Cooper Investors recently released its Q3 2020 Investor Letter, a copy of which you can download here. During the third quarter of 2020, the fund returned 9.18%, while the benchmark MSCI ACWI was up 6.94%. You should check out Cooper Investors top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Cooper Investors highlighted a few stocks and Intercontinental Exchange Inc (NYSE:ICE) is one of them. Intercontinental Exchange Inc (NYSE:ICE) is a technology company. Year-to-date, Intercontinental Exchange Inc (NYSE:ICE) stock gained 8% and on October 19th it had a closing price of $98.45. Here is what Cooper Investors said:
“During the quarter Intercontinental Exchange (“ICE”, US$56bn market cap) announced and completed the acquisition of mortgage origination platform Ellie Mae. The deal is material in size at ~US$11bn as compared to ICE’s ~US$60bn Enterprise Value. Before discussing the deal it is worth giving a little context.
ICE is run by CEO and Founder Jeff Sprecher who acquired the foundation assets for the businesses 20 years ago for just $1. Through savvy capital allocation and operational knowhow Jeff has built the preeminent financial information and exchange group. ICE’s modus operandi can be summarised as finding analogue markets and applying digital and technology solutions to significantly increase their efficiency.
A clear example of this is the acquisition of the New York Stock Exchange in 2013. At that point, the NYSE had not invested in their trading systems and were losing share to more technically advanced exchanges. ICE took control of the asset and implemented their best-in-class exchange technology, restoring NYSE’s position as the pre-eminent listing and trading venue for equities.
Jeff and his team were also early movers in building a financial data business. They recognised that financial exchange revenue is dependent on trading volumes which can be uncertain in the near term depending on the whims of market participants. However the data used to inform the trading decision has a much more stable demand profile and can be used for trading, pricing and risk management. Off the back of this insight, through acquisition and internal investments ICE has built a leading financial data business which is highly complementary to their financial exchange business.
These sorts of deals are truly proprietary and can create significant value for shareholders. The long term vision, operational and capital allocation prowess required to execute them is quite rare. One area we tend to find this sort of thinking is in Family and Founder-led companies and so with regards to our ICE investment, we had identified a deal of this nature as a key source of value latency.
ICE’s journey in the mortgage space started four years ago as they acquired some smaller assets which provide discrete solutions across the origination process. Over this period management learnt how the industry worked and where the inefficiencies were.
Today, the mortgage application process in the US still encompasses hundreds of disjointed steps involving things such as submission and verification of unstructured documents, pricing and regulatory filings. It touches many different parties including originators, lenders, counties, insurers and of course borrowers, to name just a few. Because of this inherent complexity, increasing regulatory burden and the manual processes involved the cost of mortgage origination has ballooned to US$10,000.
Ellie Mae is a Cloud-based platform where many of the aforementioned steps can be performed more efficiently and often in an automated fashion. This creates significant cost savings of up to 25%. It is a market leader in the space which continues to take share as a greater portion of the US mortgage lifecycle reaches a digital tipping point. There are also significant data and analytics opportunities for ICE, an area where they have significant expertise. Combined, these opportunities should underwrite an 8-10% growth rate at an attractive 50%+ EBITDA margin for the foreseeable future. Under this scenario the company could generate a 10% IRR on the Ellie Mae acquisition.
Our broader discussions with industry participants have furthered our thinking around potential significant strategic upside as ICE pairs the Ellie Mae platform with the rest of its assets. We believe that Jeff Sprecher’s long term vision will be to first complete the digitisation of the mortgage market and then become the platform where “gold standard” mortgages are created. Having mortgages verified by ICE’s processes and data will invoke deeper confidence from investors and allow ICE to use their existing assets and knowhow (equities and derivatives exchanges) to become the clearing house of the US mortgage market, where investors will come to trade mortgages. For context, the US equities market is ~US$35tn and the US mortgage market is ~US$11tn.
ICE can create something like the NYSE except this time they would be the only player. Our observations are that these sorts of long term strategic plays and asymmetric outcomes are typically beyond the purview of CEOs whose tenure with a company is shorter than the time required for the vision to be realised.
ICE have made this acquisition from a position of strength. The broader business is built to thrive in an uncertain environment like today. Excluding the Ellie Mae acquisition ICE will grow earnings at a double digit rate this year. We remain very comfortable with our investment, with valuation also attractive and believe the <20x Free Cash Flow multiple does not reflect the quality of the business, management team and the latent opportunities.”
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In Q2 2020, the number of bullish hedge fund positions on Intercontinental Exchange Inc (NYSE:ICE) stock decreased by about 2% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in Intercontinental Exchange’s growth potential. Our calculations showed that Intercontinental Exchange Inc (NYSE:ICE) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
