Inside Thoma Bravo’s $9 Billion Mortgage Market Windfall
Upon further review, it was deemed a giant mistake.
In 2018, the Federal Reserve’s four interest rate hikes put its benchmark rate at between 2.25% and 2.5% by year-end, ending a decade of free money. The hikes eventually got painful as rising rates stalled the housing market and a mini stock market meltdown in the fall of 2018 ensued, leading to outcries from President Trump. Within months the Fed backtracked. Now, the big question is whether rates will fall below 0%.
For San Francisco-based software private equity giant Thoma Bravo, the Fed’s epic interest rate boomerang is set to usher in a huge deal making coup, an about $9 billion windfall in a 16-month span on Ellie Mae, a software provider to the mortgage market. Thoma Bravo put up about $2.2 billion of equity to take Ellie Mae private in a leveraged buyout in April 2019, financing the rest of the $3.7 billion purchase price. Earlier in August, it struck a deal to sell the company to Atlanta-based Intercontinental Exchange for about $11 billion in cash and stock.
The return underscores the two dominant trends in the investing world right now. A Central Bank determined to use cheap money to prop up the market and stimulate the economy makes this a time of epic investment windfalls. But they’re surprisingly hard to come by. Active fund managers are struggling to beat the S&P 500 as a handful of soaring tech stocks push the index to new record highs, while most others stagnate or plunge. Meanwhile, leveraged buyout artists have been slow to deploy their trillions of dollars in investor commitments. It means the big wins are concentrated among a relatively small set of investors that had the highest conviction to act quickly on the dominant economic trends driving financial markets, such as the digitization of the global economy.
Ellie Mae is a case study in the deal-making zeitgeist. The window of opportunity for Thoma Bravo was just a few months as the Fed shifted course, and the price paid was far beyond traditional buyout valuation multiples. But stock market darlings like Ellie Mae are rarely put up for sale. Now a mixture of low rates, surging growth, and soaring multiples make these software businesses more valuable than ever.
On public markets, Ellie Mae should have been the type of company buy-and-hold investors own in perpetuity. Its Encompass software is a soup-to-nuts platform for mortgage originators, where they can manage marketing, originate and process home loans, and complete closing and funding documents. It’s in a poll position to do away with the paper mortgage once-and-for-all. Its Ellie Mae Network also connects lenders and investors with originators sourcing loans, acting as a digital network for mortgage loans. With a base of stable subscription fees and those tied to loan processing volumes, Ellie Mae attracted the savviest small and mid-cap mutual funds like Brown Capital, Kayne Anderson Rudnick, and Primecap. From its April 2011 IPO through mid-2018, Ellie Mae shares rose twenty-fold as annual revenues grew from $50 million to over $500 million.
When mortgage rates started to rise due to the Fed in 2018, Ellie Mae’s processing revenues dried up and public investors mistakenly abandoned the company’s stock. Over a span of three months between August and November, Ellie Mae’s stock plunged about 50%, culminating in late October when the company revealed a growth slowdown. “[R]ising rates, low housing inventory, and overall home affordability are serving as significant headwinds to the overall mortgage market… they are prompting us to reset our assumptions for the year,” admitted CEO Jonathan Corr on an Oct 28 earnings release. Soon investors were valuing Ellie Mae as a declining business with uncertain prospects, instead of the blue chip growth multiple it had one commanded.
Buyout funds saw an obvious mistake. Within days, three firms including Thoma Bravo were knocking on Ellie Mae’s door, inquiring about taking the company private.
An unnamed buyer set the stakes for Ellie Mae at $100 a share, or $3.7 billion. Ultimately, after about three months, about eight interested parties kicked the tires on buying Ellie Mae. The sale process leaked, causing the original high bidder for Ellie Mae to back out of its original offer, opening a window for Thoma Bravo. In mid-February, Ellie Mae’s board decided to sell to the new highest bidder, Thoma Bravo, at $99 a share, or about 40% more than its October lows. But a coup was in the offing. The purchase price was nearly 20% below Ellie’s midyear high.
Two decades ago, Orlando Bravo, the billionaire co-founder of Thoma Bravo focused the firm on software, building specialized teams of investors targeting companies in digital applications, web infrastructure and cyber security. Its playbook is to refocus struggling tech businesses on their strengths, and acquire competitors or new technologies to bolster growth. The Ellie Mae LBO was a mixture of its typical moves. Led by Thoma Bravo managing partner Holden Spaht, it first laid off about 10% of Ellie’s workforce and cut costs, and further boosted the bottom line by outsourcing some of its workforce from the expensive Bay Area. Thoma Bravo shuttered some stagnating investment initiatives. With customers, it increased pricing, removing discounts given to some older clients even as the product improved. With increased profitability, Ellie Mae and Spaht also searched for acquisitions to improve its overall software bundle.
In October 2019, Ellie Mae paid about $350 million to buy Capsilon, a natural language processing and machine learning startup that could help customers more accurately pull data from voluminous mortgage applications, lowering errors and exceptions. The business filled out an area where Ellie Mae had invested heavily, but not seen great results.
By 2020, the Federal Reserve was back at zero interest rates and telling the bond market to expect no changes for the foreseeable future. Mortgage rates were touching new record lows and the housing market was on fire. Ellie Mae’s business was surging. Its networked business, connecting all parts of the mortgage market on one platform, had picked up market share. Forecast revenues of about $900 million were almost double the trailing revenues at the time of Thoma Bravo’s buyout, and operating cash flow more than tripled.
The Coronavirus pandemic came early in 2020 and rates only fell further. After a brief slowdown, the housing market took off with record increases in new and pending transaction activity. Valuations for software companies also began to soar as the pandemic revealed the financial potency of companies digitizing entire industries. Thoma Bravo considered an initial public offering of Ellie Mae, but found a ready buyer in Intercontinental Exchange, the parent company of the New York Stock Exchange.
Already a giant cog in the trading of stocks, bonds and derivatives globally, mortgages had long been an area of investment for ICE but where success was still halting. In one fell swoop, it could finance a deal for Thoma Bravo’s portfolio company at record low rates and catapult ICE into an industry lead. While the bet is no sure thing, low mortgage rates and geographic shifts created by the pandemic may give the housing market years of pent up activity for Ellie to service. And thanks to the Fed, ICE has already raised $6.5 billion in financing at rates of between 0.7% and 3% for debt maturing between 2023 and 2060.
For Thoma Bravo, the $11 billion deal will yield over $9 billion for its limited partners, over $7 billion above its cost. So far, it’s the signature deal of Thoma Bravo’s $12.6 billion flagship Fund 13, and all but certain to make it an early standout among a recent crop of record-size buyout funds. As it sells down shares in cloud software provider Dynatrace, another giant coup housed mostly in a prior fund, Thoma Bravo is poised to return well over $10 billion to its limited partners in the midst of the Coronavirus pandemic.
The firm isn’t alone in seeing massive gains from investments where quick action and conviction were paramount, even at once-unthinkable valuations.
BC Partners bought nascent online pet retailer Chewy for $3 billion a few years ago, then merged and split it from brick and mortar retailer PetSmart. Now Chewy’s worth $24 billion. Large buyout funds like Blackstone that have tilted their portfolios towards growth bets are sitting on potentially the biggest windfalls in their history, like warehouse space operator GLP and trading platform Tradeweb, a spun off piece of its $17 billion Thomson Reuters financial data deal. Vista Equity Partners is beginning to take a portfolio teeming with valuable software companies like Ping Identity and Jamf public. The idea that buyout firms must act decisively in order to put money to work in this market was on display when Mukesh Ambani’s Reliance Industries raised about $10 billion from a “who’s who” of PE firms at the depths of the pandemic by selling a small piece his Jio mobile business.
In public markets, investors targeting expensive, but fast growing enterprise software and internet companies such as Whale Rock, Abdiel, Light Street, ARK Investments, Tiger Global, Zevenbergen and Baillie Gifford are having some of their best years ever as the pandemic accelerates digital change. The conviction has even extended to those traditionally dubbed value investors.
A few years ago, Warren Buffett and Charlie Munger lamented missing out on tech giants like Amazon, Google and Facebook. Then they invested $35 billion into Apple over the span of about a year, a massive sum even at Berkshire. Now their shares are worth $90 billion. Without the courage to invest in Apple at valuation nearing $1 trillion, Berkshire easily could have “missed” what stands to be among its best-ever investments alongside Geico.
For more on Thoma Bravo:
See our cover story on co-founder Orlando Bravo
And our original analysis of the Ellie Mae deal