Opendoor: A Real Estate Disruptor That Faces A Lot Of Uncertainty
Summary
- In an effort to disrupt the real estate market, Opendoor offers comprehensive digital solutions for the home buyer and seller.
- Opendoor has seen strong revenue growth over the past 3 years with a CAGR of 53%.
- Low gross and EBITDA margins cause some concern regarding the company's path towards profitability.
- At current price levels and when considering future forecasted growth, Opendoor's valuation while not inexpensive does not seem unreasonable.
Thesis
Opendoor Technologies (NASDAQ:OPEN) is a growing real estate disruptor that will attempt to change the way people engage in real estate transactions in the next years. The company presents an innovative business model based on digital operations, that has yet to show, however, an ability to generate profits through the strong margins that Opendoor currently lacks. While the potential for high growth and increasing market share is evident, Opendoor is faced with intense competition and other macroeconomic risk factors that will be discussed in this analysis. Finally, this analysis offers an insight into the company's valuation and the stock's upside potential.
Business Model
Opendoor's business model is simple, yet very smart and innovative. The company offers a comprehensive real estate solution for home buyers and sellers. Financing and refinancing through Opendoor are also available. People who wish to sell their home have two distinct options: they can list their property with Opendoor or sell directly to the company, receiving a competitive cash offer in a matter of a few days. Those houses will then be refurbished and relisted for sale by Opendoor. Buyers, on the other hand, can utilize the Opendoor app to tour (virtually and physically), visit homes, apply for financing at competitive rates and make an offer to buy a residential property. Help from local real estate experts is provided to the customer, through the company, in every step of the real estate buying or selling process. On both the seller and buyer side, what Opendoor aims at is to significantly simplify and speed up the process, while helping customers save on fees. Sellers can save on inspection and refurbishing costs. At the same time by selling directly to Opendoor and closing within a few days, a customer that is looking to move will save in double the mortgage expenses he would have to incur until his original home was sold with the traditional process. The home buyer is able to move in quickly, on his own timeline, while the company claims he can save up to 1.5% in fees.
The Real estate market in the United States is currently valued at around 1.6T USD and Opendoor's goal since day one has been to increase its market share aggressively. As mentioned in the 2020 10-K Report, the company operates in 21 markets as of December 2020, and management believes they are just scratching the surface of their potential. Opendoor currently aims at operating in the top 100 US Real Estate markets in the next years.
Growth History and Prospects
Over the past 3 years, revenue growth appears to be outstanding, with Opendoor's top line growing at a CAGR of 53%. There is, however, one thing that stands out and might seem very troubling to investors. Revenue in 2020, has declined to 2.6B from the impressive 4.7B in 2019. Management attributes that decline to insufficient inventory as Opendoor was faced with a pause in home purchases following the outbreak of the global COVID-19 pandemic. Management promises a strong inventory and revenue rebound, as shown below, in 2021, and most analysts tend to hold the same view. As Opendoor rebuilds inventory and continues growing by capturing more market share in existing and new real estate markets that the company is expanding to, guidance forecasts 2021 revenue of 3.5B and 2022 revenue of 6B, implying that the company will double its top line in the next two years.
Source: Investor Presentation
Profitability and Financial Outlook
One area of concern, regarding Opendoor's long-term perspectives, in my view, is the company's profitability struggles. While the company is currently unable to post a Net profit, not an unusual situation to be in for a company that is still in a very early growth phase, what is more concerning is the limited room that Opendoor's margins leave for a positive bottom line. As of the 2020 fiscal year, gross margin sits at only 8.5% and although the real estate industry is known for not-so-generous margins, we would like to see better from Opendoor. EBITDA margins are still in the negative, but some hope is offered since improvement has been noticed over the last 3 years, with EBITDA margins increasing from -7.1% in 2018 to -3.8% in 2020. Long-term, Opendoor targets EBITDA margins in the 7-9% range, while increased Gross margins are also forecasted. Source: 10-K, Investor Presentation.
Increasing profitability is going to be the most important challenge, in the next few years, along with capturing more market share across the US. Competitors like Zillow (Z) and Redfin (RDFN) are already demonstrating wider margins and Opendoor will have to catch up, in order to inspire more investor-faith in the company's business model.
Outside of the mentioned profitability struggles, Opendoor's finances present a very healthy outlook. The company has significantly increased its cash and cash equivalents balance to an impressive 1.4B in 2020, while maintaining a very safe current ratio of 5.25. In fact, Opendoor has enough cash on hand to pay all liabilities (575M), a testament to the company's wise use of leverage. Of course, a significant portion of the company's large balance in cash is going to be employed to rebuild the inventory that was depleted in 2020.
Stock Performance
Opendoor went public through a SPAC, run by the famous investor Chamath Palihapitiya. The stock, under the ticker symbol OPEN, began trading on NASDAQ on December 21, 2020. After a pricing of $31.25 at the end of the first day of trading, the stock has been highly volatile since, reaching a high of 35.88 on February 11, 2021. Significantly affected by the tech sell-off we are witnessing over the last couple of weeks, Opendoor's stock has seen a major pullback, now trading at $21.00, as of the time this article is written (Mar 8, pre-market hours). While 3 months of trading are insufficient to identify any trading patterns, many investors might view the recent pullback as a buying opportunity.
Data by YCharts
Risk Factors
Macro factors: Slower future economic growth, potential economic recessions, and/or high inflation could have a significant impact on Opendoor's business. The U.S real estate market that is currently expanding, might be heading towards a downturn, especially if we consider an interest rate increase that at some point in the near future is bound to happen. Higher rates lead to a higher cost of financing, which in turn could discourage people from purchasing homes. In addition, higher unemployment and stagnant wages also affect the real estate market.
Competition: The U.S real estate market is highly fragmented and very competitive in nature. Opendoor competes directly with traditional, offline real estate brokers and agents, as well as with other online service companies like Zillow and Redfin that are gaining popularity. The residential real estate financing business that Opendoor also engages in, is characterized by intense competition and fragmentation as well.
Profitability struggles: As I mentioned in this analysis, Opendoor's inability to maintain strong margins will present a hurdle towards profitability that is not easy to overcome. In the face of fierce competition and possible market downturns, the road toward profitability might prove to be longer than currently anticipated. This will cause investors to worry about long-term sustainability and might result in a significant price pullback.
A Forward Look at Valuation
Opendoor's high growth potential and innovative services trade at what may initially seem like a very reasonable valuation. Currently, the stock trades at 3.10x Forward 2021 sales. However, it is important to note that the company has yet to post a positive Net result and is not expected to reach profitability for at least 3 more years. Also, the lower margins that Opendoor operates with, and the fact that the real estate sector generally trades at low valuation multiples, make the 3.1x multiple a bit more pricey than it might at first appear. Just for reference competitors like Zillow and Redfin trade at forward Price/Sales ratios of 6.5 and 4.79, respectively.
Focusing on the Prices/Sales ratio I will attempt to project potential upside for the stock in the next 3 years through a scenario-analysis, in an effort to embrace the uncertainty that surrounds the company. Opendoor currently trades at a 3.10x forward Price/Sales multiple, with a 12.69B Market Cap. Revenue Growth as shown below, represents average annual growth for the next 3 years.
Guidance Source: Investor Presentation
- Bullish Case: The company beats growth expectations and grows Revenue at a 65% per annum rate. In a best-case scenario that the P/S ratio remains at today's levels of 3.1x the company will be trading at a 36B Market cap, representing a 3-year 170% upside. If the P/S multiple drops to a more conservative 2.1x, Opendoor will maintain a 24.5B Market cap, still implying a 3-year 93% upside.
- Base Case: Opendoor meets -the very optimistic- growth expectations and grows Revenue at a 50% per annum rate. With a Market Valuation that will range between 27.2 and 18.4B, Opendoor's 3-year upside is still attractive, especially if the company maintains current valuation multiples. Maximum upside, assuming an unchanged 3.1x multiple sits at 110%, while a lower forward multiple of 2.1x at the end of the 3-year period, offers a respectable 44% potential upside.
- Bearish Case: The company fails to meet growth expectations, but still grows Revenue at a 35% per annum rate. In this case, at a 3.1x or even a 2.6x P/S multiple in 2023 there is still room for gains, while at a lower 2.1x, downside potential starts creeping in.
- Very Bearish Case: Given the optimism and very high expectations surrounding growth estimates, I saw fit to include one final scenario of underperformance. Here, the 20% annual revenue growth rate that is selected, would be the result of slower market share expansion, strong competition and a possible economic downturn that affects the real estate market. A 3.1x unchanged P/S multiple is going to be basically impossible for Opendoor to maintain in this case. Both a 2.6x and a 2.1x P/S multiple would imply price depreciation and sizable potential downside of 8% and 25% respectively.
To summarize, assuming that Opendoor's P/S ratio will fall to a lower multiple in the next 2-3 years, if the company manages to meet growth expectations, there is significant potential upside for investors. Although a 50% annual revenue growth target for the next 3 years is not an easy goal to achieve, it is definitely possible, provided that Opendoor delivers the market disruption promised, while demonstrating a clear path towards profitability.
Final Thoughts
While I think that we can recognize the fact that Opendoor has some strong growth potential ahead, with a current valuation that seems reasonable, especially after the recent pullback the stock has experienced, I still maintain some reservations that make hesitant, when it comes to offering a strong recommendation for the stock. Between slim margins, intense competition and a business heavily affected by the U.S economic outlook, I would like, personally, to see Opendoor's stock price drop a bit more before I feel comfortable initiating a long position. That said, I tend to be conservative with my investing process and I would not discourage someone from buying the stock at current price levels. For these reasons, I am inclined to give Opendoor a neutral rating.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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