An Amazon for Mortgages: Why Altisource Is Buying Mortgage Builder

The price Altisource will pay for Mortgage Builder is peanuts for a company with a $2.6 billion market capitalization. But acquiring the technology vendor will play an integral role in realizing Altisource's vision of a mortgage-services marketplace.

Altisource would pay $15 million at the deal's expected August closing and up to $7 million in additional earnout incentives for the Southfield, Mich.-based Mortgage Builder Software. The firm provides a loan origination system, servicing system of record and other technologies to small and midsize mortgage bankers and financial institutions.

The strategy of expanding origination services is crucial if Altisource is ever to distance itself from having its fortunes tied to its former parent company and largest client, Ocwen Financial Corp.

While Mortgage Builder is a pure-play technology vendor, Altisource intends to use it as a venue to sell ancillary origination services, particularly to the 271 lenders that belong to the Lenders One Mortgage Cooperative. These lenders collectively originate about 14% of mortgages in the U.S. market.

Altisource acquired the parent company of Lenders One, Mortgage Partnership of America, for $56.4 million in cash and stock in February 2010. Mortgage Builder has long been the only LOS vendor with a preferred vendor relationship with Lenders One, and 19% of Lenders One members, about 50 companies, use the Mortgage Builder LOS.

"We think we will be able to convert additional members onto the platform…With a more financially strong owner of the company, they'll be able to close some transactions which they otherwise lost because of their size," Altisource CEO William Shepro said during a July 24 conference call to discuss second quarter earnings. "But at the end of the day, it's more of how it fits into our overall strategy than this company in-and-of-itself being a very big needle mover for Altisource."

Altisource's "marketplace vision" is to launch a central hub for ordering services provided by Altisource and other third-party vendors. This hub would integrate with Altisource's servicing system of record, Equator, and the Mortgage Builder LOS. In essence, it would be a mortgage industry equivalent to Amazon, where lenders and servicers can buy products like valuations, quality control reviews and closing and title services.

The portal is expected to launch in 2015. The model is similar to existing offerings like Black Knight Financial Services' (NYSE: FNF) RealEC platform and the Ellie Mae Network. The latter is provided exclusively to the namesake vendor's Encompass LOS, while RealEC integrates with Black Knight's Empower and LendingSpace LOS platforms and third-party origination systems. Each vendor uses its respective marketplace to sell its own origination services and offerings from other vendors.

Third-party vendors pay fees to connect to the portals, and they're an integral source of revenue for the vendors that operate them. For example, the Ellie Mae Network generated $28 million in revenue, or about 21% of the vendor's total revenue from 2009 to 2011. Ellie Mae stopped separately reporting its software and network transaction in 2012. But a new metric called "variable revenue," which combines earnings from the Ellie Mae Network and other transaction-based fees, totaled $55.5 million in 2013, or 43% of total revenue for the year.

Altisource posted net income of $54.7 million for the second quarter, up 75% from a year earlier, and total revenue of $296 million, up 59% year-over-year. Altisource stock closed at $118.96 per share Friday.

The Mortgage Builder purchase price is far less than the $232 million DH Corp. paid in 2011 to acquire Mortgagebot, which offered only a front-end point of sale system, but had a customer count of more than 1,000 lenders. Avista Solutions, known for its back-end LOS capabilities, had 150 customers when DH Corp. acquired it for $40 million in 2012. Likewise, Ellie Mae raised $45 million in its 2011 initial public offering and later paid $25.2 million for Del Mar DataTrac. With a customer count of more than 1,500 lender clients, Ellie Mae's market capitalization currently values the company at $800 million.

By comparison, the closely held Mortgage Builder is thought to have 125 to 150 lender users. While the purchase price is lower than other recent LOS acquisitions, it's a fair valuation for the company, said Scott Cooley, a mortgage technology consultant who founded one of the industry's first LOS vendors, Contour Software. Cooley sold Contour to First American in 1998 for $16 million, which when adjusted for inflation, would amount to about $23 million today. First American later sold Contour to Ellie Mae in 2001 for $30 million, the equivalent of about $40 million in 2014.

"While I wasn't privy to revenue and profits, from what I do know of the firm, it's in the ballpark of a normal LOS valuation," Cooley said.

"There's a much higher valuation when you're the market leader…but I think the valuation of Mortgage Builder is a pretty fair valuation," he added.

Still, with nearly a third of the purchase price tied to performance incentives, Cooley questions whether concentrating on maximizing Mortgage Builder's earnout payment will distract from research and development and other investments in the company.

"Their focus before was longevity and about making sure the customers are happy for years to come," he said. "But if you no longer own your company, and you're still managing it and have this $7 million carrot, your focus becomes the carrot and not so much the longevity of the company. Not that they don't care, but it's not going to be your emphasis and it's hard to manage that."

Through a spokeswoman, Mortgage Builder owner and CEO Keven Smith declined an interview request, citing the still-pending acquisition.

Altisource has not disclosed the performance goals tied to the Mortgage Builder earnout. But during its second quarter earnings conference call, the company announced that the $80 million earmarked for the earnout payment of its acquisition of Equator, a default servicing technology vendor, would be reduced by $37.9 million. Equator's former owners received $63.4 million at the deal's November 2013 closing.

"We had a forecast of what we thought Equator could do when we purchased Equator and they had a forecast of what they thought they could do," Altisource Chairman William Erbey said on the call. "We're actually doing as well as we thought we would do…But that does not mean that we believe we're going to hit the projections that were given by the sellers."

Next month marks five years since Altisource was spun off into its own publicly-traded company, but efforts to become less dependent on Ocwen for business and diversify revenue streams by offering origination services to the Lenders One membership have been slow going.

For a moment during the earnings call, Shepro expressed frustration at the slow pace of Altisource's penetration into the Lenders One market.

"We still have a lot of work to do with respect to Lenders One, and I'm not happy," Shepro said before abruptly stopping himself midsentence.

"The opportunity is as great as it's ever been and we need to do a much better job at executing…We basically have to be indispensable to the members," he added.

As a result of Ocwen's rapid growth, the nonbank mortgage servicer has been the focus of intense regulatory pressure, including ongoing investigations by New York's Department of Financial Services, a recently settled lawsuit with the Massachusetts attorney general, as well as scrutiny from Ginnie Mae and the Federal Housing Finance Agency's Office of Inspector General. All the uncertainty only reinforces Altisource's desire to have a more diversified client base.

"We're building a business that we believe can grow," Shepro said. "Obviously it will grow a lot faster if Ocwen acquires additional servicing rights and if they don't, we're trying to position ourselves to grow without Ocwen buying servicing rights."