Intercontinental Exchange To Accelerate Growth With Black Knight Acquisition

On May 4, 2022, Intercontinental Exchange (ICE) announced its definitive agreement to accelerate growth with the acquisition of Black Knight, Inc. (BKI) in a $13.1B cash and stock transaction. BKI is a software, data and analytics company that serves the housing finance continuum, including real estate data, mortgage lending and servicing, as well as the secondary markets.

I last covered ICE in my February 4, 2022 post. At the time, it had just released Q4 and FY2022 results that exceeded expectations. Based on an attractive long-term outlook and a reasonable valuation, I purchased 200 additional shares @ ~$127 through one of the 'Side' accounts in the FFJ Portfolio.

The recent BKI-related announcement, the release of Q1 2022 results on May 5, 2022, and a plunge in ICE's share price in recent weeks make this an opportune time to revisit ICE.

Business Overview

When ICE's Chair and CEO was an early entrepreneur, he studied the exchange space and discovered that the largest exchanges all had one asset class in common, interest rates.

When The Financial Crisis hit, it became clear that hedgers who thought they had effectively managed risk using legacy interest rate products were doing so very imperfectly. In addition, the conversion from analog to digital provided an opportunity to redefine the exchange business.

Over the past 15 years, ICE has undertaken a radical transformation and has demonstrated a consistent track record of growth.

To compete with hedging products in the corporate borrowing area, ICE acquired Creditex in 2008. It then combined Creditex with The Board of Trade Clearing Corporation in 2009 and launched a clear credit default swap market which has grown 33% YoY and which generated $72 million of revenue in Q1 2022.

The Life Exchange was acquired in 2013 and Interactive Data Corporation (IDC) in 2015. ICE then married IDC to the Bank of America/Merrill Lynch Credit and Bond Index business in 2017 to build tools and launch a powerful suite of corporate borrowing indices and reference data; ICE has doubled the revenue growth in those businesses to an average annual rate of 6%.

Because the largest amounts of consumer borrowing are tied to mortgages, ICE pursued opportunities in the US mortgage space by acquiring The Mortgage Electronic Registry Service in 2018, Simplifile in 2019, and Ellie Mae in 2020. The combination of the technologies acquired through these acquisitions can offer a lender the potential to shorten the time that it holds interest rate risk and market exposure from the time of the consumer rate lock until the time of wholesale funding. This fundamentally changes the risk profile for lenders.

By leveraging its data expertise across the company, ICE recently created the ICE Rate Lock Index. In addition, ICE has recently announced that it is launching a Futures contract on the Index in the coming weeks which creates an even more precise interest rate risk management tool.

With the proposed acquisition of Black Knight, ICE will have the potential to further improve the capital market ecosystem that surrounds the funding of US home mortgages. By:

  • shortening the duration of interest rate risks;
  • making data more transparent to the risk holders; and
  • creating more efficient hedging markets;

costs should ultimately be lower for the entire market.

Please read Part 1 of ICE's FY2021 10-K in which there is a comprehensive overview of the company's history, business strategy, competitive landscape, risk factors, and more.

Proposed Black Knight Acquisition

The proposed acquisition of BKI fits into ICE's plan to continue its track record of growth. Management believes the acquisition of BKI will allow ICE to continue to reduce the cost of home borrowing when coupled with the other US mortgage industry assets it has either built or acquired.

The purchase price amounts to $85/share which is a ~33.6% premium from BKI's May 3rd $63.63 closing stock price. A premium of this magnitude suggests there is not much of a margin for error. I, however, take some solace knowing that ICE has completed several previous acquisitions that have turned out to be immensely successful.

This presentation provides a comprehensive overview of the proposed acquisition. The following images, however, offer a quick glimpse of the terms and strategic rationale of the proposed acquisition.

ICE - Strategic Rationale for BKI Acquisition

Source: ICE + Black Knight Presentation - May 5, 2022

ICE - Transaction Details and Assumptions of BKI Acquisition

Source: ICE + Black Knight Presentation - May 5, 2022

Through this acquisition, ICE expects the Total Addressable Market (TAM) to increase to ~$14B and accelerate the penetration of the current ~$10B TAM.

BKI's highly recurring, more predictable revenues will complement ICE's existing revenue streams and increase the mix of high-growth recurring revenues. Within ICE Mortgage Technology, the mix of recurring revenues will increase from ~50% to ~70% and total ICE recurring revenues will exceed 50% on a pro forma basis.

Management anticipates the transaction will be accretive to ICE’s adjusted EPS in the first year post close, with adjusted earnings accretion accelerating thereafter.

The acquisition of BKI does not require ICE shareholder approval. However, the receipt of regulatory approvals, BKI stockholder approval, and the satisfaction of customary closing conditions are required. As a result, this transaction is only expected to close in the first half of 2023.

Plans are for the cash consideration (a combination of commercial paper, newly issued debt and cash on hand at the time of close) of the ~$13.1B purchase price to be ~$10.5B with the remainder in shares.

At the end of Q1 2022, ICE's adjusted debt/EBITDA ratio was 3.1x thereby giving it space on its balance sheet to finance the transaction.

Gross leverage at the close is expected to temporarily peak at ~4.1x pro forma EBITDA. This is below the 4.25x peak leverage when it acquired Ellie Mae from Thoma Bravo in 2020. This financing structure demonstrates ICE's commitment to maintaining a solid investment grade rating.

Financials

Q1 2022 Results

Please refer to the following material.

First quarter adjusted EPS totalled $1.43, up 7% YoY, marking the best quarter in ICE's history.

Net revenues totalled a record $1.9B, an increase of 6% versus Q1 2021 and adjusted operating income increased by 9% to a record $1.2B.

Total transaction revenues grew 4%, while total recurring revenues, which accounted for nearly half of the business, increased by 9%. This is on top of 10% growth in Q1 2021.

Q1 2021 adjusted operating expenses totalled $0.746B which is in the middle of the guidance range which was provided in early February 2022. Were it not for a few million dollars of severance, adjusted operating expenses would have been toward the lower end of the range.

ICE - Q1 2022 Performance

Source: ICE - Q1 2022 Earnings Presentation - May 5, 2022

Financial data for ICE's business segments are as follows for the three months ended March 31, 2022.

Free Cash Flow

In Q1 2002, ICE generated FCF of $0.66B which was largely deployed toward $0.475B of share repurchases.

ICE - FCF Calculation Q1 2021 and Q1 2022 - May 5 2022

Source: ICE - Q1 2022 Earnings Presentation - May 5, 2022

Debt

The following is a schedule of ICE's Debt as of December 31, 2021 and March 31, 2022.

ICE - Schedule of Debt as of March 31, 2022 and December 31, 2021

Source: ICE - Q1 2022 Form 10-Q

Commercial paper notes of ~$1.3B with original maturities ranging from 1 - 43 days were outstanding as of March 31, 2022, with a weighted average interest rate of 0.99% per annum, and a weighted average remaining maturity of 21 days.

FY2022 Guidance

FY2022 guidance released in early February 2022 is unchanged.

Credit Ratings

ICE's credit ratings were downgraded when it announced the proposed ~$11B acquisition of Ellie Mae from Thoma Bravo. This downgrade was understandable since ICE's leverage increased significantly. ICE, however, has reduced its leverage since then and it has a proven track record of deleveraging following other prior acquisitions.

ICE - Proven Track Record of Deleveraging Following Acquisitions

Source: ICE + Black Knight Presentation - May 5, 2022

Its current senior unsecured long-term debt credit ratings and outlook are:

  • Moody's: A3 (stable and affirmed on May 5, 2022)
  • S&P Global: A- (stable and last reviewed on February 24, 2022)

Both ratings are now the bottom tier of the upper-medium grade investment-grade category. These ratings define ICE as having a strong capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

ICE's ratings are acceptable for my purposes.

Dividends and Share Repurchases

Dividend and Dividend Yield

ICE's dividend history is accessible on the NASDAQ website; ICE does not maintain its dividend history on its website.

At the time of my October 29, 2021 post, ICE's quarterly dividend was $0.33/share. Shares were trading at ~$135.50 thus resulting in a dividend yield just shy of 1%.

On February 3, 2022, ICE announced a ~15% increase in its quarterly dividend to $0.38/share. The dividend yield was ~1.2% based on my ~$127 purchase price.

On May 5, 2022, ICE announced its 2nd $0.38/share quarterly dividend. Based on my $102.70 purchase price, the dividend yield is ~1.5%.

Share Repurchases

ICE's weighted average diluted shares outstanding in FY2012 - FY2021 (in millions) is 365, 395, 573, 559, 599, 594, 579, 565, 555, and 565. The weighted average share count for Q1 2022 was 564 million.

Following the $11B acquisition of Ellie Mae from Thoma Bravo in September 2020, share repurchases were suspended until leverage fell below 3.25 times Adjusted Debt-to-EBITDA. This level was attained in Q4 and ICE reinstated its share repurchases and acquired $0.25B of outstanding shares during the quarter.

In December 2021, ICE's Board approved an aggregate of $3.15B for future share repurchases with no fixed expiration date that became effective on January 1, 2022. As of March 31, 2022, the remaining balance of Board approved funds for future repurchases was $2.7B.

In Q1 2022, ICE repurchased a total of 3.7 million shares of its outstanding common stock for $0.475B, consisting of 3.3 million shares for $0.425B under ICE's Rule 10b5-1 trading plan and 0.4 million shares for $50 million on the open market.

NOTE: Rule 10b5-1 allows company insiders to set up a predetermined plan to sell company stocks in accordance with insider trading laws. The price, amount, and sales dates must be specified in advance and determined by a formula or metrics.

Given the proposed BKI acquisition, ICE is suspending share purchases until its leverage falls below 3.25x, which is anticipated to occur toward the end of 2024. This decision is similar to that when ICE announced its intent to acquire Ellie Mae from Thoma Bravo.

Valuation

ICE's diluted PE in FY2011 - FY2021 is 18.52, 16.46, 29.52, 66.86, 24.11, 23.09, 25.66, 17.00, 25.15, 31.76, and 25.23.

When I acquired shares in August 2020, the low/high and mean adjusted earnings estimates for FY2020 were $4.28 – $.4.81 and $4.40. I erred on the side of caution and used $4.30 with the $103.60 share price to give me a forward-adjusted PE of ~24.

At the time of my March 1, 2021 guest post at ValueofStocks, ICE had just reported FY2020 adjusted diluted EPS of $4.51. Using the current $110.31 share price, I arrived at an adjusted diluted PE of ~24.5.

On August 9, 2021, I reviewed ICE at which time ICE's share price was $120. Using this share price and FY2021 - FY2023 broker guidance, its valuation was:

  • FY2021 - 13 brokers - mean of $4.86 and low/high of $4.66 - $5.01. Using the mean estimate, the forward adjusted diluted PE is ~24.7 and ~24.5 if I use $4.90.
  • FY2022 - 13 brokers - mean of $5.22 and low/high of $5.06 - $5.53. Using the mean estimate, the forward adjusted diluted PE is ~23 and ~22.2 if I use $5.40.
  • FY2023 - 10 brokers - mean of $5.79 and low/high of $5.41 - $6.05. Using the mean estimate, the forward adjusted diluted PE is ~20.7 and ~20.3 if I use $5.90.

When I wrote my October 29, 2021 post, ICE was trading at ~$135.50 and its valuation based on broker guidance was:

  • FY2021 - 18 brokers - mean of $5.02 and low/high of $4.87 - $5.16. Using the mean estimate, the forward adjusted diluted PE is ~27.
  • FY2022 - 18 brokers - mean of $5.40 and low/high of $5.06 - $5.81. Using the mean estimate, the forward adjusted diluted PE is ~25.
  • FY2023 - 16 brokers - mean of $5.95 and low/high of $5.41 - $6.41. Using the mean estimate, the forward adjusted diluted PE is ~22.8.

In my February 4, 2022 post, I disclose the purchase of additional shares at ~$127. Its valuation based on broker guidance was:

  • FY2022 - 19 brokers - mean of $5.59 and low/high of $5.41 - $5.78. Using the mean estimate, the forward adjusted diluted PE is ~22.7.
  • FY2023 - 17 brokers - mean of $6.13 and low/high of $5.85 - $6.33. Using the mean estimate, the forward adjusted diluted PE is ~20.7.
  • FY2024 - 4 brokers - mean of $6.76 and low/high of $6.58 - $7.03. Using the mean estimate, the forward adjusted diluted PE is ~18.8.

I have now acquired additional shares on May 5, 2022 at ~$102.70. ICE's valuation based on broker guidance is:

  • FY2022 - 19 brokers - mean of $5.53 and low/high of $5.29 - $5.73. Using the mean estimate, the forward adjusted diluted PE is ~18.6.
  • FY2023 - 19 brokers - mean of $6.03 and low/high of $5.75 - $6.27. Using the mean estimate, the forward adjusted diluted PE is ~17.
  • FY2024 - 13 brokers - mean of $6.60 and low/high of $6.12 - $6.99. Using the mean estimate, the forward adjusted diluted PE is ~15.6.

I envision these broker estimates will be adjusted over the coming days but that ICE's valuation will remain attractive.

Final Thoughts

I initiated an ICE position on August 21, 2020 @ $103.60/share. Although the current share price is much the same as almost 2 years ago, I am not concerned.

I like ICE's strategic decision to accelerate its growth with the proposed Black Knight acquisition. However, the significant purchase price premium does raise eyebrows. Nevertheless, I am confident ICE's management knows exactly what it is doing. This is not ICE's first acquisition and Black Knight's capabilities will dovetail nicely with ICE's existing offerings ultimately leading to long-term shareholder value creation.

In recent posts I mention that investors would be wise to heed the advice Ben Graham once provided Warren Buffett when Buffett worked for Graham-Newman:

'In the short run, the market is a voting machine. In the long run, it is a weighing machine. People have been successful investors because they've stuck with successful companies. Sooner or later the market mirrors the business.'

ICE did not fall within my top 30 holdings when I completed my January 2022 Investment Holdings Review. With this recent purchase, I now hold 350 shares in the FFJ Portfolio and additional shares in a retirement account for which I do not disclose details. Despite not being a top 30 holding, I like the company's long-term prospects. Therefore, I acquired another 50 shares @ $102.70/share on May 5, 2022 in a 'Core' account in the FFJ Portfolio.

I wish you much success on your journey to financial freedom!

Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long ICE.

Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.