Acquiring Minds in Mortgage Technology

 

Weve seen the mortgage technology sector go through a tremendous number of acquisitions.  Some firms, like FiServe, owe most of their size and existence to their never ending stream of acquisitions.  Some acquisitions have been dismal failures while others have proved to be highly beneficial to all parties involved.  Each year, dozens of companies are acquired in our sector.  So just what determines which are winners and losers?  Since the late 80s, Ive been involved with a significant number of acquisitions and have watched many more from the sidelines.   This article discusses some general trends and what makes an acquisition a success or a failure.

 

In the 90s, the goal for many founders was an IPO but not any more.  Sarbanes Oxley, directory liability and a host of other issues have surely taken the polish off any IPO.  Today, there seems to be more interest in taking public firms private than the opposite.  Founders now look almost solely at an acquisition as the exit strategy.

 

 Technology firms are very unique in that so much of the company typically centers around the founder.  When you look at some of the successful names in the industry, there typically is a great founder behind them.  However, most founders have limits to their abilities.  Many are very comfortable in a small business environment where they can control most aspects of the business.  However, when it comes to growing the firm beyond a few dozen employees, it can become a significant challenge.  A founder must completely change their focus to managing people rather than managing the product.  This is where a business can sometimes fall down and when their acquisition by a larger firm can help.  A good example is Del Mar Database (San Diego, CA).  It was sold by its original founder that may have become uncomfortable with the firms growing size.  The acquirers brought in a new management team and invested into its growth.  The firm grew rapidly and was sold only a few years later for significantly more money to FiServe.  The success of this deal hinged upon an experienced buyer that brought in the right talent.  The customers won with better products as well.  There are many other firms with similar success stories.

 

On the other hand, we have seen failures as well.  Some companies did well under the direction of their founders.  Then, with the acquisitions, the firms failed to live up to expectations.  We have seen this with four of the LOS providers Byte, Contour, Genesis and Interlinq.  All four were acquired and later the founders departed.  The acquiring firms were challenged to take the firms to a higher level of success.  One could point fingers at technology issues and/or management talent. The impact was the acquirers had a lackluster ROI for their investment.

 

One of the top reasons for making an acquisition is the synergies between the two companies.  When First American acquired Credco, they were able to cross-sell Credit Reports to the same customer base of their title operations.  Further, they developed integration solutions so the credit reports could be delivered electronically directly to the lenders systems.  The result was the huge growth of Credco in the late 90s and in just a few years the investment had paid for itself many times over.  When FiServe makes an acquisition, they do so primarily on the basis of ROI.  Still, they hope that the acquisition will yield synergistic benefits as well.  Often, a mortgage firm will purchase products from multiple FiServe divisions.  Customers expect that the different products from the same firm would integrate well together which is typically, though not always, the case. 

 

Another reason firms make acquisitions relate to control of a process and to ultimately sell more of a different product.  For example, when Contour was originally acquired by First American in 1998, the main emphasis was to increase sales of credit reports, flood certificates, title policies, appraisals and other First American products through the Contour LOS software.  First American to this day owns a large chunk of Ellie Mae mostly for the same reason.  Ellie Maes successful ePass system has been proven to help sell various products to the users of their LOSes.  Fidelity bought Eastern Software with no doubt, some similar ideas.  As the title industry becomes more automated, it will become ever more crucial to be tightly integrated with the LOSes of the industry where often title policy orders are originated from.  Again, customers benefit through a streamlined solution for ordering their needed products and services.  Ellie Maes ePass has been well received by their customers just for this reason.  The right acquisitions can make such evolutions possible.

 

Even these acquisitions dont always work.  In the past, First American had acquired several document service firms with the idea of putting them together (the roll up strategy in acquisition speak).  All were leading firms during their peak but after their acquisition by First American, the firms had trouble combining together and increasing their overall market share.  Perhaps the technology was too difficult to combine together or perhaps the right managers werent found.  Regardless, the game of acquisitions can be hit and miss.  To be sure, it takes several years to really know if an acquisition was a success, failure or just treads water.

 

For larger firms, one big hit can offset many acquisitions that dont pan out.  In most cases, an acquired firm wont loose significant value and can often be resold later if its not working out.  On the other hand, a successful acquisition can return many times the investment.  Thus the larger firms might take a similar view as a venture capital firm in that one big hit will offset many flops.  FiServe has made a lot of acquisitions over the years and Id consider some of them as flops.  Still, they have been successful overall and their stock has jumped over 50% in the last four years.  They continue to look at new acquisitions that will benefit their customers and build synergies among their massive amount of mortgage technology assets.

 

What is new in the last year or two, are a new breed of buyers.  These come from two groups.  The first are the private equity firms which have been all the rage on Wall Street.  From universities to pension funds, money is pouring into these funds.  One of their targets is technology firms with proven products and a solid customer base.  A second group of buyers are the foreign buyout firms.  There is an interesting phenomenon happening in that some of the international firms are buying U.S. firms.  They are active in the mortgage technology sector.  If you look at technology firms on the India stock market they are being valued at fairly high P/E ratios.  These buyout firms can buy mortgage technology firms in the U.S. for about half of those P/Es.  They can purchase and combine several firms with synergies and launch a foreign IPO.  In short order, they can double their investment.  Theres no shortage of cash flowing to many of the high growth foreign markets.   Its a simple formula that will likely work for years to come.  Ironically, a lot of the money flowing into these foreign markets are coming from U.S. investors.

 

For sellers such as the founders of a firm, the attraction of selling is typically related to a cash-out scenario after years of hard work.  While this is the obvious, many actually have more underlying reasons.  Many, such as Warren Myers who founded Myers Internet Services among others startups, is what I would consider to be a serial entrepreneur.  He is more interested in the startup phases then turning a startup into a large company.  He sold his firm to eMagic in January, 2006.  My own experience is that its often more enjoyable to take a firm from 1 employee to 100 then it is to go from 100 employees to 1000.  Thus, some will sell their firm when it hits a certain size and theyll start anew again.  No doubt, Myers will be back at it with a new firm soon.  Entrepreneurs sometimes feel an acquirer would be better at taking their firm to the next level.  Finally, there are personal reasons such as retirement or medical/family issues. 

 

With the declining mortgage market, well see a number of acquisitions related to consolidation.  Some technology firms are likely to already be having cash flow problems and may be forced to go with a fire sale situation. 

 

Which acquisitions will flounder and which will exceed depends upon a lot of factors.  The most important is the talent of the management team.  They must be well experienced with mortgage technology.  Second in importance are selling synergies.  Will the combination yield an increase in sales for the acquired firm?  Finally, there are a host of issues such as technology synergies, asset sharing, cost reductions and partnering.   In the end though, it takes a good acquiring mind to know just how to put together a successful deal.

 

Scott Cooley is an independent mortgage technology consultant and can be found at www.scooley.com