"The Lord bless you and keep you;
The Lord make His face shine upon you,
And be gracious to you;
The Lord lift up His countenance upon you,
And give you peace."
Numbers 6: 24-26
The stock markets are beyond crazy, most investors who have been in markets for a while now are realizing this. I was expecting some volatility this week and there are now major conflicting issues. Supply chain chaos has led to extreme inflation (don't pay attention to the Treasury Ten-Year Note), and all of the sudden the omicron variant is here.
So what's the response - major pain and punishment for select aggressive growth plays as usual. In fact, the inflationary/rotation pressures have already punished select aggressive growth companies strongly the past couple months, and ironically, omicron has further exacerbated these companies witnessing the strongest selling pressure today. We now find ourselves in the fourth sell-off during 2021 on selective aggressive growth companies.
The key catalyst was the buy-the-dip mantra from retail investors. This led to very short durations of broad declines that were quickly bought up, with the climax occurring during 2020 and early 2021. It's taken Wallstreet a little bit of time, but once the February peak hit in 2021, it's been an entirely different story, as buy-the-dip has worked only for a short period, with harsh sell-offs soon after. Wallstreet as always is using tactics to shakeout retail investors. To put it bluntly, investors are facing a wild-west environment, where no rules apply for short-term gyrations.
To get a sense of the market's lack of logic at the moment, I always think it best to use illustrative examples. The way to do this is through peer comparisons. I've selected some charts from top-ten holdings in the portfolio that in my opinion, reflect clear schizophrenia. Hopefully this helps paint the illogical pictures of how Wallstreet and traders are taking advantage of short-term trading volatility - in two words, this is a HIGHLY EMOTIONAL market.
Roku, Inc. (ROKU)
I've said it and I'll keep saying it, Roku is trading as if it is the worst streaming company in the market. Sure investors can question Roku's valuation level or the competitive markets, Wallstreet surely has as a FUD tactic, but investors need to pay attention to peer companies like Discovery Communications, Inc. (DISCA), At&t, Inc. (T), The Walt Disney Company (DIS), and Comcast Corporation (CMCSA). Should Roku be leading legacy streaming plays in poor performance, unquestionably the answer is no. Roku is down 40% over the past six months, and even much more from the summer peaks.
The fact that legacy companies are outperforming Roku, and are the weakest performers for streaming peers is a critical red flag. On the flip side, FAANG-M streaming plays like Apple, Inc. (AAPL), Amazon, Inc. (AMZN), and Netflix, Inc. (NFLX) are all doing quite well, and the most egregious example - The Trade Desk, Inc. (TTD), is the big winner. Roku continues to outperform all of these companies from a Revenue growth perspective, and in some cases, Cash Flow inflection (Netflix!).
For those believing the FUD that Roku was extremely overvalued and competition presents a major risk for Roku's future, there is no evidence of the latter (aside from Company A saying they are doing X). And for the former, even with reduced valuation multiples, Roku still offers substantial upside potential. So the question is, how will the tables turn for Roku and when?
This will likely require a little time and patience. Roku is not immune to the supply chain chip shortage issues and this has had a modest impact on financial results and expectations. This will last into next year. And investors need to laser in on Roku's ARPU - this is the fundamental metric to determine Roku's future. If Roku can successfully increase this metric towards $85 by 2025, chances are Roku will be generating north of $9 billion in Revenue, potentially equating to a 20% Cash Flow margin to boot. At 15 and 85 times EV/Revenue and OCF/share, Roku would be worth $900. As markets normalize and begin to once again recognize clear aggressive growth leaders (financially superior to boot), this scenario will have legs to come to fruition.
Investors focusing on the ARPU metric will be able to see on a quarterly basis how the company is being impacted by competition. I always attempt to provide conservative financial models inputs to generate my estimates. For instance, my assumption for Roku's ARPU for 2021 was below $38, and Roku has already eclipsed this. My mid-term 2025 estimate for ARPU is $82, and if Roku hits or breaks through this level, chances are strong that the SP will land in the $900-$1,000 area, especially as there is upside potential in the event Roku achieves higher performance on ARPU.
Vroom, Inc. (VRM)
Vroom has simply been decimated over the past six months. The key red flag for Vroom is the fact that it is the worst performer for its peer group with only Truecar, Inc. (TRUE) and Shift Technologies, Inc. (SFT) being near this level. To this point, Vroom's valuation is beyond depressed. Additionally, Cars.com, Inc. (CARS) and CarGurus, Inc. (CARG) are performing quite well. All of these peers are much smaller players, all expected to grow much slower than Vroom in 2021, as well as over the mid- and long-term.
One could argue that the iBuying market has cooled off substantially from an investor perspective (it has), but this is not of concern when it comes to investment potential. The main reason for declines in my opinion is Wallstreet's negative and punishing influence on Vroom based on the company's shifting of its business model from asset-light to more asset intensive approaches. The logic here is that an asset-light model was expected to yield better unit economics and it hasn't. Now Vroom is tasked with increasing capital expenditures to grow the business, all the while Carvana, Inc. (CVNA) has already taken this approach and proven its early dominance.
Another red flag on this chart are the leading performance of legacy used vehicle companies like AutoNation, Inc. (AN) and CarMax, Inc. (KMX). These companies have witnessed strong Revenue growth through vehicle sales, as have Carvana and Vroom (exponentially greater), stemming from pandemic impacts. But the market is not factoring for when a more normalized growth period materializes. Once this occurs, companies like Carvana and Vroom will re-emerge as the true growth leaders that they are, while legacy peers drop below 10% Revenue growth, and lower in the future. Ironically, even in a broad positive market for all peers, Carvana and Vroom are taking substantial market.
So what's the catalyst to turn things around? I believe that we are in a rising tides lifts all boats year and that once legacy and smaller peers display their true colors, Carvana and Vroom will become more visible winners. For Vroom, once the market recognizes this, the SP will jump as the discount is extreme. Vroom is now trading nearly 0.5 times EV/Revenue. Both Carvana and Vroom continue to burn Cash, but Vroom does have a modestly better negative Adjusted Free Cash Flow Margin, for what it's worth.
For investors concerned with Cash Flow, companies like Carvana and Vroom should not be measured based on traditional Cash Flow metrics. Even companies like AutoNation and CarMax should use adjusted Cash Flow metrics. It remains to be seen how Carvana and Vroom will be capable of generating Adjusted Free Cash Flow in the future, but even traditional companies are highly levered. Distinguishing between vehicle inventory and short-term Vehicle Floorplan debt is important to clearly understand Net Cash/Debt. In the case of a company like AutoNation, Cash Flow margins have inflected purely resulting from the pandemic and they will revert back. AutoNation is much higher levered than Vroom, even when factoring for inventory.
Opendoor Technologies (OPEN)
On the surface, Opendoor looks like the clear winner here, that is, if you like holding the best negative performer out of a peer group. Opendoor has been hit with the crab analogy - when a crab in a bucket full of his friends is getting close to the top, those at the bottom pull him back down.
I've got to give a shot out to one of our Site Members here for the following article from Livewire. This piece provides some good context with respect to the recent shift away from iBuying by Zillow Group (ZG) versus Opendoor's sustained success and future potential. I concur completely - bottom line, Zillow didn't have the human capital required to succeed and failed to execute, while Opendoor now has a much clearer path to grow its market.
Opendoor is on track to become a preeminent leader in iBuying with the added potential of leveraging this vertical model into a suite of value-add services to customers. Prior to Zillow's decision to no longer compete in the iBuying market, 2022 Revenue estimates were north of $8 billion. Those have now dropped to $7 billion, all while Opendoor's Revenue estimates have jumped to nearly $15 billion, from $11 billion or so.
I continue to pose the question. Do investors want to own a piece of a business that may be on track to generating $40-$50 billion in Revenue by 2025? At the same token, this company may be capable of witnessing parabolic Cash Flow inflection during the 2025 to 2030 time frame.
Offerpad Solutions Inc. (OPAD) is now the iBuying number two, while Zillow and Redfin Corporation (RDFN) will be subject to obsolescence over time. In Zillow's not to distance hey-day, it wasn't uncommon to see the SP valued just below 10 times EV/Revenue. If Opendoor continues to execute and scale the business through 2025, and considering a 4 times EV/Revenue multiple, the SP could equate to $255, as I've updated my financial model. Opendoor clearly recognizes this opportunity and the company will likely invest to take advantage of bolt-on acquisitions to improve customer experience value-adds, as well as to maintain capital efficiency needs to increase Real Estate Inventory and Revenue.
I think that this is one crab worth investing in and I will continue to defend Opendoor aggressively.
I like to revisit these types of snapshot pictures of how markets are disconnected from time to time. If there is one fundamental aspect of investing when it comes to Wallstreet's no winners philosophy, it is that parity inevitably wins. The goal of this portfolio though is not to achieve parity, but to successfully pick winners over time. In any case, there's just too much upside-down, bizarre world here where leading innovators are punished unduly.
During days and weeks like those of late, investors need to keep their wits and strategies in place.