Updated: Jan 9, 2021
Matthew Chapter 6, verses 22-23 state, "The eye is the lamp of the body. If your eyes are healthy, your whole body will be full of light. But if your eyes are unhealthy, your whole body will be full of darkness. If then the light within you is darkness, how great is that darkness!"
While this passage is directly related to where I need to place my focus in my life, advising that it is best suited to seek God versus earthly treasures, I still find it very insightful for an investment parallel. If my life is meant to honor God and be a positive impact for others around me, I must be light in a world of darkness - I like that, but it will come with challenges.
Similarly, in a world of confusion and misrepresentation when it comes to investments, I need to have light guiding the path for opportunity, especially in preparation for challenges. This point is what brings me to today's topic on Opendoor Technologies (OPEN).
Just before Christmas, Opendoor was trading above $31 per share. On January 4, 2021, the Stock Price, SP had dropped to nearly $22 per share. On this day, I would normally have averaged the position. However, I had recently assessed Zillow Group's (ZG) information as it has been a core holding for some top fund managers. What I discovered caused me to reduce my interest in Zillow and rethink about Opendoor's prospects.
I believe there are some very important aspects to consider with what has transpired due to COVID and how this has impacted both Zillow and Opendoor, especially as it relates to growth potential. I am an aggressive growth investor so if a company seems like it is not offering strong Revenue growth, then I will become less interested in it. Previously, I had selected Opendoor over Zillow because of this directly - Opendoor's prospects were assumed to be much more robust from a Revenue growth stance.
Defining the Opportunity
The core opportunity for Opendoor is the substantial total addressable market (TAM) to transition traditional home sales to e-commerce, a $1.8 trillion opportunity. As a part of this, there will naturally be a further cross-selling opportunity for other products and services that revolve around home buying and selling.
Zillow has obviously become aware of this, as has Redfin Corporation (RDFN), among others. During 2019, Opendoor was the clear market leader doing $4.7 billion in Revenues. Zillow did $1.4 billion during the same year for the same market segment. For 2020, Opendoor is expected to generate only $2.6 billion in sales stemming from COVID impacts. Thereafter, the company is projected to see a strong recovery approaching $10 billion in Revenues by 2023.
I am modeling Opendoor to generate a 2% Operating Cash Flow, OCF margin during this time, with a Price Target, PT of $70 per share as a result. This affords Opendoor an initial SP to OCF per share multiple at 250 times as the company sees its first sustainable cash flow inflection.
Using similar growth trajectories and valuation multiples for Zillow and I can substantiate a PT of around $200 per share. Today, we don't have enough information to assume that Zillow will indeed maintain current OCF margins, and whether their business will scale similar to Opendoor. On the other hand, we don't have visibility into Opendoor's annual performance to get a clear comparison. Notably, we need clear perspective on the details of declining Revenues for 2020.
Where More Clarity is Needed
Doing a crosswalk with Zillow is where things get a little dicey. Zillow has only recently competed with Opendoor through its Homes segment which purchases and sells homes directly via Zillow Offers. During 2019, this segment generated $1.4 billion as mentioned above, including the purchase of 6,511 homes from sellers. During this same year, Opendoor sold 18,800 homes, generating nearly $5 billion in Revenues.
But there is a discrepancy with what Opendoor has been stating on its presentations related to COVID impacts during 2020, and what Zillow's financials have provided for comparable information on the Revenue side.
Opendoor has stated that the company paused their offers during April 2020, and de-risked their Balance Sheet, BS, from $1 billion in real estate inventory to just below $180 million as of July 2020. According to the most recent information for September 2020, this has further been reduced to $150 million. This creates the biggest discrepancy with Zillow, as we have similar information from Zillow's financials, but the impact has been inverse for Revenues, and more transparency is needed for OCF for Opendoor to confirm what is assumed.
On a positive note, Opendoor has much less exposure to debt, and $1.3 billion in Net Cash, although Zillow does still have $1.8 billion in Net Cash as well.
Zillow has similarly de-risked their BS with a reduction in real estate inventory from $840 million in 2019 to $125 million as of September 2020. This essentially shows correlation between the two companies. Per Opendoor's most recent 8-K filing, they disclose BS and Income Statement, IS information, but do not provide any Cash Flow, CF details. For Zillow, their OCF has increased to over $800 million on a last twelve-month, LTM basis, equating to a 23% margin. As this has predominantly been driven by the change in real estate inventory, we would suspect that Opendoor should similarly have a substantial inflection in CFs for 2020.
However, Zillow's LTM Revenues for its Homes segment have increased to over $2 billion through September 2020. Opendoor does not provide a similar comparable here, but does disclose that the company has generated $2.3 billion in Revenues for the first nine months of 2020. During these same nine months, Zillow has generated $1.4 billion in Revenues respectively, reflecting an increase of 85% from the same period in 2019.
Opendoor has disclosed that the company is expecting around $2.6 billion in sales for all of 2020, an approximately 44% decline from 2019. Zillow is tracking to exceed $2 billion for the year, bringing both companies into nearly parity. As Opendoor had more real estate inventory than Zillow, the de-risking alone is not a clear indication as to why Zillow's Home segment Revenues are growing, while Opendoor is seeing a steep decline.
We do know that as of the last quarter Zillow still has one-third of its Home segment generated off-line. There is still revamping that Zillow is doing to improve its online-focused developments for the future. From a margin perspective, Opendoor is financially superior with its online-focused model. Judging form the inverse relationship, we can deduce that Opendoor's exposure to the online market has had a more severe impact to its Revenues. But we don't have the specifics on this, and it will be an important topic of discussion for the company's first earnings report as a public company.
Despite some confusion and lack of visibility, there is one thing for certain. Opendoor is in the fastest growing aspect for the real estate TAM of $1.8 trillion. They are ahead of Zillow, but Zillow will aggressively look to compete, others will likely follow. I like Opendoor's niche focus and opportunity to continue to build cross-selling products versus Zillow's transition risks, and legacy business priorities.
We are in a very strong real estate market and Zillow's core IMT segment was up only 7% from 2019 through September 2020. This is the most profitable part of the business, and the swings of building real estate inventory can substantially reduce positive OCF, causing the need to consider debt to fund future growth.
While Opendoor faces similar risks, the company is more lean, and margins are in a much better position. The decisions to reduce offers, de-risk and maintain margins was a good move. I suspect that for these reasons, Opendoor will continue to outperform Zillow's growth for home offers. However, once more financial information is provided over the next year, we will have better visibility.
I remain committed to Opendoor as the best way to get exposure to the real estate market over the long-term, especially for an aggressive growth investment opportunity. I will look to begin building the position as a higher weighting when the stock drops back below the $25 per share level.