Intercontinental exchange (ICE 0.66%)known as ICE, recently announced that it would acquire Black Knight (BKI 0.48%) to grow its mortgage technology business. The move was announced ahead of the interest rate hike telegraphed by the Federal Reserve. Will rising interest rates hurt his target company, or will ICE have the last word?

Is this the right time?

On May 4, ICE said it had agreed to buy a real estate company Black Knight. ICE made the bold move to close gaps in its mortgage technology segment, which it built by acquiring loan origination software company Encompass and closing finance, compliance and recordkeeping companies Simplifile. and SEAS.

In 2020, before agreeing to be acquired, Black Knight acquired Optimal Blue in a $1.8 billion deal. Optimal Blue has added secondary mortgage solutions and data analytics to Black Knight’s legacy real estate services, loan origination, bankruptcy services and data businesses. The combined company would be one of the first end-to-end mortgage lending platforms.

Sounds good, but the timing seems questionable. Black Knight’s software solutions segment accounted for 85% of overall revenue in 2021. The segment derives revenue from the number of loans it manages and loans that originate from the platform. At the time the ICE/Black Knight merger was announced, the Fed had signaled rate hikes that would lead to higher mortgage rates and a slowdown in the mortgage industry.

The big picture

On the other side of the coin, Black Knight also has recurring and stable revenue streams. For example, 57% of Black Knight’s revenue in 2021 came from software services, where rising mortgage rates will likely slow the growth rate of revenue-generating loans. More importantly, however, rising rates will also significantly deter seasoned lenders from refinancing and going off the books. The segment now looks more like a growing annuity business, albeit at a slower pace than in the past.

Black Knight’s Data and Analytics segment provides clients with a wealth of data on everything from property values, to information on prepayments and defaults, to mortgage loan performance. The company’s data covers nearly 100% of the US population. Revenue from its data and analytics segment comes from recurring licenses and subscriptions and accounted for 30% of 2021 revenue.

Despite adding some transactional revenue at a questionable time, the combined company’s mortgage technology segment will increase its recurring revenue from 50% of segment revenue to 70%. The impact on the entire combined business is significant. ICE’s recurring revenue after the acquisition is expected to increase from 48% to 55%.

Outside of its mortgage technology segment, ICE operates 13 regulated exchanges and commodity exchanges, including the New York Stock Exchange and six clearinghouses. Its Fixed Income and Data Services segment is a platform that provides bond pricing and execution to its clients. These segments provide ICE with a steady stream of transaction-based revenue and profit.

Mainly based on the perceived impact of rising mortgage rates and the acquisition of Black Knight, ICE stock is down 29% this year. Investors worried about the adverse effects of mortgage rates no longer need reassurance. ICE estimates that the addition of Black Knight will increase its total addressable market to $14 billion and accelerate penetration of its existing market by $10 billion. Additionally, the merger could reduce costs by $200 million and provide $125 million in cross-selling opportunities.

With ICE stock down this year, it trades at an adjusted price-to-earnings ratio of 13.8, well below its five-year average of 33.5. Long-term investors may find value in the stock as the company transitions to a more recurring revenue business model.

BJ Cook has no position in the stocks mentioned. The Motley Fool recommends Intercontinental Exchange. The Motley Fool has a disclosure policy.