A High-Tech Play on Real Estate's Rebound

07/16/2012 11:30 am EST

Focus: STOCKS

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

It may be a bit wiser to find companies that have unique products and services the entire industry values, instead of looking for niche players, suggests Benjamin Shepherd of Personal Finance.

Many a hapless analyst has been burned trying to predict a decisive turn in the housing market over the past few years, as perpetually falling real estate values and weak consumer confidence foreclose on a meaningful recovery.

However, home prices appear to have stabilized, giving the industry a shot of confidence. The S&P/Case-Shiller Index of prices in 20 metropolitan areas rose 0.7% in April, beating expectations. Prices in all 20 cities were above their recent lows.

The rise in home prices has boosted three important housing market indicators. New home starts and sales of both new and existing homes are posting a marked recovery so far this year. After a long period of pessimism, most analysts are finally upgrading their ratings on a wide swath of housing-related stocks.

At the same time, government efforts to help homeowners are accelerating, allowing more borrowers to refinance or avoid foreclosure.

Uniformity of opinion doesn’t necessarily mean a real recovery is in the offing. Millions of people are still “underwater,” owing more on their homes than their homes are worth. And a major economic set­back could reverse the recent uptick in housing prices.

However, fundamentals of the real estate market are now the best they’ve been in almost four years, with momentum clearly shifting for the better. We’re taking this oppor­tunity to highlight housing stocks that will benefit from any rebound in the market.

The Tech Play
The residential mortgage busi­ness has always been a complicated one, requiring hundreds of hours of staff time to shepherd a loan from origination to closing and servicing. That process has only become more complex over the past few years, as the number of required disclosures soars because of previous fraud dur­ing the boom times.

Ellie Mae (ELLI) operates one the largest electronic mortgage origination networks in the US, providing software to the residential mortgage industry that’s geared to simplify processes. The company’s main software product is its Encompass loan origi­nation platform that can perform a variety of functions, from document and compliance management to in­come verification and customer re­lationship management.

While customers have the option to license the entire platform, that can be an expensive and time-con­suming proposition. Because Ellie Mae focuses primarily on selling to small and mid-sized operations that can’t always make that kind of investment, it recently began offering Encompass on a Software as a Ser­vice (SaaS) basis, whereby the soft­ware is provided to users via the Internet rather than individual copies for storage on each PC and laptop.

In addition to SaaS reducing up­front costs and allowing users the flexibility to customize the func­tionality of the product, Ellie Mae also offers SaaS users two pric­ing models: they can either pay a set subscription fee, or a “success-based” fee that’s only charged when a mortgage is successfully closed.

This flexibility has allowed the company to make significant head­way with smaller operations over the past couple years, boosting En­compass to nearly 30,000 users—it added 5,000 users in the first quar­ter alone—while actually increasing revenue per user by 77%.

SaaS revenues increased 137% year over year to $8.4 million, or 40% of total company rev­enue. The remainder of Ellie Mae’s revenues come from its mortgage origination network that connects originators, underwriters, investors, and almost anyone else involved in the process.

Integrating all of those disparate users on a single plat­form speeds up the process, reduces costs and limits the possibility of er­rors. Currently about 59,000 indus­try professionals connect to the Ellie Mae network, with the company get­ting paid on a per-transaction basis.

Since going public in 2008, the company’s annual revenues have grown from $34 million to $55 million. Earnings per share (EPS) have also accelerated substantially, growing from just 5 cents in 2010 to 24 cents last year. EPS is fore­casted to reach 44 cents this year and 62 cents next year. Although a fairly young company, Ellie Mae already has almost $30 million in cash on its balance sheet, with solid cash flows and no debt whatsoever.

Ellie Mae has demonstrated that it can thrive in tough environments. The company’s brisk growth should continue, as the real estate market improves and documentation and compliance requirements become increasingly onerous.

Ellie Mae continues to develop new product offerings to supple­ment its Encompass platform. And given the extremely fragmented na­ture of its industry and the com­pany’s acquisitive nature—it has picked up ten companies over the past year—Ellie Mae is likely to ac­quire a few cheaply valued competi­tors this year.

With impressive growth pros­pects in an improving market, El­lie Mae is a buy under $20.

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