Description

Redfin (RDFN) is a long, with multi-bagger potential if they continue to execute. Like TSLA, AMZN, PCLN amongst others before it, it will never fall into the category of traditional value stock, but we think it represents a unique opportunity to disrupt an industry in painful need of disruption, much as the others listed have done. While CEO Glenn Kelman is not a founder, he is a highly regarded leader and manager.

While Realogy is the largest brokerage in America, Redfin is quietly becoming an important factor. BTW, I really liked rhianik's write-up on RLGY from January; we just think RLGY is the past and RDFN is the future.

A look at a few of the facts from Redfin’s S-1:

20 million monthly uniques on its website and mobile app.
$16.2 billion in sales volume in 2016 (would have been no. 5 on RealTrends 500).
26,868 transaction sides in 2016 (would have been no. 10 on RealTrends 500).
$267 million in revenues, a 44 percent year-over-year growth.
Gained market share in 81 of 84 markets.
Grew listings from 20 percent of its business to 30 percent of the business.

The business : The average RDFN agent does 34 transactions a year and generates $350,000 in revenues (not sales, not GCI, but revenues) for RDFN. The industry has ignored RDFN for years, assuming that it was just a buy-side discount brokerage with a fancy website. Brokers and agents have been dismissing them as well, saying things like, “I send my clients over there because they just come back to me.”

The employee model that RDFN has used from the beginning has drawn disdain from the industry, because Redfin would never attract top-producing agents who have unlimited income potential as an independent contractor, have enormous egos that make them difficult to employ, and account for most of the profits at the traditional brokerages. When Redfin filed to go public, a number of the real estate intelligentsia pointed to Redfin’s tiny market share numbers and suggested Redfin was yet another hyped up soon-to-fail company. Anecdotally, I've read numerous posts by people who have used RDFN agents and noticed absolutely no difference in the quality of service versus the traditional agent. Also, the hostile responses RDFN illicits from the traditionalists tells me they are doing something right...Compressing their thought to be sacrosanct 3%. What they also have lost in their critiques is that ultinmately for RDFN, market share is a means to an end through revenue growth, and ultimately profits.

Redfin’s Q4 2017 and Q1 2018 guidance slightly disappointed the street, though the numbers are still outstanding :

Revenues of $97 million for the quarter, up 40 percent YOY, and full year revenue growth of over 35%
A much smaller operating loss in Q4 YOY ($2.4mm) vs ($5.4mm); It is important to note that RDFN is closing in on break-even profits. It is possible that the company sees break-even operating margins in 2018, and they will certainly be profitable in the summer months. The point here is that with $200mm in cash, RDFN has a lot of flexibility. 

RDFN calculates gross margin differently from other brokerages, because it pays for all of the selling expenses of its employee agents; it is a decent stand-in for company dollar. I am unaware of any brokerage in the U.S. with company dollar over 30 percent (RDFN); the national average is around 15 percent. The traditional brokerage then has to pay all of its operating expenses out of that 15 percent. Result? The average brokerage in the U.S. has 3 percent profit margins; the best operators are sitting at around 5 percent to 6 percent profit margins.
Redfin is at over a 9% profit margin on north of 35% gross margins. Not impressive for a technology company, but impressive for a brokerage.
As a point of comparison, look at the NRT, Realogy’s in-house brokerage: NRT had EBITDA of $52 million on revenues of $1.3 billion, or a 4.1 percent profit margin...And EBITDA is higher than net income, so the actual profit margin is lower than 4.1 percent.
Plus, what other large brokerage (say in the top 50 of the Real Trends report) is growing revenues 35 percent YOY? Not Realogy and not HomeServices of America — which we know because both have to report their numbers.

But that’s not all, as we believe Redfin’s revenues are tied directly to its web traffic, primarily because CEO Glenn Kelman and crew think of it that way. This is important, as Redfin’s traffic growth is quite impressive : Up 38 percent YOY to over 20 million average monthly uniques, compared to 9 ish million for Zillow, and 2 million for realtor.com. If you look at the key statistics that Redfin offers, there is a case to be made for a strong correlation between its website traffic and revenues (it’s around 0.86, which is strong). The average revenue per 100,000 users is over $130k, which is an enormous improvement over the years, as RDFN is getting better at converting traffic. 

We think that if Redfin manages to keep up its traffic growth, we cab get over $525mm on the topline for 2018, suggesting over $30 billion in sales volume. This would put RDFN past Douglas Ellman, obviously concentrated the high end markets of NYC, and a familiar name to some VIC members. With HomeServices of America acquiring Long & Foster, this would make Redfin the third largest brokerage by volume in the country.

There is a good reason why Redfin’s traffic growth is so closely correlated to revenue growth. Redfin doesn’t have “agent adoption” problems. When it invests in technology, new business processes or new efficiencies, all of its agents use that technology, business process or efficiency. 
Because they’re employees. No one else can do this, because their agents are 1099 independent contractors who can and do routinely tell the broker/manager/company to take a hike (See, e.g., Realogy’s acquisition and subsequent rollout of the Zap Platform.)

In any event, we think RDFN could be profitable to own in 2018, having multiples of upside over the years to come. I do not see how the company with its technology and current financial flexibility could ever be a zero, so hence I find this an interesting assymetric bet on disruptive play in an ossified industry. 

Catalyst

Continued execution.