Description

Onthehouse (OTH) is an Australian enterprise software company whose strong free cash flows have been hidden by a (zillow-esque) consumer division. 

The enterprise software business (office functionality for real estate agents) provides a ~10% normalized after-tax FCF yield inside of the standalone public company.  Their product is incredibly sticky with large switching costs, giving the business excellent margins and pricing power.  There is no customer concentration and churn is minor even in years where they’ve raised prices.  The product category is a duopoly nationally but OTH is regionally dominant and an attractive acquisition target for their main competitor.

~10x FCF for that business is already interesting, but the consumer division, which offers substantial upside optionality is why you should keep reading. 

Before we talk about that product – let me introduce Mike Dempsey. 

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Mike founded the payments company Ezidebit in 1999 and it grew from nothing to handle transactions for 16,000 businesses.  The business sold for ~$300m in 2014 with the Dempsey family owning ~70%.  Mike was 50 years old. 

When asked what he’d do next Mike said, “I think the real estate market needs a good shakeup so I’ve got some ideas there.”

Fast forward a year and Mike has purchased ~20% of Onthehouse for around ~$10m and the company has changed the CEO and board members (with Mike and his brother both now on the board).

People familiar with the situation have said that Mike isn’t spending his time and energy here to make ~$2-3m on a $10m investment.  He is most interested in the OTH consumer division.  This brings us back to the upside optionality of the investment.

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Onthehouse.au (consumer division) competes with REA group, the 800 pound gorilla in the Australian online property listing market.

The company’s plan was to separate the consumer business from the enterprise division, highlighting the cash flow and economics of enterprise while funding the growth of the consumer division through VC investments.  But a better alternative emerged and Onthehouse.au is now working to form a JV with the real estate industry owned realestateview.com.au, creating a more meaningful competitor to REA with scale and synergies.  It is expected to be immediately profitable but will consider raising strategic investments to accelerate marketing and product development.

The plan is to create a viable competitor to REA group.  The real estate industry wants this to happen and should favor the new JV as the second player.    

REA has a market cap of $6.5bn (over ~100x the market cap of OTH) and a piece of that pie is what Dempsey is playing for here.

Handicapping the value of this JV is challenging, but arguably an investor pays less than nothing for that asset today.  With the entire company selling for less than $60m there is substantial upside asymmetry.

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After Dempsey got inside, kicked the tires, and saw what the JV looked like he (with Macquarie) made a bid to acquire the remaining 80% of OTH, bidding 75.5c (unsolicited) in December. 

An independent committee rejected that bid and subsequently updated the market on its progress in launching the new and transformational consumer JV.

It seems there are a couple ways this can play out from here:

• ·         OTH accepts the Dempsey current or revised bid.  This provides an unexciting absolute return but a reasonable IRR.
• ·         OTH conducts a real process (they’ve hired advisors) and the enterprise business could be sold to their cash rich private competitor (Rockend) at a nice premium.  Perhaps shareholders keep the consumer business or perhaps Mike buys that individually.  This seems like a fine outcome.
• ·         OTH remains a standalone public company.  It de-consolidates the consumer business and demonstrates the attractiveness of its enterprise division while retaining the optionality of the new JV.

Each of these outcomes seems fine since the standalone scenario offers a highly attractive risk/reward in the medium term.

DISCLOSURE

Have ownership interest in Onthehouse at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on the authors buying or selling activities for this or other stocks. The author may buy or sell shares of Onthehouse without notice for any reason at any time.

Catalyst

Sale or deconsolidation of consumer business