|Shares Out. (in M):||663||P/E||0||0|
|Market Cap (in $M):||12,421||P/FCF||0||0|
|Net Debt (in $M):||-1,884||EBIT||0||0|
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It’s been roughly 7 months since pcm983 posted his long on Opendoor. The stock went from $16 to $35 (good call pcm) and now sits at $18. This recent decline in the stock price and the low expectations from sell side for 2021 has set up OPEN for a great long opportunity here.
I advise anyone interested in the name to go read the long idea posted by pcm983 from Sep/2020 to get some good color on the business and also read the discussion from the comments. I’m going to skip the business description here and go straight to the key points of why we should go long now. I do provide some of our view on the business itself further below as we actually like the business more now than our initial skepticism given the allegedly inventory risk we thought, but now we feel a lot more comfortable with.
Why this opportunity exists?
Opendoor paused home purchasing and posted pretty dramatic sales decline over Q3 and even worst in Q4 accelerating the decline rate. This negative read combined with previously company sales guidance is reflecting in sell side wrongly underestimating Q1 and Fy21 sales estimates. However, our analysis indicates that OPEN will blow out Q1 and FY2021 estimates by a significant amount. The stock price has also been under strong selling pressure due to an early unlock of shares, which should be view as good news going forward into Q1 since 87% of the floating shares have been traded just in the last 30 days, so it’s fair to assume whoever wanted to sell the stock have already sold it. More importantly, we think this is a good business to own for the long-term despite what appears to be a thin margin business. If we apply the implied SoTP multiple from Zillow’s iBuying segment we think OPEN should trade at $100/share by the end of this year, however we like to be conservative and we rate at $50 stock price at half Zillow’s iBuying multiple, even though we think if anyone deserves a premium it should be Opendoor.
Early unlock of shares as of 3/18:
Opendoor has 664m fully diluted shares, including the SPAC, PIPE and the additional Feb/2021 offering, management bonus and option grants. A total of ~529m shares were supposed to be locked-up for 180 days, and to be fully unlocked at 6/16 but there was an early unlock of 50% of those shares if the OPEN stock price would trade above $15 for 20 straight trading days. Those shares were unlocked as early as 3/18.
OPEN could beat Q1 sell side sales estimates by > 60%:
Sell side is projecting $620m Q121 sales but our analysis points to a range of $800m to $1bn and ~$5.3bn in Fy2021 vs sell side at $4bn. We think sell side is overlooking the ramp up from Opendoors home acquisitions so far this year.
If we look back to OPEN’s SPAC presentation published in September 2020 (slide 39), the company disclosed a $3.5bn sales estimate for 2021. That means they must have prepared that presentation ~2 months before September, which was still relatively early days during the pandemic and a lot of uncertainties for 2021 outlook and so Opendoor likely gave a quite conservative number. Now if you are sell side, you combined the company $3.5b guidance with the subsequent bad results from Q3 and Q4 where sales were down -72% and -80% and the fact that even in Q4, Opendoor guided $600m to $625m for Q1 sales, it makesthen total sense that sell side would be inclined to estimate ~$620m in Q1 sales and $4bn for the full year. They must think that even with the economy reopening and things normalizing that a $500m sales beat for the year should be more than enough. However, when looked at the alternative data provider Yipitdata from their Zillow’s product, which has some comparable Opendoor stats and triangulated that with our other channel checks, we came out with a strong conviction that OPEN can do at least $800m to $1bn in Q1 sales (29% to 60% higher than sell side). Even better, we also think there is a good chance that EBITDA will be positive in Q1 given the strong continuation of home price appreciation in the market.
This Chart shows New Listings thru 2/28
And this Chart shows Yipitdata’s unit sales (home count) based on their observed data.
This alternative data supplier has historically had a 1-5% margin of error on their estimates, and according to these charts, Opendoor has sold ~1,500 homes in 9 weeks. That’s 167 homes sold per each week, which is not impressive and still ~55% below pre-Covid, but a closer look at the the last 3 weeks of February and they sold ~253 homes per each of those weeks and ~310 over the last week ending 2/28.
If we extrapolate and think they can maintain this level of 310 homes per week for the remainder of the quarter, at $300k ASP would equate to $825m in Q1 sales (33% higher than sell side). Our offline checks with realtors and people on the ground, indicates it’s more likely that the subsequent weeks during March have accelerated homes sold. Assuming 33+ additional homes per week (which is the avg weekly increase over the last weeks) would imply a $924m in total Q1 sales. See below.
Interestingly, BTIG released a note Today that further validates the company’s ramp up with more than doubling their new listings at the start at Q1 to mid-April, which is an indicator of strong upcoming Q2 sales as well.
Another interesting data point is that the Opendoor CEO "Eric Wu" had first published during the Sep/2020 presentation, where he disclosed the company planned to double the number of markets going from 21 to 41 over the next 3 years, and just recently during the Q4 earnings call in March 4th, he said Opendoor will be live in 41 markets by the end of 2021. That is a massive acceleration of timeline. This highlights that the outlook completely changed from just a few months. Another indication of such positive outlook for the iBuying market is the recent March presentation by Offerpad stating they will grow 27% this year compared to 2019 while adding 5 new markets. Which bears the question: How will Offerpad grow sales 27% from pre-Covid if they are only increasing their markets by 35% while Opendoor will deliver sales -15% below 2019 (according to sell side) at the same time they are doubling the number of markets? It doesn't add up.
What is the upside?
In the short-term we think the stock can go up to $50/share (170% upside).
We are underwriting $5.3bn in sales for the full year of 2021 and close to a $1bn for Q1. If we use the implied sales multiple that the market is giving Zillow, we get to a $100 share value, so being extra conservative and applying half their multiple we arrive at a $50/share target for 2021.
The market is basically saying that Zillow's iBuying is worth $20bn vs Opendoor's $12bn, at the same time that Opendoor sells ~2x more homes than Zillow.
Below you can see our estimates compared to Sell Side.
- See that is not crazy to think Opendoor can sell 19k homes with 41 markets vs 18k in 21 markets during 2019.
- We also see a positive EBITDA surprise in Q1.
Below we provide some of our views on the business but as a trade for 2021 you don’t have to read the rest, only if you are interested in the long-term potential growth which we are.
Zillow vs Opendoor
Many investors have shown preference for Zillow as they have a stronger brand, more web traffic and controls the top of the funnel with a very profitable business that generated almost $600m in EBITDA last year. I agree that Zillow is well position and that getting a ton of free traffic from their SEO positioning in Google is a big deal, but I don’t see Opendoor having a disadvantage. This was already discussed in PCM’s idea from last year, so I’m just going to add a little contribution thought.
1) First of all, with think the iBuying market is big enough for both players and we already see signs of a duopoly. There is definitely a huge barrier to entry and being first is extremely important. Zillow has entered by obvious defensible reasons, then there is Offerpad but I think is early to see them as a real threat.
2) Although Zillow has a CAC advantage and web traffic volume over Opendoor, it’s fair to say Opendoor has the know-how operations and pricing advantage over Zillow and they can build their brand from here. It’s going to cost more in digital ads but not impossible to effectively compete for web traffic.
3) I haven’t seen any proof that Zillow can make more money than Opendoor. It’s rather much the opposite with Opendoor unit economics much better. You can pick any metric and Opendoor has substantially higher margins than Zillow, and not to mention that Zillow’s cash burn rate is rather alarming. It is difficult to compare apples to apples on their contribution margin since these two could be manipulating their contribution margins, so putting that aside and focusing on gross margin and subtracting all the other key costs (S&M, G&A and R&D) we note that Zillow has burned 4x and 2x more cash than Opendoor in 2019 and 2020 respectively (inclusive of the unusual big non-cash SBC expense in Q4 for OPEN).
We See iBuyers as an inevitable outcome.
The reality is that it is going to be inevitable and technology will play a huge role in the future of the RE industry. The value these iBuyers offer customer is not centered around lower fees, but rather the convenience and time savings. For whoever wants to sell a home, it’s straight forward to understand the value (instant cash-offer). For buyers, we heard some skepticism about what is the value. You need to look at this from a behavioral shift on newer generations. Young people don’t like to talk over the the phone or have to deal with salespeople. They rather use a mobile app that can do everything. One good use case is through Opendoor's mobile app you can schedule a visit to a home and when you arrive at the place you can use your mobile phone to simply unlock the entrance door by connecting with a smart locker. This is happening Today. So I'm not saying RE agents will be completely removed, but their value in the supply chain will decrease. When we are talking to $100k to even $1m home prices, these customers will like to do-themselves. For example, imagine you are laying at bed getting ready to sleep, but you want to spend some time looking at potential homes you are looking to buy. So you might want to open the app and spend 30min a night on some days just looking at homes that are available on the app and you can save them as favorites to look again later with your wife, girlfriend or whoever, but you will want to do-it-yourself rather than having to exchange several emails with a RE agent over the course of weeks or months during that process. It used to be that a RE agent doing this work was a huge time savor and value added, but the reality is that all these organizational tasks will be fully automated by technology and so what's left for the agent? The personal service they can provide. That's something technology cannot replaced, but it's going to be more tailored to the high-end luxury homes market.
It may be difficult to fully appreciate this behavior shift if you not one of one of the young ones, but simply ask around any younger kid in mid to late 30s or even late 20s that have recently gone through buying a home if they like to interact with a RE agent or even better, ask if they think they could easily do without the agent. Opendoor and Zillow will become this huge liquidity providers that maybe won’t make much money or just break-even from the spread of buying/selling homes for several years ahead, but during this time that they are growing and becoming a ubiquitous brand they will be making money and growing their ancillary services as well. As a customer, would'nt you rather deal with as fewer 3rd parties as possible? Wouldn't you prefer to use a single provider as long as you know you can have access to the entire inventory?
High Level Business View
You can only go long if you believe the company can and will manage their inventory efficiently well. If you don’t believe this, don’t even bother with the economics, you will always disbelief the numbers and focus on the low margins and tell me on a recession they will go belly up and that Covid they got lucky because of the suburbs/city dynamics from the lockdowns.
I think the street overstate the inventory issue too much. I read this comment by WJT on the Sep/2020 VIC post and think he made a great point. His words below:
“I want to make one other point regarding the alleged inventory risk thesis consistently mentioned elsewhere. Let's imagine for a second a scenario where the bears are right and there is the long awaited second coming of the housing crisis. Instead of home prices falling by 12% throughout a year, this time they fall by 50%, and overnight. What is the impact to iBuyer Zillow? Well, if they were at their target level of $20bn homes a year, given they have a target hold period of 90 days, their inventory level is $5bn. 5bn*.5 = 2.5bn loss on a $25bn stock. So the stock would be down 10% on the inventory risk.”
Putting inventory risk aside, and looking at the business model, our view is quite simple. Customers will happily pay the same (or slightly higher) price for a much better experience and 90% less time spent. At a high level, the economics are:
a) 6% realtor commission from both sides – 2/3 of sellers are buyers so 66% of the use customers Opendoor can in theory get 6%, however over the long-term as the brand Opendoor becomes ubiquitous in the housing market, it should quickly ramp up to 80%+ home transactions with Opendoor getting the full 6%.
b) 0.75% in home price appreciation – if we assume in a normalized environment the housing market should appreciate 3% annually, that’s 75bps in 90 days turnaround.
c) 1-3% in pricing efficiency – this is where their pricing algorithm will play a role pricing for maximum potential spread from cost to sale price, or from the customer’s perspective, the premium they are willing to pay for selling the home for an instant cash offer.
d) 0.5-1% title & escrow (achieved 83% attach rate only after 9 quarters from launching).
e) 1.5-2% Mortgage
f) 1-3% Others (warranty, upgrade & remodel, home insurance, etc…)
There is a total of 14% potential revenue fees that were already disclosed by management (or 11% if we don’t include “others”).
Direct selling costs that in the future should be 1-2%, holding cost another 1% and interest another 1% and subtracting all these costs we get to a ~7-10% final contribution margin.
There are over 5.5m existing homes sold every year and if within the next 10 years we believe these iBuyers can reach 10% penetration with Opendoor reaching 40% of that market at ~8.5% contribution margin, ~$500m annual overhead, this company can literally generate $7bn in pre-tax income. I think the revenue figures (in this case would be $88bn) scares people away, going back to that inventory risk, however as WJT pointed out, the risk is not as bad as we think even in a major housing market contraction. The company can pause buying homes while decreasing inventory and in this case of $88bn annual sales, the worst case where GFC like event of 50% home price decline, would be an $11bn hit (50% decline on $22bn inventory) for a company that is doing $7bn in pre-tax profits. That's literally the most draconian scenario and looking from this angle, although it is pretty bad but no as bad as initially thought.
$7bn pre-tax income from a duopoly company operating in an industry with huge barriers to entry will deserve a multiple of at least 20x, which we think could translate to ~$212+ share.
That’s an oversimplification of the long-term upside, but it’s a view we believe the company can achieve. Opendoor already have 4% total share of the house market on their more mature markets. All it really takes is to extrapolate that to the rest of the US. Something they can absolutely do over the next decade. You usually don't lose money investing in category killer businesses, and Opendoor is one.
- The single most important risk is the inventory risk as they scale. Although we feel way more comfortable than we initially were, it’s nonetheless the single key risk to watch, how the company deals with the 90+ day cohorts of unsold homes.
Q1 sales beat, followed by sell side upgrade.
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