Description

Intro

A future tech star that is misunderstood by the market, or another Softbank inflated “disruptor” that got big fast by burning cash and is nothing more than a real estate brokerage? We believe that it doesn’t matter which category Compass fits into as the stock will work from these levels based on our projected cashflow as their growth rate slows and adjacent services are rolled out, boosting margins.

Manchu recently wrote a short pitch on Compass. After recently initiating a position we will argue the opposite view.

We think the main bear arguments are overblown. We would counter by arguing that:

1.       The technology is a differentiator, and while the tech gap will narrow over time as other brokerages catch up, the Compass platform is well designed for what agents need

2.       Compass will not experience elevated churn once attractive deals for agents mature

3.       Compass can achieve industry average margins

4.       People are missing the economics of adjacent services

5.       The housing market, while hot, is not that much above the long run average.

With a DCF driven target of $16.10 we get 90% upside from current levels.

What is Compass?

Compass is a real estate brokerage that operates under the classic industry model. Agents work for the Compass banner, getting access to the Compass platform, technology and brand. In exchange, agents pay Compass a share of their commissions (about 20%). This is the same model as the biggest brokerages in the US like Home Services (owned by Berkshire) and Coldwell Bankers/Century 21 (owned by Realogy). The difference is Compass operates under a pure brokerage model whereas other national brands operate under a mix of a local franchise model coupled with an owned brokerage model.

Compass differentiates itself with its almost entirely owned tech stack that they have built and acquired. Agents can complete all their daily tasks, paperwork, marketing and scheduling within the app. For a better understanding please watch this 12 minute video put out by Compass around the time of the Spring IPO.

Inside the Compass Tech Platform

History and how Compass got so big so fast.

Compass was founded in 2012 by current CEO Robert Reffkin. From their base in NYC, Compass positioned itself as a tech enabled brokerage built from the ground up to make agents lives easier and ultimately more productive. Using VC money, including major backing by Softbank (still the largest shareholder), Compass spread out aggressively over the country by either buying up high end local brokerages, or more commonly offering very attractive economic terms for a few lead agent teams to switch to Compass. We’ll expand on that a bit as it’s important to the bull and bear case. When Compass opens a new market (say Kansas City), they will recruit a few local superstar agent teams. They generally do this by offering very attractive splits for the initial two year contract. An agent might only pay Compass 5% of their commissions the first year and 10% the second, before the contract is renewed on more favorable terms. Competitor splits as a whole are around 22-24% and for Compass as a whole are generally 20%. Compass may also offer agents a marketing budget ex “Here’s 50k to cover a couple of years of marketing spend to switch to us”.

The model has been very successful, with Compass growing from launch, to 1% in 2018 and now about 5.5% in 2021. This places Compass #3 nationally. (note: market share is calculated on GTV basis). However, Compass has lost a fortune getting there.

This certainly makes a strong argument for Compass being another Softbank inflated money pit, so let’s dig in to the 5 points in the intro to argue why this model will work in the long run.

The technology is a differentiator, and while the tech gap will narrow over time as other brokerages catch up, the Compass platform is well designed for what agents need

We think the integrated tech platform at Compass is a differentiator. We use Tegus for our expert calls and the vast majority of the calls with agents are coming back quite positively on the platform, enabling agents to improve their sales and marketing efforts, get more clients, and freeing up time to sell.

Quote from an agent currently with Compass, call conducted July 2021. He was asked about his experience with the platform.

Well, just understanding how the technology integrates with what it is that we use? Is the technology all that it's cracked up to be? How does it fit with any other technology? I can speak to the Compass platform because I use it every single day, and I can speak to what I used before. I can't speak to other platforms that other companies have. So I think the best way to describe it is it's like if you've never had an iPhone and then you're given an iPhone, yes, you know how to make calls and you can probably figure out how to text.

But if you want to download an app or you want to add other function, it's the easiest smartphone to use for the functionality of what you're trying to do. And that's the way I would administer the Compass platform is it's set up in a way where you're like man! It's pretty simple stuff. This is pretty self-explanatory.

The buttons are pressed. What am I trying to get done and what they've done is they've created it in a way where it was like wouldn't it be cool if I had a button that I could press, and it would show me all the other brokers that have sold properties at this price point? Oh, they have already done that.

Wouldn't it be cool if I can just press a button, and I have a digital ad set up for me? They have already done that. They created it to be super simple functional and also in a way where you could have the things that you really want.

There's not a lot of bluff in it, because I've seen other CRMs that I've tried that you end up with things that you're like, "I'm never going to use it" There's this stuff in here, what am I going to do with this thing?

The CRM platform on Compass is all things that are used daily. You can go into that CRM platform and some people do every single day because it's really just created with the functionality of what your day-to-day is.

So they don't really get involved with a lot of other stuff. Like the automation is awesome. It saves us so much time with having to not worry about oh, we got to go into Facebook back end and manager and put all the stuff through there or anything like that. Or I got to send out these postcards, it just takes all the vendors with small one bot and then have it acclimated to your marketing budget is awesome.

Compass has built and acquired different parts of the platform over the prior years and has hired some great people. Expert calls indicate the tech took a leap forward post 2018 after Compass hired Joseph Sirosh as CTO. Prior he was CTO of AI at Microsoft. Other notable hires include Greg Hart as Chief Product Officer in March 2020, who was running Amazon video and before that Amazon echo.

Compass spends vastly more on R&D than any of the other brokerages, who tend to use 3rd party tech exclusively. We model the spend continuing to increase to $317mm in 2022 up from $52mm in 2018. For comparison recently spun Douglas Elliman will spend about $15mm on R&D in 2021 (half the principal agents as Compass, 5% of the tech spend).

Coldwell Banker has chosen to license 3rd party technology, which will likely eventually be considered good enough by agents, but they are still playing catch up. Here is a comment from the VP ops of one of the largest Coldwell Bankers franchisees from a call conducted in September 2021 (emphasis added).

The thing that's really nice about the CB tools other than CRM, it stinks, but we're getting a new one. I don't know if you're familiar with Moxi. Moxi is a third-party company. Realogy had teamed up with Moxi.

And so now we get the Moxi suite. We just launched MoxiImpress and MoxiPresent, which is our e-marketing and listing presentation tools. Engage, which is the CRM is coming later in the year, that will replace the antiquated Zapp that they've probably sunk about $0.25 billion into.

I was with the company right when they bought Zapp, it was a disaster. But I had to launch all the companies on the Zapp platform. And it never went well. So the nice thing about Moxi is it's very integrated. And really, a lot of the tools are integrated.

Coldwell Bankers has gone with Moxiworks as a 3rd party solution. It’s interesting to note that as of last September Coldwell was still replacing their CRM tool and trying to find a better solution. In our research we did come across Moxi as a very well respected technology platform for agents. That is why we believe while the Compass platform does offer the best tech, we do eventually expect the gap to narrow as licensing Moxi will probably be “good enough” for many agents at CB and other brokerages with no internal tech. In the mean time, Compass should continue to grow and the satisfaction with the current platform will lead to low agent churn for the foreseeable future.

Here is another call transcript from an agent who left Compass, but despite having left he still says out of the national brokers, it’s not even close. Call was conducted in September 2021

Honestly, I think Compass nationally is probably the best. I mean the only other biggest competitor is Realogy, the parent company that owned Coldwell Banker, Sotheby's and a bunch of these brands, right?

But really the technology is nowhere even close to Compass, which is actually why I made that statement that I still think Compass has the ability to be significantly successful because I think they've amassed good enough talent and they've built good technology, which they continue to improve. And I don't see anyone else who has that cash infusion to be able to do what they're doing.

I mean I think Windermere as a pocket is great. MoxiWorks is great. But these are so small in compared to the national presence of Compass that I think it will be hard for anyone else and I don't believe real estate is going into the Redfin, Zillow world of self-service real estate. So I don't think those models will succeed.

Compass will not experience elevated churn once attractive deals for agents mature

This is probably the most important part of the thesis. We discussed how Compass got so big so fast, namely enticing (bribing?) agents to switch over with attractive splits for the first two years. The bears argue that after these sweetheart deals are done these agents will just leave for another attractive offer. We would argue that 1. the current numbers are not bearing that out and 2. Agents will stick around because they are getting so many more referral deals than on any other brokerage platform.

For the first part we’ll cite the NPS from the Compass prospectus for existing agents. 68. That’s an extremely high score, showing very high levels of satisfaction with the platform. The prospectus also calls out agent retention being continuously in the 90’s. In fireside chats management has stated retention is currently mid 90’s. For context the industry generally sees 20% annual churn, so these are exception numbers.

On the last conference call the CEO also states that Q3 and Q2 were the lowest churn levels Compass has seen in years.  From end of 2018 to end of 2019 Compass grew from 2,694 principal agents to 6,787 principal agents, huge growth. Those 2 year deals are up for renewal in 2021 and yet Compass saw some of its lowest churn in years. If agents were churning off after their initial deals ended, it would be showing up in the numbers by now.

Further, we can look at their oldest market, NYC, which should have the least amount of agents under initial, preferenced deals to see what Compass churn should look like at scale. On a recent fireside chat the CEO called out that 85% of agents are off their initial contract. NYC as a whole has a commission split structure close to 70/30 (meaning one of the markets the most in Compass’ favor) and yet according to a recent fireside chat comment Compass is seeing 98.5% retention. This measure includes agents who retire meaning churn in NYC, Compass’ oldest and largest market, is incredibly low.

Expert calls also confirm that there is no elevated churn, with most agents extremely satisfied with the platform.

Quote from agent who left Compass, call conducted in September 2021

Now the question is, will it change? I have seen a lot more people join Compass than I ever thought would have, which surprised me here as well as in other parts of the country. I've seen the growth more than I expected. And what's very surprising is there's very few leaving once they join. And I don't know if it's because they're all on these special packages, and they still have maybe one more year of that expiring.

I don't know. But that's the more surprising thing to me is how few have actually left. We in our office, we've actually had two that have left Compass and come to our office who are extremely happy outside, but I haven't seen enough exodus there, which is, in my opinion, quite interesting.

To us it is clear agent retention at Compass has been strong, and the model will work if they can retain agents after initial deals expire. We believe beyond satisfaction with the tech, that many agents are seeing many more referral deals once they join Compass, which makes the value proposition to joining/staying extremely strong.

Come for the tech, stay for the referrals:

If you move to a different city, and your agent refers you to a local broker in the new city, it is standard for the referring broker to get part of the fee when the next transaction closes. Yet based what we have seen, that almost never happens. Why? The franchise model makes it very difficult for agents operating under the same national banner to connect internally and see or care which agent is operating in which city. By building Compass from the top down and setting up a strong internal referral system, Compass is helping agents get double digit referrals a year when they maybe got a few in their careers before joining Compass. We cite two experts calls with agents below, but it does seem pretty universal amongst all Compass agents; they are seeing many many more referrals than they ever experienced before Compass.

Agent call conducted in July 2021

There’s also a referral network that Compass has built up, kind of like on a Facebook type of thing. And we have gotten, this year alone, at least 15 referrals on homes in our area, and we give referrals out to agents. The referral network is amazing. And they just keep coming up with innovative things.

Yes. Interesting. And then I want to go back quick to another thing that you brought up, the referral. For all those years, how many referrals did your wife get from her previous company’s agents?

Licensed Real Estate Agent at Compass

Zero.

Zero. And how many years was that?

Licensed Real Estate Agent at Compass

Almost 20 years? To me, it was a joke and we used to laugh about that.

And how many have you guys gotten this year so far?

Licensed Real Estate Agent at Compass

We have so many referrals. Five buyers that we were given in the last three weeks from all over the country in referrals.

And how much was it year-to-date, I'm curious?

Licensed Real Estate Agent at Compass

On referrals, I would bet, we've done about $25 million in referrals this year maybe.

Agent call conducted in August 2021

Got it. How many referrals have you gotten from the Compass network?

Real Estate Broker at Compass

Probably in total, over the two and a half years, five or six. Something like that.

Have you ever gotten any before Compass?

Real Estate Broker at Compass

No. I mean because I was with a mom-and-pop after that. So like five or six more referrals than I've ever had in my career.

We think the referrals agents at Compass are receiving is a big reason why they choose to stay (beyond the tech platform) after initial deals expire and helps contribute to low churn.

Compass can achieve industry average margins

Compass is currently running at about -0.2% EBITDA margins, in what is a hot real estate market. Bears will argue that this means they will never be profitable enough to justify the current valuation. We believe that as they continue to scale and growth slows, industry average margins will emerge even as the macro normalizes in the coming years.

The first part is splits. The gross margin of Compass is effectively the split percentage. Compass and other brokers run the entire commission through the income statement as revenue with the agents share being the cost of sales. Compass has trended between 78.5% and 82% COGS for the past 3 years with 2021 looking like it will come in around 80.6%. Peers like Realogy generally have COGS closer to 75%-76%. We model Compass getting to 79% but this may prove to be conservative. Why are we confident? Well just the way the growth was structured, as agents mature on the platform and come off their initial contracts, their splits tend to revert to more traditional levels. This is a big tailwind to the financials as Compass slows the new agent adds and a bigger percent of the base are on more normalized deals. Again looking at NYC, Compass’ oldest market, we see a 70% COGS. NYC is a unique market with better broker splits than the rest of the country but clearly Compass as a whole will see better splits as growth slows.

We expect further leverage on each line item, though less so on R&D spend. We have Compass gaining 1.6% EBITDA margins from COGS and a further 4.7% margin from all other line items over the next 9 years (2030 terminal). From 2018 to 2021 Compass managed to show scale of all other line items of 21.2%. Asking for 4.7% is not herculean over a 9 year period where revenue increases 170% (9.5% CAGR).

We will discuss our revenue assumptions a bit later on but here is an overview of our take on margins. Terminal margins of 6.1% are in line with comps over the cycle. We should note these do not include adjacent services which we are modeling separately. Management of Compass believes they can achieve high single digit EBITDA margins in the intermediate term, which bring them well above us for what it’s worth. As a separate point, just by Compass moving to peer level splits with agents they would achieve about 5% EBITDA margin vs our 6.1% terminal level, ignoring scale on any other line.

The bears are missing the economics of adjacent services

Another point we think the bears are making is how much more attractive the numbers look once you add in adjacent services. We model adjacent services as a separate line item, and what we see under our DCF is the target price moving from $12 to $16.10 by adding in this cashflow stream. By adjacent services we are focused on Title and Escrow, and Mortgage, but in reality there are many more services attached to a home purchase or long term ownership that would be easy to cross sell.

We actually came to do our work on Compass in a back handed way. We initially had looked at a slew of prop tech companies (Real Matters, Doma, Angi, Zillow) and passed on all of them. What became apparent, was while these prop tech companies might be successful at signing up large banks as clients and would do well within the refi market, all of them struggled to make inroads into the purchase market. Why? Because the agents dominate that market.

The vast majority of people who purchase a home never really think of Title and Escrow. They conduct a home purchase transaction a few times in their lives and often aren’t even aware they need this service. They then turn to their agent who guides them through the process and makes recommendations of who to use. Agents cannot get compensated for a referral based on regulations, but generally are happy to refer servicers that get the job done accurately and do not derail the process by missing deadlines and paperwork. The agent just wants to close the sale and get their commission.

The economics of these services is quite compelling. The average fee in T&E is about 2.5% of the home purchase price at this price point (includes the insurance portion which is basically a flow through) and Compass can expect a 25% contribution margin when this scales. Industry average attach rates are 30% which we model Compass achieving in 2025, though this may prove conservative.

Here’s why we think the 30% attach is conservative. The title service will soon by fully integrated into the Compass platform which will enable agents to stay on top of any internal paperwork being done, so as to not hold up the transaction. Compass is just now rolling out these services. As of Q3 Compass was offering T&E services in just over half their geographies and should cover their entire operation at some point in 2022. They have done this by buying local Title and Escrow operations and then will begin flowing traffic their way (making CAC tiny). They will use the big providers (Fidelity, Stuart, First National) to handle the actual insurance portion, thus avoiding having to provision for long term losses. Compass is currently seeing mid single digit penetration company wide but in areas like southern California where they’ve acquired a well integrated title operation into their platform, attach rates are in the 40’s.

As a fully owned top down brokerage model, it should be easier to cross sell services than under a franchise model. Across expert calls it became apparent that it is very hard to get franchisees to buy in from the top down dictated JVs as each franchisee is it’s own profit center chasing their own relationships. Here’s a quote from the VP ops of a large Coldwell Bankers franchisee again

Yes. So Realogy tried or they have title resource group. But the problem is that they would go out and they would try to do joint ventures with the brokers, but they wanted to have complete control over everything and they're entrepreneurs. And they don't want to give up control.

So there's some truth to what you had said about being fragmented and all that. I would say the Coldwell Banker network doesn't feel fragmented. I mean, we very much share resources as far as knowledge. But I'm not knocking on the door of one of my fellow franchisees and going, "hey, we should do this thing". Our JV is our JV. Our mortgage companies are a mortgage company.

Same thing with Realogy trying to have a mortgage relationship. They had Coldwell Banker mortgage, and now I think the Guaranteed Rate is who they've teamed up with. Nobody sees any benefit. From a brokerage level, it's "I'll support your ancillary services, but I got to get paid for it".

I got to have some skin in the game, or I need to wet my beak to pick your analogy. I sound a mob boss, but it's like, I need a little taste. It's if I'm going to be pushing your services, even down to the miniscule level of a home warranty, I want my $100 for pushing your warranty.

I used to also work for American Home Shield. So I was also a B2B warranty person. So I very much understand the ancillary relationship. Everybody wants their piece of the pie. Yes, we want the product to be good, but pay me. Who's going to pay me more? That's the one that's all of a sudden going to be the highest quality product.

It's a very cynical way of looking at it, but that's just the way it is. So Realogy never successfully got their title company JVs off the ground. So they're mainly successful because of Coldwell Banker Realty and success is a relative term. I don't think Title Resource Group been that successful. I mean I think they make a profit, but it's nothing to write home about.

I haven't seen any annual reports lately, so I couldn't really tell you. But as far as on the franchise level, we don't have any interest. I mean, any of the big ones I've talked to, they have zero interest in working with Realogy on any kind of joint venture with Title. And they really don't care about the mortgage thing either because they just don't see the value. I've got homegrown relationships. I don't need you.

If you read over the above, he’s differentiating between the Coldwell Banker franchise group and wholly owned brokerage. The wholly owned brokerage is actually having decent success. Here’s directly from the RLGY 10-k:

“The capture rate of our title, escrow and settlement services business from buyers or sellers represented by our company owned brokerages was approximately 34% in 2020”

If Realogy, which isn’t nearly as integrated as Compass on the tech side is seeing 34% capture rate, then underwriting Compass to be 30% at scale is conservative.

We see similar attractive capture rates on mortgage, which Compass is really rolling out in 2022. They structured the mortgage product as a JV with Guaranteed Rate. The entire economics will run through Compass’ income statement but roughly the math should be: attach rate x buyside transactions x 1.7% mortgage fee x 50% of purchase price mortgaged. This gets us a revenue number and Compass has guided to a 30% contribution margin at scale, even after paying their JV partner their share of the economics.

Industry average attach rates are 20% but we can see there is a big variance to that number, with the operators the closest to the buyers, and the earlier in the buying experience seeing the best results.

We model Compass to achieve 20% attach in 2025, but again think that is conservative. Compass plans to have a few mortgage options built into the platform to quickly offer to clients. How hard would it be to have their own mortgage offer being 5 bps less than the rest and win a higher share?

 Realogy does not disclose mortgage attach rates, but mortgage EBITDA contributed 17% to total company wide EBITDA in 2020 (3 years after launch). And this is with 70% of agents being a part of a franchisee which is harder to cross sell to. Our 20% attach rate would lead mortgage EBITDA to contribute a similar percentage to the total.

Adding these adjacent services makes a large difference to the profitability of Compass 

This is just two adjacencies when in reality there are dozens Compass could eventually target. Think Insurance, Warranties, Appliances, Renovations, ect. Basically everything ANGI and a lot of other prop tech things are targeting, but who don’t have an army of agents who can drive the process.

The housing market is hot, but its not THAT hot.

Another bear argument is the housing market is hot and will invariably turn. While housing sales are definitely running above average, they are actually not too far above long term average. On top of that we can model out to the average and adjust the projected numbers. Here’s how we see the market using historical data:

Ultimately what we did was look at historical existing home sales from 1989 until 2020. We then adjusted for the fact that the population has grown (so there should be more sales if ratio of pop/transactions is constant). Looking at this data, we see the mean sales number is about 5.5 million transactions. The peak was 2005 (no surprise) at an adjusted 8mm and the trough was 1991 at 4.3mm. 2021 is looking like it will come in around 6.1mm units for the year, which is a bit below the 75th percentile year. So a strong housing market yes, but not outlandish.

We actually think the market will remain strong in 2022. With inflation running at 6% and 30 year mortgage at 3% who doesn’t want to own a home? But for modeling purposes we decided to start 2022 at the long run average rate of 5.5mm in 2022 and then grow it from there in line with population growth of 1%. Even if the real world experience will obviously be more variable, It seems like the only fair way to run a DCF. Finally to get GTV we model housing prices growing at 4% per annum in notional terms. This is in line with 2% GDP + 2% Inflation and assumes housing stays at constant portion of the economy.

This gives us a macro view from which we can run a sanity check on our top line assumptions for Compass to make sure we are at a reasonable market share rate, so let’s turn to that now.

Revenue Assumptions

The main drivers are Principal Agents, Transactions per Agent, Average transaction size and take rate. Take rate has been pretty constant at 2.5% (5% cost split between buyer and seller agent) but let’s look at the rest of the drivers.

We’ll start with average transaction size. Remember in the market share forecast we modeled 4% growth per year. Here we effectively have Compass’ average deal size go flat until 2025 from 2021 levels before growing 1% thereafter. The reasoning is Compass already has 3x the national average transaction size which is a function of it’s dominance in the major cities. As it rolls out to the tier 2 cities, as it is now, the transaction size will lag the market. We have the 3x number declining to 2.2x the national average in the out year.

Principal agent growth is in big part a function of new city rollouts. Compass accelerated new city expansion in 2021 due to the hotter market after a slower rollout in 2020. We have this tapering off as they penetrate the rest of their target markets.

Finally we look at transactions per agent growth. Admittedly we played around with these numbers to reflect the modeling of a slower market in 2022 (long term average) before modest growth for a few years. Historically when agents transfer to the Compass platform they see an uptick in transactions so in a flat market we think of transaction per agent growth being a function of how many new agents are making up the base and still increasing their productivity in their first year or two with Compass.

Ultimately, there are a lot of assumptions here, and garbage in garbage out. We are more comfortable with our overall marketshare forecast that sees Compass double from 5.5% in 2021 to 11% by 2028. Given Compass was able to 5x from 2018 (1.1%) to 2021 (5.5%) asking them to double in 7 years does not seem like a stretch. And much of that is baked in as they saturate markets they have already opened. Management thinks they can ultimately address about 2/3s of the US markets and capture a 20% share of those markets, for an overall rate of 13-14%. This would be below that.

Target price:

We use a DCF with a 10% discount rate and a 3% terminal growth rate (again, less than the 4% LT market growth). It gets us to a $16.10 target, good for almost double from here. It’s worth pointing out the IPO was done at $18, putting our DCF actually below that level.

This correlated to a 16% IRR over the next 9 years (and likely much higher share price performance in the next 5).

Further Upside:

There is further upside to our cash flow forecasts than we have modeled in. As mentioned above, there are many more adjacent services that Compass could go after. Compass is in the process of rolling out an end client portal on their website, with the hope being clients will first sign on during their home buying/selling journey and then keep logging on after to manage their home care needs (insurance, repairs, landscaping ect). While that might be overly ambitious there are plenty more services to cross sell directly tied to the home transaction up front. This should be low hanging fruit.

The other low hanging fruit would be international expansion. Canada is an obvious geography given the proximity and cluster of 5-6 large markets to focus on. Western Europe is another one. However in expert calls and in speaking with management, the strategy is not fixed yet as whether it makes more sense to do the entire broker model in international markets (other than Canada), or simply white label the software platform and charge a monthly subscription fee. The latter would obviously be pure SaaS revenue and would go a long way to leverage the large R&D spend of Compass which is currently going to support the U.S. only.

Risks:

We wrote this report around the idea of refuting bear points so there is not much to add here that is not addressed above. We will say that perhaps a perceived risk to people first looking at the space would be the use of agents declining over time they see disintermediation from tech. We will just say this hasn’t been the case over the past 30 years and if anything the percentage of transactions with an agent involved has actually increased.

Buying or selling a home is the largest financial transaction most people will ever face, and it’s something they only do 2-3 times in their lifetime. Given the massive perceived risk of getting it wrong, most prefer to use an agent.

I-buyers could also be a risk to the long term use of agents. Luckily for us Zillow’s experience last fall, in a rising market, shows how far away they are from solving the home selling experience. We would also point out that I-buyers, even those who have continued, have focused on the more cookie cutter low end of the market. With Compass’ average transaction size being about 3x the industry, the homes in this category are less at risk of being I-bought.

Balance Sheet:

Thanks to the IPO Compass’ balance sheet is pristine with 20% of the marketcap in cash. As of September 30th there was $791 mm of cash on the balance sheet with no debt outside of a concierge service bank line, where Compass effectively loans money to clients to spruce up their home prior to listing. We consider that an operating cost and expense it rather than adding it back to our FCFF calculation. In any case it’s tiny at 19mm drawn last quarter.

Conclusion

While Compass was more than fully priced at it’s $18 IPO price, the current trading price of $8.50 offers significant upside. Compass has a superior tech stack than its peers, and while that advantage should narrow over time, we expect it to remain significant. Even agents who have left Compass admit compared to the national peers, Compass is miles ahead.

Agent’s will not run for the hills when their initial sweetheart deals expire, instead a very high NPS, extremely low churn in the most mature markets such as NYC, and a strong pipeline of client referrals will see Compass post industry leading retention numbers.

The market is missing the impact the adjacent services will have on the financials. And while the housing market is hot, it is more lukewarm, and we model a return to the long run average starting next year. With international expansion and a potential to white label the software, there is upside beyond our modeled numbers.

Post Script:

We want to give credit to Mike Delpetre for some of the slides in this write up. While doing our research we came across his website and a presentation he put together that was well done, and well, we cribbed some slides. It can be found here. https://www.mikedp.com/articles/2021/7/5/the-2021-emerging-models-in-real-estate-report

Catalyst

adjacent services growing to be more meaningful

turning ebitda positive 2022