ICE counters investor pushback on Black Knight deal

Intercontinental Exchange executives said Thursday they are not worried that its pending acquisition of Black Knight could be derailed by antitrust concerns analysts have raised, even though investors have had a different reaction.

After the deal was announced on May 5, an initial bump drove Black Knight’s stock price to a high of $79.78. However, by the end of that day it had sunk back to close at $72.84. ICE had valued the transaction at $85 per Black Knight share.

“Based on Black Knight’s current share price, the market appears to be ascribing about a 60% probability of a deal closing,” Ryan Tomasello, an analyst at Keefe, Bruyette & Woods, said in a research note issued after the market closed on May 5. “While difficult to precisely quantify, we believe that some discount is warranted based on antitrust risks given the combined market share of ICE and Black Knight’s various businesses.”

Divestiture of an asset that concentrates market share, such as Black Knight’s loan origination system Empower, could help win regulator support of the deal, according to Tomasello.

However, ICE executives declared Thursday they have no plans to sell Empower, and in fact, it serves a different segment of the mortgage industry than Encompass, the leading LOS system, does. They said they expect the deal ultimately won’t be seen as concentrating market share.

“It’s a large deal, so we expect it to take time for regulators to understand the complementary nature of our two businesses,” ICE President Ben Jackson said. “But at the end of the day, we’re confident that they’ll come to the same conclusion that we did.”

Black Knight starts in the front end of the business, at the real estate transaction, where ICE Mortgage Technology does not have any assets, Jackson said, and then picks up the path after a mortgage closes.

“Black Knight’s other core business is data assets,” said Jackson. “So they have proprietary data assets, and very unique capabilities that we do not have that we believe are going to be very beneficial to our clients.”

Finally, Jackson addressed the LOS situation. “It’s important to point out that the customers that they cater to are fundamentally very different and have a completely different mindset than the customers that we serve today at ICE Mortgage Technology,” he said. Empower is “very highly customized based on the experience that that lender may want to provide for their clients.”

Encompass, on the other hand, is a standardized offering where users can only make some basic configurations around the perimeter, Jackson explained.

Meanwhile, while ICE does not offer servicing technology, Black Knight MSP’s high market share (63% of first-lien mortgages and 26% of second-lien loans) “could raise concerns when combined with high market share in other areas of the pro forma business, particularly origination,” Tomasello said.

Optimal Blue, which has a 40% share of product and pricing engine users, is another possible regulatory concern. Encompass has its own, less robust, PPE and the customer overlap could also raise regulatory concerns, he added.

However, Ellie Mae has had a longstanding relationship with Black Knight over the years, with many of its products, including Optimal Blue, available on the system, ICE Mortgage Technology President Joe Tyrrell noted during the call.

“By expanding our solution set beyond originations, we will be able to deliver a life of loan platform that reduces friction and drives transparency across the workflow,” Intercontinental Exchange Chairman and CEO Jeff Sprecher said. “The integration of our solutions will strengthen the overall mortgage ecosystem, bringing more choice and delivering efficiencies for lenders, servicers, partners, and ultimately the end consumer.”

ICE is planning to make significant investments to help modernize certain parts of both MSP as well as Empower, Jackson said. It plans to keep Encompass and Empower as separate systems.

“These two solutions really now give us the opportunity to address any technology philosophy that a lender might have,” added Tyrrell. Because those two loan origination systems are complementary, it accelerates ICE Mortgage Technology’s ability to increase penetration into its total addressable market.

“There obviously are some customers that we have in common … but what we really see is the cross-sell opportunity into these two bases,” said Tyrrell. “So even where we might have a similar customer, perhaps it’s a customer that’s using Encompass and also using MSP, there’s still so many other solutions we now have available jointly that we can cross-sell to that individual lender.”

But the deal would still have to get past the Justice Department’s Antitrust Division or the Federal Trade Commission, which are skeptical about mergers.

Antitrust regulators look at merger and acquisition deals from two perspectives: horizontally and vertically.

The first question would be whether the parties involved have directly competing products and if so, how close the merging parties are as competitors, and what their market shares are, said Michael Lindsay, a partner at Dorsey & Whitney and co-chair of its antitrust practice group.

“Ultimately what you’re trying to figure out in the horizontal part of the analysis is regardless of what the parties’ intentions are, will the proposed transaction enable the parties to increase price without losing so much business that the price increase becomes unprofitable?” Lindsay said. “They might be horizontal competitors, but it might not be problematic because they wouldn’t be able to raise prices after the deal.”

(He added that in some other industries, where the product is distributed at no charge to the consumer, “price” may not be the right metric.)

“I think it is generally tougher these days to get matters through these agencies,” said Lindsay. “And in part that’s true even for routine transactions that no one seriously thinks even hint at a competition problem.”

FTC Commissioner Noah Joshua Phillips, a Republican, representing his own views only, believes the agency is hostile to these deals, he said during an April 27 speech at the Berkeley Spring Forum on M&A and the Boardroom.

The agency’s current leadership view is based on three ideas, he claimed. “First, M&A generally produces little social value and a great deal of social cost,” Phillips said. “Second, the costs include a wide swath of ills including lessened competition but also disadvantaged labor, inflation and undermined democracy.”

Finally, M&A’s a privilege granted by the government, rather than a natural part of commerce, he said.

Other possible bidders could upset the apple cart. KBW, for example, has mentioned CoStar Group, one of the losing bidders for CoreLogic.

“It is also possible that other scale services/technology providers could view Black Knight as an attractive way to expand into the under-digitized mortgage industry given Black Knight’s entrenchment and client roster, which could present synergy opportunities to firms similarly focused on banks/lenders,” Tomasello said.

Private equity also remains a possibility for a competing bid. “We also think Black Knight could benefit from a more aggressive investment cycle to capitalize on the mortgage market’s ample digitization opportunities, which could be more effectively executed without the scrutiny of the public markets,” Tomasello said.

Both companies reported earnings Thursday, with Black Knight’s reported a day early.

During the first quarter, ICE Mortgage Technology had segment revenue of $307 million, compared with $346 million in the fourth quarter and $355 million one year prior.

But it was able to shift its revenue mix, with the majority now coming from recurring sources, $156 million, versus $151 million from transactions. In the first quarter of 2021, it was $125 million and $230 million respectively.

ICE Mortgage Technology’s GAAP operating income fell to $53 million from $86 million in the fourth quarter and $106 million in last year’s first quarter.

“While total mortgage technology revenues declined year over year in the first quarter, we once again outperform an industry that experienced a 40% decline in origination volumes, including an 80% decline in term refi volume,” Warren Gardiner, chief financial officer, said during a call with investors.

Black Knight reported $364.6 million for the first quarter, compared with $60.7 million for the fourth quarter and $54.1 million in the first quarter of 2021.

Software solutions reported operating income of $153.1 million, versus $151.3 million during the prior quarter and $139.7 million from the previous year. Data and analytics ended up with $15.2 million of operating income, compared with $14.7 million and $15.9 million one year ago.

“Our first quarter results represent a strong start to the year, as we achieved organic revenue growth of 9%, adjusted EBITDA growth of 9.5% and adjusted EPS growth of 12.5%,” said Black Knight Chairman and CEO Anthony Jabbour in a press release. “We continue to see positive momentum across all of our business lines as lenders and servicers look for ways to drive revenue growth, increase efficiency and maintain regulatory compliance through the use of innovative technology solutions.”

Meanwhile, the previously announced leadership transition at Black Knight will take place as scheduled on May 16. Jabbour will become executive chairman, current president Joe Nackashi moves up to CEO and chief financial officer Kirk Larsen adds the president’s title.