Description

BLND stock is up +100% in the last 30 days, so there can be significant volatility to the stock in the next few months. I don’t think Q4 will necessarily be a great quarter, but I’m not trying to play quarters here. This is about strategic positioning. This idea has a 24-month period and I do think the stock can double much sooner (albeit a recession). BLND is a small cap with low trading volumes, which makes this name untouchable by most funds out there, but also makes it interesting name to enter 2024 with. I’d expect a lot of funds going to smallcap names, especially the ones that have gotten significantly beaten down.

At $2.65 a share, despite being up 100% in the last 30 days, the stock still trades at a very attractive multiple of only 4x 2024 sales. That’s a very low multiple for a 70%+ gross margin SaaS company that will be compounding sales at over 30% in the next 3 years with multiple new products ramping up, expanding its footprint in the banking SaaS industry. 

Consensus numbers estimate company only gets to ebitda profitabilit by 2025 with only ~$10m in adj ebitda. I'm well above the street, estimating ebitda profitabilty much earlier, in mid-2024 and think company can do ~$100m in adj ebitda in 2025, assuming a soft or no-landing. But even in a hard-landing scenario, I'd expect higher than $10m in adj ebitda as I think management can cut even more cost as the top-line wouldn't necessarily come down as much, as the mortgage industry is already in a hard-landing. Such scenario will also force the fed to cut even more aggressive, which would be directionally positive for the mortgage industry.

Business Description:

BLND is a $600m Market Cap software-as-a-service (SaaS) company specializing in the banking sector. It provides a white-label platform designed to enhance the digital consumer experience for various banking products. Their customers primary consists of banks, but its services are also utilized by fintech companies and non-bank mortgage lenders.

Founded in 2012 with an initial focus on streamlining the mortgage loan application process, the company now holds a 20% market share in U.S. mortgage originations through its platform. In 2022, Blend's platform processed over $1.7 trillion in loan applications. The company's client base includes 39 of the top 100 U.S. banks, 11 of the top 25 mortgage originators, and 4 of the top 10 credit unions, with notable customers such as Wells Fargo, U.S Bank, PennyMac and Navy Federal. The company's revenue model is primarily usage-base involving transaction fees, but it’s also supplemented by recurring subscription fees.  

Here's an overview of the company's primary revenue lines:

• Brand Platform Revenues (70% of total company revenues)
  • Mortgage Suite (51% of total company)
    • All revenues from products if/when related to a mortgage application (ie., core mortgage app + income verification + home owners insurance + closing etc)
    • The only mortgage related product not reported here is Title, which is reported separately.
  • Consumer Banking Suite (14% of total company)
    • All revenues from non-mortgage related transactions. Those can be a Personal Loan application, a credit card application, a home equity loan, etc. It can include similar products such as Income Verification, but only when not used for the purpose of a mortgage application.
• Title revenues (30% of total company)
  • 2/3 comes from Title365 which Blend acquired in 2021, while 1/3 comes from their software-enable title.

Main competitors:

1. SimpleNexus (acquired by nCino) primarily works with smaller banks and has not yet demonstrated the scalability required by larger banks. Before being acquired by nCino, SimpleNexus also lacked some third-party integrations that Blend offers. The acquisition of nCino may not pose a significant threat. The nCino platform, built on Salesforce’s Apex, is limited to Salesforce's Platform as a Service (PaaS), which could constrain its product development speed compared to Blend. We believe SimpleNexus might remain a less formidable competitor in the long-term following this acquisition.
2. Roostify (acquired by CoreLogic) differs from Blend in a few key areas. Besides not having the same proven scale, Roostify lacks a range of product offerings beyond mortgages. In the mortgage sector, Roostify primarily serves as an API provider. While this allows for more customization, it comes at the expense of requiring significantly more coding and IT resources on the part of the banks.

Thesis:

Blend is a company that has been largely ignored by investors since the downturn in the mortgage market, is often viewed as just another failed tech IPO from the 2021 bubble. Its Total Enterprise Value plummeted from $4bn to as low as $150m earlier this year and is now valued at $600m. Many regard Blend as a mere cyclical mortgage business masquerading as a tech-driven software firm unable to turn a profit. However, the reality is that Blend is indeed a high gross margin SaaS business. It’s true fundamentals have been masked by the ill-advised acquisition of Title365, a cyclical, low-margin and low-multiple business, and its top-line has faced a double-whammy impact, from Title365 revenues declining more than 90% from its peak, as well as Blend’s core mortgage platform revenues declining as a result of massive downturn in mortgage originations volumes.

However, things are now inflecting for the better and we expect BLND to be a multi-year and multi-bagger winner in this next bull phase for the mortgage market.

Key points:

1. Title365 overhand is nearly over: BLND paid $500m for this business when it was doing $200m in annual sales. At the time of acquisition, Title365 had 2x more sales than Bland Platform and 50% lower gross margins. The rationale for acquiring this manpower-intensive, low-margin business, which negatively impacted Blend's market valuation, was unclear and considered a major misstep by management. However, today, Title365's revenues have plummeted by 90% from their peak, the goodwill from the acquisition has been fully written off, and much of the workforce has been laid off. The company plans no further investment in this area and is open to divesting it, though no returns are expected from such a sale. Importantly, this move will no longer adversely affect Blend's valuation and margins.
2. The mortgage market has troughed: Mortgage originations have been on a negative y/y decline for 9 straight quarters with the lowest point in 1Q23. We anticipate that by either 4Q23 or 1Q24, quarterly originations will return to positive y/y growth. Refi volumes are currently down -90% to 1m per year (vs 8.78m in 2020 peak) or -70% below 2019 levels, while Purchase volumes are down -33% from 2021 peak or -20% below 2019, as a result of higher rates, however, mortgage rates have fallen by -13.3% since Nov/1 going from nominal 8% to 7%. Additionally, the market now anticipates 125bps of fed rate cuts in 2024. Regardless of whether these expectations are overly optimistic, the critical point is that mortgage market has bottomed out. Ultimately, this trend will be a crucial factor of Blend’s stock performance over the next 2-years, since most of their revenues are still mortgage related.
3. Blend's core mortgage mortgage volumes have been outperforming the industry: Since the mortgage industry volumes went negative in 3Q21, BLND have been reporting mortgage volumes 7-40pts higher than industry volumes, as they continue to gain share. Reported mortgage revenues have been even better, adding another ~15-20pts delta to growth differential. This is due to BLND increasing revenue per loan and adding more attach products (ie., homeowners insurance, title, income verification etc...) For example, in 1Q23 and 2Q23, while mortgage industry volumes declined -60% and -39% y/y, BLND mortgage volumes declined -52% and -31% (representing a delta of ~8pts) and BLND mortgage revenues declined -33% and -17% (adding another 19pts and 14pts delta respectively).
4. The management has efficiently restructured the business: They announced annualized cost savings of $100 million, (opex and cogs) inclusive of a 28% reduction in operating expenses alone from 3Q22 to YE23. They have exceeded these targets, with current operational expenses already 33.5% lower 3Q23 vs 3Q22, and further reductions are probable in 4Q23. We also think there is potential for more cost cuts in 2024, especially if management fully divest Title365, which still maintains a considerable number of employees.
5. Valuation is still very attractive: BLND stock has already moved quite a bit, but this move is nothing compared to the upside from here. BLND is currently valued at $630m TEV, or 4x next year’s sales (my numbers) and that multiple does not include any Title related revenues. This is incredibly attractive for a SaaS business with 70%+ gross margins that will CAGR revenues at ~40% by 2025 (albeit a recession).  
6. Consumer banking products (non-mortgage related) growth will accelerate: In 2021, only 5% of the company's total revenue came from consumer banking products like credit cards, deposit accounts, personal loans, identity and income verification. Now, these products account for 15% of total revenue. This revenue stream has been growing at a low-20% rate this year but is expected to accelerate to mid-30s. Currently, 30% of Blend's customers have implemented or are in the process of implementing Blend Builder, which allows easy access to these ancillary products in a low-code environment. Implementing Blend Builder typically takes several months, after which customers configure add-ons and go live, eventually scaling up by replacing their internal process systems for those products. For instance, Wells Fargo now uses Blend Builder for all their personal loans. Key to Blend’s long thesis is the fact they already have a lot of the top Financial Institutions as clients and just need to continue to increase cross-selling these new products. However, the Blend Builder makes it very easy for the smaller regional banks as well, as they are simple drag and drop interface with very little coding require. 
7. Capital structure de-risked: Some investors raised prior concerns on the $220m of bank debt maturing in mid-2026, especially since the company is not yet profitable, despite having $245m in cash. In a wise move, the company recently paid down $85m of its debt in Nov’23, leading to lenders granting a 1-year extension. The remaining $135m gross debt now matures in mid-2027. While we didn’t anticipate liquidity problems, this decision was a positive step that removes some other investors’ prior concerns we have heard.
8. TAM is large and BLND has a lot of future pricing power: There are different ways to look at TAM. FI/FIS/JKHY combined banking revenues are ~$18bn. nCino says its TAM is ~$18bn. They also say their SimpleNexus TAM is $4bn. Bank IT spending to 3^rd party was $12bn in 2019, growing 8%/year. Right now BLND only gets paid $65-80/loan so they are extracting very little value, as their bank customers save $1500/loan. If we simply assume BLND can charge 10-20% of the value they save customers, let’s say $150-300/loan at some point in the future, that will translate into a $1.2bn to $2.4bn TAM from 1 product alone, their core mortgage (which does not include any attach products such as Income Verification, Homeowners insurance, closing, title and etc that they sell alongside core mortgage applications). CEO Nima agrees they are under-monetizing, but they want to build out more products first. I think we can be looking at the next Fidelity or Fiserv here with a multi-year of compounding growth as the industry evolves and companies like Blend are the key beneficiaries.  

Valuation

We anticipate that with the mortgage market's recovery, a more efficient cost structure, and growing sales from non-mortgage products, the business could realistically achieve $300 million in top-line sales with around $100 million in adjusted EBITDA (33% margin) by 2025, focusing solely on Blend Platform Revenues. This could justify a 20x adjusted EBITDA multiple, leading to nearly a $8 share price (about 200% upside), or a 6.4x sales multiple for a business growing its top-line by over 60%. These projections align with management's forecast of a 25% top-line CAGR by 2026, or 30%+ in a normalized market, which we expect by 2025 despite potential recession scenarios.

Key risks:  

1. Inflation/Federal Policy: The main risk is a resurgence of inflation. This could lead the Federal Reserve to consider raising interest rates again, delaying the decrease in mortgage rates.
2. Recession: While the mortgage markets seem to have already experienced a significant downturn, an actual recession could temporarily halt home transactions. However, it could also hasten the reduction of interest rates, which would be a positive direction overall.
3. Competition: We consider Blend the leading player in terms of volume and the superior product for their main mortgage product. However, as they broaden their product suit into consumer banking, the competitive landscape is expected to become more intense.

Additional information on Blend

The company's present strategy centers on expanding its reach in non-mortgage-related products. The main focus is on Blend Builder, a low-code development platform tailored for banking clients. This tool enables their banking customers to customize designs, automate workflows, and set business rules for various banking products available through Blend. The range of products that can be configured using Blend Builder includes personal loans, credit cards, income and identity verification services, home equity loans, deposit accounts and more. 

A key aspect of Blend's end-to-end solution is streamlining complex back-end data integration required for various financial products. Take, for instance, its mortgage product, arguably the most intricate offering. Blend has established integrations with thousands of third-party systems, including essential CRMs, loan underwriting/origination systems, credit bureaus, other financial institutions and numerous local county clerk’s offices. In today's fast-changing digital landscape, where legacy banks may struggle to quickly adapt to new consumer behavior and the rise of fintech competitors, Blend is becoming increasingly vital for Banks if they want to stay competitive. It enables banks to concentrate on their core competency of loan origination while Blend handles the user experience and intricate back-end processes.

What's great about their Builder product is that it grants full control to banks, more specifically, to the appropriate personnel within these banks. For example, an employee overseeing the Income Verification workflow process doesn’t have to be a developer. Normally, to make adjustments to such workflow, they would have to initiate an internal ticket request, which would go to the bank's IT department (often a third-party company), leading to a waiting period of several weeks or even months for the adjustment to go live. With Blend Builder, this same employee or his manager can simply log in to Blend’s platform and make the change immediately (sometimes with no coding necessary), saving weeks or months of "waiting time." Additionally, the platform offers an easy way to visualize all workflows for each product, enabling managers from any department, including C-suite executives, to easily access them. This leads to greater transparency, efficiency, and minimized risks. At the same time, Blend offers a beautiful, elegant UI interface to the bank’s end consumer, which can also be fully configured by the bank. This is the future of banking. 

While companies like Fiserv, Fidelity, and Jack Henry have traditionally been at the forefront of core banking systems, focusing on back-end processing, Blend is carving out a dominant position in the front-end aspects of banking technology. This shift is particularly evident in their approach to mortgage processing, arguably the most significant and complex financial transaction for consumers, involving intricate steps and integration with multiple third-party systems. In an era where digital-first experiences are paramount, especially among tech-savvy younger generations, the value of a seamless user interface is the key. While systems such as Black Knight and CoreLogic are integral to the loan process, primarily on the back-end underwriting side, they lack direct consumer interaction. This is where Blend's strength lies. By focusing on the consumer-facing top of the funnel, Blend provides an elegantly designed user interface that caters to both consumers and loan officers. This approach, which harmonizes front and back-end data processing and seamlessly connects to various loan origination systems, positions Blend as a pivotal player in redefining the digital banking experience. Through Blend Builder, they're also simplifying the coding aspect of integration. It's like expanding their stakeholder base, extending their value proposition to include operational managers and developers.

Catalyst

• fed cutting rates
• mortgage industry originations back to positive growth (in Q4 or Q1)
• Divesting Title365
• Possibly more cost cuts
• Achieving ebitda break-even at in 2024