Description

OnTheMarket is a profitable and cash generative subscription revenue business with a c60% market share trading a little over 1x ev/ sales and 7x ev/ ebitda (fwd). Its chequered history as a plc and the view that this is ‘just another portal’ has driven the shares to a significant discount to intrinsic value. OTMP is underearning and through its already strong market position and buy in from agents, plus the differentiating strategy which is delivering real value add to its agent customers, there are revenue catalysts in place to drive significant earnings growth which the market does not appreciate.

Description

OnTheMarket is the UKs 3rd largest property portal behind Rightmove and Zoopla. OTMP is the parent company of Agents’ Mutual which itself was formed in 2013 as a challenger portal by agents who were unhappy with the power and fees charged by RMV and ZPLA.

As with the other major portals, Agents’ Mutual was formed with the support of several large agencies, namely SpicerHart, Knight Frank, Savills, KFH, Strutt and Parker and Chestertons and all were issued shares in OTMP in lieu of this support. Founding agents in RMV and ZPLA are no longer shareholders having sold out at a great profit, thus OTMP is the only one retaining agent support and around 60% of the equity still sits with agent supporters (albeit this is spread across c3,000 agents with only a few >1% holders). From my referencing, OTMP is critical in the portal ecosystem as a check and balance against RMV and ZPLA as without a 3rd option these two would continue to ratchet up prices and agents would have no option but to participate.

The market’s perception is that OTMP is just another portal, competing with larger portals with stronger network effects. I think that this narrative is wrong and OTMP can become a quai-one stop shop prop-tech provider for small agents who comprise c60-90% of the market. This will be a modular offering comprising a listing portal alongside many of the processes and functions which agents need to win instructions and to market properties. Crucially, they enter this market with 60% share of total agents already on their portal, but over 90% of small 1-3 office networks who are the core market. The transition is from a pure portal offering with some ancillary revenue streams, to a technology provider with an accompanying portal which will continue to generate 90%+ of revenue from long-term subscription.

Why does this opportunity exist?

OTMP has not had a smooth journey since flotation with several missteps driving the share price to c50% below it’s listing price:

1.  Free listings: in the early days, agents were allowed to list for free (sometimes for years) as management attempted to build traction on the portal. This meant that the business was unable to recoup its customer acquisition costs and the economics deteriorated. This has been changed with new management and with no new agents signing up on a free tariff and with existing agents rolling off discounts, this drives a natural increase in ARPA.

2. End of lock-up: c60% of the Co’s stock is with agents of which roughly 2/3 is locked up until Feb 23. The market views this as a significant risk. However, agents have not been selling down even when they have come out of lock up so I think this risk is overplayed. Regardless, the company has over £8 million of net cash, continues to generate cash, and has a growing institutional following so the ability to buyback an overhang itself or by other investors should be appreciated.

3. Litigation: the prior CEO was involved with several litigations against agents large and small which was not good viewed favourably by agents. The ‘one other portal rule’ anti-competition suit brought was ultimately found in OTMPs favour, but likely damaged relationships. Prior management also aggressively pursued non-payers while new management are less aggressive and more interested in maintaining the relationship for the long-term.

4. Potential dilution: c36m shares under authority to issue to agents, was intended to be used on the largest firms (Connells etc) but this did not transpire and is highly unlikely to. This authority will lapse on 22 Dec 2022 and the shares won’t be issued so the prospect of massive dilution is mitigated. Agents’ Mutual founders are also entitled to options which represent 10% of ISC. I fully dilute for this and more in my workings.

INVESTMENT THESIS

1. OTMP has a differentiated position in the UK portal market and does not need to take share from RMV or ZPLA or rapidly increase fees to agents to succeed. ‘Founding father’ agents view OTMP as ‘strategically important’

The portals market is dominated by RMV with around 16k agents (90% penetration) and ZPLA with around 14k agents (75% penetration, as per last results in 2016). OTMP has grown from 3k to c11k agents (60% share) and I expect this to remain broadly stable going forwards. RMV generates c100m visits per month which is 3x and 5x that of ZPLA and OTMP, respectively. RMV also generates close to 20 page views per visit, vs ZPLA on 5 and OTMP on 11.

Because of the high penetration, the incumbents are unable to grow without increasing prices to agents. RMV has increased its ARPA per month from £157 in 2005 to over £1,200 today. This has been somewhat justified given its reach and agents now consider RMV an essential business cost for this reason. However, most are unhappy with this dynamic and admit that a sustainable model is unlikely without being on RMV, albeit ‘exclusive to OTMP’ agents are growing, now >950 from 700 last year, so there is some evidence that agents are trying to navigate away from RMV (but not a core thesis point for us).

ZPLA ARPA at last disclosure was £365 and is now probably closer to £500. The business differs to RMV as it is more centred around generating ancillary consumer revenues, exemplified by ZPLA’s acquisition of uSwitch prior to being acquired by Silverlake in 2018 for £2.2bn. Since de-listing, Zoopla revenues have remained around flat but operating profit dropped from £35 million to £5 million (or £14 million pre-Covid). This may be indicative of OTMP and others taking share or requiring ZPLA to work much harder to maintain share. OTMP management comment that Zoopla are marooned – can’t increase rates with no value proposition for agents, no real differentiation versus RMV, and may have to re-IPO. There is a sense that OTMP can take meaningful share by from ZPLA by being more agent focused and a better value proposition all round (but again, this isn’t required for the thesis to work).

It is difficult to enter the portal market and succeed with previous attempts having failed or been consolidated by RMV and ZPLA. Wider competition comes from local and print media publisher-branded portals which are powered by RMV and ZPLA, and super-aggregators/ search engines like Home, Nestoria and Trovit. In my view the latter are low quality, ad-filled, out of date with irrelevant stock and frustrating to use. Non-agent backed upstarts have come from Tesco and Google (via google maps, failed due to low usage). Tesco listed agent properties and private properties along with tools to manage private sellers’ sales, but ultimately this failed due to regulatory reasons and low traffic. My referencing also suggested that bridging the agent and private market is impossible without upsetting agents and these models will not survive.

Until very recently, Boomin was the most relevant upstart portal. It was privately funded and was launched by the Purplebricks founders with £52m invested to date. My agent referencing suggested that Boomin was offering free terms and shares to agents (8k signed) to attract listings. As of last week, Boomin has gone into administration. Visits were well below critical mass and the site had poor traction despite massive marketing spend. It was reported in April 2022 that Boomin attracted £20m new financing at a £150m valuation, vs OTMPs mkt cap at the time of £60m. That cash was obviously burned in a few months without generating any meaningful or monetisable benefit demonstrating the difficulty of entering this market and achieving economic scale. My referencing suggested Boomin was charging £400 rack rate (discounted to £325 in year 1) for a 3-branch firm, vs OTMP at £295 rack rate in the same region. This should prove the ARPA opportunity for OTMP which has 20x the page views, genuine traction and value add to agents, but is monetising at a lower ARPA rate.

Referencing with agents suggests that OTMP is a critical part of the ecosystem to keep RMV and ZPLA pricing in check. The large agent shareholders I referenced (Savills, Knight Frank etc) view OTMP as strategically important and are heavily incentivised to ensure its support and survival. I find few companies with this level vested interest from its customers to ensure its survival.

OTMPs strength is proven through the recent re-contracting of the agency customers who signed up for 5 year minimums on the group’s listing. These include Arun, Chancellors, Chestertons, D&G, Glentree, KF, Savills, Spicerhart, Webbers and Carter Jones. Plus new wins from Lomond Group (+60 branches) and Foxtons (+60 branches). Foxtons is interesting as my understanding is that they were also major funders of Boomin.

2. Housing market will slow, but I do not think that housing transactions dry up and new home builds collapse. Affordability, high household savings, strong labour market support and requirement and funding for new builds should sustain >1m transactions p.a.

The UK residential property market serves around 1.2m transactions per year across c18k agents. These numbers have been broadly consistent since the financial crisis. Prior to this, transactions were c1.6m and almost halved through 2008. A smaller drawdown was experienced around 2017 on the back of the shock Brexit vote.

The two key drivers for estate agent earnings are number of property transactions and house prices. Consumer confidence, mortgage availability and cost of living all affect these, but it is generally accepted that there is a base level of ‘essential’ moves in the economy of c700k p.a., with the balance being discretionary. I think that transactions can stay above 1m, which sustains a strong agent market.

The agent market is fragmented with 1-3 office firms taking around 60% of the market and 10% across the largest three nationals with over 125 branches, the balancing 30% is between 4 and 125 branch firms. OTMPs agent distribution mimics this split. I view this as a positive since revenues are spread over a long tail of c11k agents with the largest only c2% of sales.

Barriers to entry for agents are low and the number of agents in the market is reasonably constant and has been growing slowly despite sales commissions coming down (thus more agents diversifying into lettings to substitute this lost revenue). I couldn’t find robust numbers for agents and growth over time but backed this out from RMV reports. Their numbers suggest the market size at c20k agencies. OTMP prospectus suggests 18-19k bricks and mortar agents.

In the financial crisis, RMV comment that they estimated the number of agencies in the market fell by 20% due to low sales values and transactions. This is broadly reflected in their agencies under contract which declined by c15% but had mostly recovered this a year later and fully recovered two years later. All these data points suggest that the market is reasonably resilient and whilst subject to shock, can bounce back quickly, aided by an entrepreneurial agent demographic and low barriers to entry. The concentration and churn in small firms may be a net positive since these are more likely to consume the OTMP product upsells versus large nationals with much more established systems and processes.

3. Revenue growth drivers are baked in as agents and developers roll off discounted terms and onto full rack rates – ARPA grows from £200 to £270 which underpins £46 million of revenue

OTMP generates 98% subscription-based revenues from agents and new home developers who pay to use OTMP’s core listing service. ARPA (Average Revenue Per Agent) per month is currently £222 (+7%) with 10,720 branches. New home ARPA is £129 (+40%) with 2,398 developers. Typically, c60% of contracts are 3-5 years which attract a small share incentive (30-50% of the contract value). Contracts have inflation escalators.

I calculate the agency rack rate works out around £300 per month based on the rate card and my assumptions around branch locations and cohorts (extrapolated from UK dwelling stock data). On that basis, I assume that the business can likely realise £270 of monthly ARPA (i.e. -10%) after discounting + lettings only discount (50%, but only 10% of the agent base) and agent churn dragging down the mix. Thus, ‘agency’ could be a c£36 million revenue business in time with c11,000 sales and/ or sales + lettings offices. The catalyst to drive ARPA increase comes from features which are only available to undiscounted rates, and discounters on bi-annual price reviews. Typically sales people try to push through £25 per uplift.

New homes are also a significant potential source of embedded ARPA uplift. Developers are charged on a per development basis. OTMP has grown to 2,398 new home developments on the portal generating £129 ARPA. OTMP are significantly undermonetising as both RMV and ZPLA have a higher new home ARPA than agency ARPA (RMV: £1,367 vs £1,158; ZPLA: £377 vs £365[prior to delist]). This is supported by the high margins and absolute profits generated by new home builders for each incremental sale (think a c£1000 commission for an agent versus tens of £1000s for a developer). Conservatively, I think that OTMP should be able to charge slightly more than their agency ARPA on a normalised development base of 2,000, generating annual revenues of almost £7 million. Currently, OTMP are doing better in new home ARPA growth as the incentive to turnover stock is high. Through Covid demand was so elevated that new homes required very little marketing to sell, now developers must work harder.

Therefore, via embedded ARPA increases, I think that the portal side is a c£42 million revenue business with inflation escalators I assume no significant share changes.

4. New features/ functionality can ‘displace and replace’ existing cost lines in the agents’ operating model providing cost and procurement savings, streamlining, and improving efficiency. This can drive an incremental £120 ARPA in the medium to long-term, generating incremental revenues of c£16 million and group revenues of £60 million

OTMP is building a differentiated value proposition for its agents which will help them manage their business and reduce their costs of doing so, all whilst delivering a property portal which is 1/5 of the price of Rightmove. The agent ecosystem is complex and OTMP grow into this market already with a 60% share of agents.

I think that the new features upsell could be improved in leaner times as agents look for better value from suppliers. In 2009 RMV introduced ‘Choice’ which allowed agents to brand themselves on the site for £200 per month along with a 12-month price freeze thus agents were walked up from £325 to £525 ARPA for nearly zero incremental cost to RMV. I think that OTMP can do something similar here, with relatively low development costs, competitive pricing and value-add rationale for the agent bundled with the core listing portal generating a strong ROI for the agent.

The new features are linked to the four-pillar strategy which is built around 1) the core listing service; 2) software; 3) data and market intelligence; and, 4) communications and marketing tools. I expand on some of these below:

Not all OTMPs agents will require all these initiatives, and some won’t require any. I assume only the smallest firms would be a target since the large nationals (>125 branches) will have their own systems and processes in place. I assume terminal uptake of 50% of the 1-3 branch firms (60% of the market share) and 25% of the 4-125 branch firms (30% of the market share) take the full upsell. This equates to 4,125 agencies in total @£320 per month generating an incremental £15.8 million of revenue.

To put that that in context, blended across the base of agents and new homes the ARPA out-turn is £373. 30% of the cost of Rightmove. 25% cheaper than Zoopla. Below the old Boomin rack rate. But generating significant cost savings for the agent and streamlining their operations.

5. Unit economics are potentially exceptional with scale. I see scope for 40%+ EBITDA margins while assuming that OTMP is investing proportionally much more than peers

Best in class portal operators such as Rightmove and Autotrader generate >70% operating margins. This is because the network effect drives lower customer acquisition costs – marketing costs are typically 5% of revenue; sales staff requirements are low, as are staff requirements overall and cost bases are mostly fixed. Incremental and development capex are also very low. Yet customers perceive the portal as essential and will walk up a 5-10% p.a. price escalator with most of that growth dropping through.

I do not think that OTMP can earn Rightmove economics which has first mover advantage, significantly higher brand recognition, and a stronger network effect. But I do think that at scale OTMP can generate 40%+ EBITDA margins and c30% free cash flow margins.

Staff costs: £15 million compares to £8.9 million pre-Covid and £7.5 million in 2021 with Covid help. Headcount at 2021 increased to 215 at an average cost per head pre-Covid of £51k. Management comment that the business shouldn’t need any additional heads from this point thus £15 million = c£70k per head, thus plenty of room for inflation.

Marketing costs: pre-Covid were £12 million and were halved to £5.9 million in 2021 (another plus of the model is the ability to cut marketing costs to maintain profitability). I assume that these grow to £12 million p.a. in a terminal case since incremental marketing of the portal should decline as it gains more awarenesss and the network grows. Incremental marketing around new agent features will not be expensive since this will be driven by the sales team rather than expensive TV, radio and social marketing.

Other costs: office, rent, rates, utilities etc. I assume this doubles from £4.9 million to £8 million which feels conservative given the business is already scaled in terms of heads.

Working capital: I assume that the cash flow profile is slightly negative for prudence. The underlying portal/ subscription model is cash flow positive, and most new features are likely sold on the same basis.

Capex: capitalised staff costs are c£1 million p.a. Other costs are assumed in development spend and a small amount <£100k p.a. on tangible assets. I assume that OTMP must spend more in the interim years to build out the product offering (could be £4 million p.a but on terminal assumptions this drops back to c£2 million p.a., in line with RMV spend c£2m p.a. (but proportionally much higher, 3.4% of sales vs RMV 1%).

Tax: cash tax at 25%

These fundamentals generate a pathway towards a 36% pre-tax FCF margin, and 26% post-tax. On an absolute basis, c£22 million and c£15 million, respectively, compare favourably to a current fully diluted market cap of £60 million and enterprise value of £52 million.

Valuation

Base case

My base case returns can be based on several methodologies. Average upside is well over 3x undiscounted. I assumed earnings and sales multiples of 50% or greater versus RMV, which itself has de-rated by c50% in the last 6 months. My SOTP assumed 5x the recurring/ subscription businesses and 1-2x for the other parts. I assumed a further 10m shares dilution for whatever incentive plans or agent incentives could materialise, but this number should be too high. I assume cash is zero (from £8m net cash today), which is also unrealistic since this business should continue to generate cash and grow the cash pile.

·   SOTP = £245 million = 276pp/share

·   EBITDA = £232 million = 261p p/share (assumes 50% of RMV multiple)

·   FCF = £193 million = 216p p/share (assumes 50% of RMV multiple)

·   Initial target price: 200p

Downside case

My downside case assumes that the business fails to generate any traction in the ‘other’ revenue streams and doesn’t grow ARPA past £250. Revenue would drop to £39 million versus a fully loaded operating cost base of £35 million, generating £4 million of EBITDA. However, one would also assume that marketing costs could flex down from £12 million assumption such that a sustainable level of earnings could be £6+ million of EBITDA. Around half of the headcount in IT is ‘growth’ so that would also fall away, although I haven’t factored this in. This would attract a lower multiple as the business would be hamstrung without ARPA and ‘other’ revenue growth options. Cash earnings yield should be entirely distributable ex growth which is probably c6-8%.

Risks

1. Big downturn in UK market: this is changing quickly but i am confident that the base level of transactions holds up. Higher mortgages may force more people to downsize but regardless only 30% of homes in the UK are mortgaged so 70% of the market would be unaffected. New homes sell through has to be more aggressive by developers. Agents may focus more on their own cost bases and search for value. Could be a positive for OTMP and accelerate uptake of new features

2. FY earnings: the half years were a little disappointing on the agency side, i thought ARPA would have grown more strongly. Costs were also higher than I expected. I think that the market sees FY as hard to achieve given the weight. H2 should be strong with new agents signed up and I think that they beat consensus on new home arpa. Marketing is highly discretioanry and this should be lower than H1 which had a few one offs.

3. Glanty/ CRM delays: management going for a land grab which will delay profitability. Potential that this narrative masks lack of traction which will be difficult for outsiders to see.

4. Agent customers prevent ARPA uplift: agent customers and shareholders may have more leverage than management let on around ARPA uplifts and this prevents a reasonable price escalator (below inflation) while costs grow more quickly. Large agents are very few and small agents, are are the majority, have less negotiating ability. 

Catalyst

> Agency ARPA progression towards £270-300

> New home ARPA converging quickly to agency ARPA

> Growth/ traction in ‘other’ revenue lines

> Stable agency and developer numbers (c11k and 2k or better)

> Cost management – staff, marketing, and capex – should generate strong margin progression