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Opendoor V. Zillow

Updated: May 17, 2021

1 Thessalonians chapter 5 verses 16-18 state, "Rejoice always, pray continually, give thanks in all circumstances; for this is God's will for you in Christ Jesus."


It's always easy for me to praise God when times are good. Far too often, I get caught up in negativity or unhelpful thinking when times are rough or uncertain. It is during these times that I must let go of my frustrations, usually resulting from a lack of control or "my perceived way" being negated, and to rely on God's truths - Jesus Christ is Lord.


I find this verse very relatable to what I've been dealing with regarding the portfolio's position in Opendoor Technologies (OPEN). Just because things aren't working out well right now, is no reason to cry foul, or worse yet, lose focus on the future potential.


As such, here's my two cents on Opendoor now that earnings are out vs. Zillow Group (ZG). This is all on a last twelve-month, LTM basis and specific to Zillow's comparable Homes segment.


Zillow

  • Homes Revenue: $1.64 billion

  • Homes Revenue Gross Margin: 7%

  • Number of Homes Sold: 4,908

  • Real Estate Inventory: $472 million

Opendoor

  • Revenue: $2.1 billion

  • Revenue Gross Margin: 10.9%

  • Homes Sold: 7,467

  • Real Estate Inventory: $841 million

Summary

What we know from Zillow's performance last year, is that about 66% of their Homes Revenue was digital so the company is still in the process of converting the model entirely to ibuying. That being said, Opendoor did see a substantial drop, more so than Zillow on a quarter-over-quarter basis; for Revenue and Homes sales in Q1 2021 - 40% and 50% declines respectively versus Zillow's 9% and 18%. But Opendoor did crush Wallstreet estimates by 20% on the top-line, and beat Zillow's entire Homes Revenue segment performance during the quarter at $747 million versus $704 million. I would assume that 25-33% of Zillow's Homes segment is still non-digital, meaning that Opendoor is still likely about 40% higher on their top-line for the quarter.


Opendoor's guidance for Q2 2021 sits at $1.05 billion at the mid-point, 42% higher than Q2 2020., and 15% higher than initial Wallstreet estimates All-in-all I'd say it was a very strong quarter, it was measured against Opendoor's pre-pandemic peak in Q1 2020.


The key moving forward is to recognize that Opendoor will need to continue to purchase homes as inventory as part of its business model. In fact, in Q1 2021, Opendoor purchased 24% more homes than last year, despite selling fewer homes by 50%. This had a significant impact on Operating Cash Flow, OCF, as Real Estate Inventories in one quarter witnessed OCF drop from $682 million in 2020, to ($159) million on the LTM with ($855) million stemming from changes in Real Estate Inventories. The question remains, at what scale will Opendoor be capable of consistent OCF. It may take some time, and the company will need further capital infusions to grow Homes in Inventory. Zillow will face the same challenge, and how real estate cross-selling tools for both home buyers and agents will likely continue to evolve over time.


I continue to invest in Opendoor as it is poised to lead the fastest growing segment for digital real estate's future. From Zillow's perspective, I see two risks that have emerged - 1) Zillow will continue to need to digitize its Homes segment 2) Zillow will inevitably need to further distinguish its IMT services and Homes segment, potentially into an updated platform, as Opendoor is likely to build products and services from its platform over time.


From a valuation perspective, Opendoor trades at a discount of just below 50% to Zillow from an EV/Sales multiple, at nearly 5 times. I view this as a conservative multiple to value Opendoor on over the mid-term. Opendoor's ambitions are to strongly penetrate the housing industry through ibuying. As such, the company is on a trajectory towards $20-30 billion in Revenue over the next 5-7 years. This equates to a Stock Price, SP approaching $200 per share based on 5 times EV/Sales.


Follow-Up Notes to Consider

I was thinking about a housing pull-back as I wrote, but I think it's always prudent to weigh the short- and mid-term accordingly. We could view Coinbase similarly, with respect to Bitcoin and Cryptocurrencies being near a peak possibly.


Coinbase is a great example of how powerful scale truly is on that note. Coinbase is taking about 1.4% net of off $73 billion for retail, net transaction revenue as of 2020. Based on the net, Coinbase has an adjusted Free Cash Flow, FCF margin at 23% (adjusted after accounting for the impacts from Custodial Funds Due to Customers Operating-Financing Activities).


If Opendoor were to generate, say $18 billion in Revenue by 2025, with a 10% Gross Margin, that would be $1.8 billion. Even if Opendoor keeps its operating expenses below $1 billion, somewhere around $900 million is left over. Also to do $18 billion in Revenue, Opendoor would need to sell somewhere around 64,000 houses or more. It is going to cost Opendoor $14 billion or so to purchase those homes to sell, obviously over a period of five years, but could involve up to $3 billion in any given year.


The good thing is that there have been over 5 million home sales per year since 2012, which would only be 1% at 64,000 in a lower scenario, despite forecasts calling for 6.7 million home sales in 2022. The opportunity to scale is clear.


For me, I see a consistent increase in Real Estate Inventory and Gross Debt. As long as this remains roughly 1:1, I think that the remainder of Opendoor's operations can possibly remain Cash Flow positive. In other words, how comfortable are investors with Opendoor using leverage to consistently grow the business, as it is collateralized against inventory, restricted cash, and equity interests? I see Zillow facing the same challenge for the digital transition, and growth, so the same risks for the same competitors.


Right now, Opendoor has a Net Cash position at $1.5 billion, while Zillow is at $2.4 billion. Either company can increase cash via equity offerings, but at the same time, debt will likely increase. Zillow's Gross Debt has increased 11.5 times since 2015. Opendoor is flat since 2017.


Opendoor has already demonstrated the de-risking capabilities of the company in a challenging environment during the pandemic, which translated to positive OCF. Even during the lowest performing home sales year in the Great Recession, sales were above 4 million. Opendoor likely will be capable of de-risking during real estate downturns, especially as scale increases, and Revenues diversify. As stated above, I do believe that Zillow's IMT/mortgage segments will be at risk of competition from Opendoor and their platform over time.


As Gross Debt is collateralized for both companies, I would consider generating an adjusted FCF metric, that includes Financing Activities to offset changes in Retail Inventory and Credit Facilities, but excluding Equity Offerings. If Opendoor is able to successfully mitigate against down-cycles, ascribing to this type of metric will likely be a more stable way to measure the company's performance, but that's just me.


Using this metric, Opendoor generated ($390) million Adjusted FCF LTM, while 2020 and 2019 illustrated around ($145) million or so each year., while 2018 was ($384) million. Going back to $18 billion with potentially $900 million in Operating Income, and it is likely that Opendoor may be generating $400 million or higher in adjusted FCF by this time.


I've been looking to scrutinize how companies like Opendoor and Zillow will have a Cash Flow relationship as they scale. It's always more challenging when companies experience wide gyrations in OCF - it's usually a sign that either working capital line items are in Investing/Financing activities, or other Financing Activities have interdependent relationships with reconciliations or working capital. There's new business models, Affirm as another example in addition to Coinbase above, where investors need to really consider these relationships. Hopefully this is helpful, at a minimum, generating further thoughts discussion.

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