Why Ellie Mae Is Set to Soar

Simon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

What a year it has been for Ellie Mae (NYSE: ELLI)!

The company rang the NYSE opening bell on Feb. 4, in part to commemorate its 15th anniversary.  It also served, unofficially, as a recognition as one of the Exchange's best-performing stocks last year.  Ellie Mae's market cap quadrupled in 2012 alone, and its share price jumped from an IPO of $6 in 2011 to north of $21 today.  That's a nice 250% gain for shareholders in less than two years.

Many skeptics would look at a run-up like this and be quick to assume that the company is due for a pullback.  But looking deeper into the underlying business, it's clear that Ellie still has plenty of room to run.

My bullish conviction centers around two key aspects:

  • Ellie Mae brings value to their customers
  • Ellie Mae has an asset-light business model that is highly scalable

Value to the Customer

Ellie Mae is a leading provider of on-demand, automation solutions for the $1.6 trillion annual U.S. mortgage origination industry.  It uses software and cloud computing to help regional lenders initiate new mortgages.  In layman's terms, Ellie Mae makes it easier for lenders to make new loans.

And there are quite a few lenders that want to make new loans.  The company estimates there are 190,000 mortgage professionals in the US (which excludes the megabanks such as Citi or Wells Fargo, who also initiate mortgages), with an addressable market of $2 billion - $3 billion.  Ellie did just over $100 million in revenue last year.  So the pond is clearly large enough for it to make a bigger splash in.

But here's the kicker.  For better or for worse, the now-infamous subprime mortgage fiasco gave birth to a very important new trend: regulation.  New regulations imposed by the Dodd-Frank Act, combined with new disclosures required by the Consumer Financial Protection Bureau, make being compliant in new loans issued increasingly difficult.  It's not just getting harder to obtain a mortgage these days.  It's also getting harder to provide them.

The key takeaway is that this new trend of increased regulation has opened the door of the whole industry to disruption.  Being compliant is a headache.  It's a hassle.  Unless you're a glutton for punishment, going through hundreds of disclosures and regulations is something that you don't really want to deal with. 

As a mortgage professional, what you do want to deal with is 1)  making the greatest number of new, high-quality loans that you can (which in essence makes you the most money); and 2) making sure that you're compliant with all of the above-mentioned federal regulations. 

Enter Ellie Mae. 

Ellie takes care of all of the behind-the-scenes dirty work to ensure that your loans are compliant.  They monitor regulations and provide their best-in-class Encompass 360 software.  On top of all of that, they don't charge you until your new loan goes through.

For these reasons, I believe that Ellie Mae is offering a win-win scenario.  They provide a service that guarantees compliance in exchange for a nominal fee on top of completed transactions.  That's a business model that brings value to their customers.

Asset-Light Business Model

Apparently, customers have been responding well to that value-creating business model.  Ellie reported in 2012 that it now has 74,000 active users on its Encompass software, a 40% increase over 2011; 41,000 of these users are utilizing the company's on-demand Software-as-a-Service (SaaS) platform via the Ellie Mae Network, which is one of the keys to the development of this business.

SaaS is really and truly built by the network effect.  The Ellie Mae Network allows users who are already using the Encompass software to immediately order services for various transactions (some examples are credit, flood, title and appraisal reports) from other providers.  Each time a user orders a service over the network, Ellie Mae charges a transaction fee.

Once users get set up on the network, the cost of providing services to them is very low.  Visa and eBay are living proof of the power of the network effect.  Visa's number of cardholders rose from 94 million in 2003 to 104 million in 2011.  Over that same time period, the company went from being unprofitable to raking in over $3.6 billion a year in earnings and achieving a net margin of over 40%.  eBay has increased its number of PayPal users to 121 million at the end of 2012, yet has maintained net margins of nearly 20% for the better part of the past decade.  If you build it, they will come..

Ellie Mae is already seeing similar signs of the network effect taking root.  Its revenue obtained from the SaaS platform increased 70% in 2012 and now accounts for 89% of total revenues.  Alongside the impressive revenue growth, they managed to also increase gross margins from 72% to 77% year over year.  Average revenue per user on the Ellie Mae Network rose 41% and is significantly outpacing the associated costs.

I read into this that the company's business model is working effectively.  Ellie Mae has established a platform that is valuable and is succeeding in attracting users.  Over time, the costs flatten out and the transaction fees (revenues) start to drop directly to the bottom line.  As an added bonus, as users become more and more familiar with the site, the switching costs become higher for them to leave for something else.

Gearing Up for Growth

Ellie Mae has a huge opportunity to capitalize on the resurgent housing market.  It's doubled its customer acquisition team in the past few quarters, increased its capacity for data, and it's building out its Ellie Mae Network.

I like what I see so far.  If Ellie Mae can continue to attract users and keep them using the site, this company's growth is far from over.


TXinvestor82 owns shares of Ellie Mae.  The Motley Fool recommends eBay, Ellie Mae, and Visa. The Motley Fool owns shares of eBay and MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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