

ENCOMPASS SOFTWARE -- For mortgage originators, ELLI provides Encompass software, a comprehensive operating system that handles key business and management functions involved in running a mortgage origination business, and serves as a gateway to the Ellie Mae Network.

Mortgage originators use Encompass as a single tool for loan processing, marketing, customer communication and to interact electronically with lenders, investors and service providers over the Ellie Mae Network. ELLI also offers Encompass users a variety of additional services, including automated preparation of the disclosure and closing documents borrowers must sign to obtain a loan, electronic document management and websites used for customer relationship management.

For the lenders, investors and service providers on othe network, ELLI provides electronic connectivity that allows them to do business with a significant percentage of the mortgage origination professionals in the United States.


Software and services made up 78% of ELLI's 2010 revenues . The software component of software and services revenues is derived from mortgage originators who either license Encompass software for an initial fee as a perpetual license with annual maintenance fees. Or users can subscribe to the Encompass software as a service, or Encompass SaaS, for a monthly per user subscription fee or for fees on a success basis with monthly minimums, which ELLI refers to as success-based pricing

Network transaction revenues made up 22% of ELLI's 2010 revenues. Lenders, service providers and certain government sponsored entities using the Ellie Mae Network pay ELLI fees when they effect a transaction over the Ellie Mae Network. A transaction occurs when an Encompass user sends an electronic service request to any lender, service provider or other participant through our network and that request has been accepted.

Gross margins -- ELLI achieves its highest gross margins on its network transaction revenues. Gross margins on the services component of the software and services revenues have been affected by use of third-party providers. ELLI intends to continue to reduce third-party costs by internally developing or acquiring additional document preparation and other technology.

GROWTH PLAN -- ELLI's focus is on lender Encompass users because mortgage origination volume has shifted significantly to mortgage lenders. Mortgage lenders typically order more of ELLI’s services than mortgage brokers.

An additional focus is on selling Encompass SaaS, or software as a service, success-based pricing model to align customer payment to Ellie Mae with their receipt of revenues.


  • By promoting increased use of the Ellie Mae Network to produce additional Network Transactions revenues,
  • By seeking to expand the services component of Software and Services revenues through an increase in the number and usage of services, such as compliance and document preparation.
  • ELLI believes that Encompass and the Ellie Mae Network also directly address mortgage originators’ need for increased efficiency and profitability during a period of decreased mortgage origination volumes by providing additional functionality for mortgage lenders.

As an additional response to market conditions, ELLI has, beginning in late 2009, focused marketing and sales efforts on its Encompass SaaS offering, and particularly the Encompass SaaS success-based pricing model, in contrast to the license model -- because ELLI typically generates higher revenues per user through its Encompass SaaS offering than through its license offering.

At December 31, 2010, ELLI had 14,678 active SaaS Encompass users, of which 8,704 used the success-based pricing model. SaaS Encompass users generated $38.8 million of our revenues in 2010, of which $4.9 million was generated by users of the success-based pricing model.

SEASONALITY -- Network transaction revenues and the services component of software and services revenues generally track the seasonality of the mortgage industry, with increased activity in the second and third quarters and reduced activity in the first and fourth quarters


The Ellie Mae Network based on offers mortgage originators accessibility to a critical mass of investors, lenders and service providers and enabling mortgage originators to transact all aspects of the mortgage origination process over the network.

In addition, the Ellie Mae Network provides investors, lenders and service providers with greater access to the mortgage origination community, which enables them to increase their revenue opportunity and lower the cost of marketing and customer support.


The mortgage industry has undergone significant change since 2007, largely in response to the hundreds of billions of dollars of loan defaults and massive losses suffered by lenders and investors. This has led to four major trends that have significantly impacted the residential mortgage industry, including:

• increased regulation;

• increased quality standards imposed by lenders and investors;

• greater focus on operational efficiencies; and

• a significant market shift from mortgage brokerages to mortgage lenders as the number of mortgage brokerages has declined.


  • Mega Lenders: There are approximately 20 "mega lenders" which typically are large commercial banks that have both a retail channel in which they work directly with borrowers to originate loans and a wholesale channel in which they buy loans originated by other mortgage originators, such as mortgage banks, smaller lenders, credit unions and mortgage brokerages.
  • Mortgage Lenders: There are approximately 7,500 other mortgage lenders, such as mortgage banks, smaller commercial banks, thrifts and credit unions. Mortgage lenders source and fund loans and generally sell most of these funded loans to mega lenders or other investors.
  • Mortgage Brokerages: There were forecasted to be approximately 12,000 mortgage brokerages at the end of 20103, which are independent sales companies originating loans for multiple mortgage lenders. Mortgage brokerages process and submit loan files to a mortgage lender or mega lender that funds the loan.

% MORTGAGE ORIGINATOR SPLIT -- In 2009, 48% of mortgages originated nationwide were funded directly through the retail channels of the mega lenders and the remaining 52% were funded through other mortgage lenders and brokerages, four based on information published by Inside Mortgage Finance. For 2010, this split was 50/50.

MANAGEMENT LAPSE -- In connection with the preparation for the IPO, ELLI discovered that certain of the stock option agreements held by directors, employees, ex-employees and consultants had not been authorized in accordance with all corporate law requirements. Accordingly, in April 2010, the board of directors authorized the confirmation of certain stock options and the grant of certain replacement stock options, or replacement options, to certain individuals.

LEGAL PROCEEDINGS -- ELLI is involved in several lawsuits as the defendant: Page 76 - 78 in the March 28 S-1 filing.

COMPETITION -- The Ellie Mae Network is only available to mortgage originators using Encompass software. The principal competition to the use of the Ellie Mae Network remains traditional methods of exchanging data and documents among mortgage industry participants by e-mail, facsimile, phone, courier and mail.

Lenders and service providers, including those who participate on the Ellie Mae Network, can and do connect with mortgage originators that are not Encompass users in a variety of ways, including through other networks between mortgage originators and lenders and service providers such as MGIC Investment Corporation and RealEC Technologies, Inc.

In addition, competition comes from mortgage originators using a standalone web browser to go individually to each investor, lender, or service provider’s website and then manually upload loan data or enter information into the website.

Mortgage originators may continue to use these methods due to habit, personal business relationships or for other reasons, despite the disadvantages of duplicative efforts, time delays, errors and costs, redundant paper documentation and potential privacy and security breaches.

USE OF PROCEEDS -- ELLI will use $40mm from 5mm shares from the company. Its shareholders intend to sell 2.5mm shares, 33% of the IPO for general corporate purposes, including working capital, sales and marketing activities, general and administrative matters and capital expenditures.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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