The Good Brigade
Company description:
Opendoor Technologies Inc. (NASDAQ: OPEN) operates a digital platform for residential real estate in the USA. The Company’s software platform enables consumers to buy and sell a property online. Opendoor also offers complementary services such as B. Title Insurance and Escrow Service.
Opendoor is an iBuying company, the largest in the US by property purchased (Source: Opendoor, Zillow, Offerpad and Redfin Annual Account/data). iBuying is the process of buying a property from consumers and selling it at a profit, also charging some service fees for the service. The selling point for consumers is that Opendoor eliminates all the stress and uncertainty of selling a home with a transparent listing based on the current condition of the property.
Zillow (Z), a competitor of Opendoor, exited the iBuying business in 2022. We’ve covered this as part a paper on Zillow Here. Zillow was down in the iBuying market and chose to focus on the marketplace side of the business. This means that Opendoor remains by far the biggest player on the market.
Opendoor was a value destroyer, with the stock falling below $3 from an ATH of $35. This is the type of decline usually reserved for scams and financial meltdowns.
Much of this was driven by a reversal in the housing market and a change in macro conditions, which we will discuss in more detail later.
Data from YCharts
With Opendoor’s stock somewhat flat, now seems like a good time to investigate the company. Much of our analysis will focus on macro conditions and the housing market going forward. Financial analysis will take into account what investors are paying for and are likely to pay for going forward.
Housing market and macroeconomic framework:
real estate market:
The global property market experienced a surprise boost during the COVID-19 pandemic thanks to government stimulus such as the UK’s stamp duty exemption. U.S. home prices have skyrocketed 15% in 2021, something that hasn’t happened in many years. Opendoor benefited greatly from this phenomenon as they were able to acquire and sell a steady stream of properties to high demand. Her earnings skyrocketed 210% in 2021, which was a remarkable achievement. In 2022, however, the pace began to slow as those who wanted to buy or sell had already done so.
This led to an artificial slump in home sales seen below in the second half of 2021 and into early 2022.
Data from YCharts
Which brings us to the elephant in the room, the swoop in 2022.
Macroeconomic Conditions:
Macroeconomic conditions have deteriorated in 2022 and are expected to continue to do so in 2023.
The main reason for this is a rapid rise in inflation, which has been above 5% for over a year. In response, central bankers around the world have raised interest rates, which has not yet been successful. US interest rates are currently at 4.5%. The net impact has been all-powerful pressure on households and consumers, with a cost-of-living crisis caused by both higher borrowing costs and price hikes. Importantly, mortgage costs have risen significantly, with the US floating rate now above 6%.
Average 5/1 Adjustable Mortgage Rate (FRED)
Consumers are paying almost three times the interest they were paying not so long ago. The good news is that people in the US generally stick to fixed rates for 5+ years and so many will be able to avoid it entirely. However, the problem for Opendoor is that it takes away the incentive to move/buy a home. Why would people want to take out mortgages at current rates when they can wait a year or two and hope rates go down? Why would people even consider moving when their spending is increasing and economic conditions are weakening?
The impact of this has been falling home sales and falling prices, with Reuters estimating a 12% drop from the peak. This has the opposite impact of the COVID-19 situation for Opendoor as stock is now more difficult to sell and prices are regularly falling. As inventory becomes more difficult to sell and the required margin is achieved, new properties have to be purchased at even lower prices to reflect the greater risk. From a financial standpoint, this has brought GPM down from 9.1% in FY21 to 5.3% in the LTM period.
Outlook:
Interest rates are the main catalyst to turn Opendoor’s business. Futures markets are currently pricing in further rate hikes, which peaked in June at just under 5%. This suggests that interest rates will remain elevated for the remainder of 2023.
The OECD expects inflation to remain above 5% in 2023 before declining in 2024. This will further exacerbate cost of living problems and likely contribute to a recession.
So more of that is likely the minimum we’ll see in 2023. It is likely that things will continue to deteriorate and impact Opendoor.
finance
According to the CEO, Opendoor is fundamentally changing the way the company works
We are advancing our roadmap with the launch of our Exclusives marketplace, which brings home buyers and sellers together. Since our first round of funding, we have envisioned Opendoor as a core transactional layer, initially built by owning and transacting inventory itself, with plans to launch a marketplace once we have established a supply and demand network of customers who directly do business with Opendoor. (Source: Q3 investor package).
This suggests they are taking a similar move to Zillow and moving to a marketplace-focused operation. Because of this, their financial profile may change in the coming years. For now, however, we must assess the business as it is.
Opendoor – financial analysis (tikr terminal)
Opendoor’s finances are very messy. They’re arguably what’s expected of a growing tech company, although we wouldn’t necessarily classify that as tech.
Revenue growth has been phenomenal, driven by COVID in recent years, but has been impressive since listing. The increased capital has enabled Opendoor to fund larger purchases and increase sales.
CoGS have grown in line with revenue, suggesting that monetization is not improving and better deals can be found. While not a certainty, we would believe Opendoor’s improved brand image could mean greater bargaining power with sellers/agents. So far this has not been the case.
S&A costs are up at a CAGR of 68% versus 88% of revenue, suggesting their customer acquisition costs are attractive. This probably supports how they have been able to grow sales at the rate they have.
Margins have improved over time, primarily because their cost base is relatively fixed outside of S&A and CoGS. LTM GPM, as we noted earlier, has fallen due to falling prices reducing their ability to generate profits from sales.
On the balance sheet side, stock levels as of November 2022 are worrying. If prices continue to fall, there is a major risk that they will not be able to achieve the target margin and may have to hold stocks longer than desired. We are already seeing evidence that inventory turns have been declining year-on-year since December 19th. Since GPM is thin at 5-10%, the error rate is very low. However, it should be noted that inventory as a percentage of sales is lower than on December 21 and December 18.
If we look at our credit analysis, we can see how this growth has been funded. Opendoor has taken on significant debt and issued additional stock to fund its inventory. Leverage has reached astronomical levels and the company’s EBIT is currently still negative. The CFO was $555 million in the LTM period, which is well below their cash balance. For this reason, it is unlikely that further cash will need to be raised in the short term. However, the balance sheet does not look good. With margins that thin, it’s hard to imagine how the company would even be able to fund interest payments, which make up nearly 50% of gross profit.
Overall, it’s clear why Zillow left the iBuying market. Margins are low and the business is becoming capital-heavy. Given the high level of debt and the current profitability profile, we find it difficult to see how the business can continue in its current form with iBuying. Should it fully transition to a marketplace, the question is will this business fare better. If we use Zillow as an example, the GPM is 20% and the EBIT margin is -6%. This suggests that Opendoor will find itself in a nearly identical position in terms of bottom line profitability.
Evaluation
Opendoor shares currently trade at a multiple of 0.5 times LTM sales, which is slightly below the peer group average.
Evaluation (tikr terminal)
If an investor wants exposure to the tech real estate space, it would be difficult to justify a 0.5x multiple for a company that has a difficult path to profitability when Zillow is available at 1.15x.
The reality is that it is extremely difficult to value the asset until a clear path to profitability is established and what the economics of that are.
Analysts believe that EBITDA positivity will be reached in two years and marginally in 2024. By 2026, the company probably still won’t be earning enough to meet its interest payments.
Analyst Forecasts – OPEN (tikr terminal)
Diploma
Many are quick to suggest that a company is undervalued when its stock price falls sharply. Many are also quick to suggest that a company is a technology company when it really isn’t. We think both are the case here. While the revenue growth has been impressive, there’s no real path to profitability. Since the store wants to evolve into a marketplace rather than iBuying, you are essentially buying a brand at this point. In addition, the company may have technology in its name, but it is currently very asset intensive and there is a real risk that current inventory cannot be realized at profitable levels.
As the year ahead is expected to be similar, we could see a further drop in Opendoor’s share price. Upside potential exists if valuation falls to a level that reflects only the value of the brand, or if current inventory can be sold at levels above current margins.
We rate this stock as a Sell.
Editor’s Note: This article covers one or more Microcap stocks. Please be aware of the risks associated with these stocks.
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