For all of 2020’s economic chaos and woe, this year has been a good one for IPOs and potential investors. The last few years saw companies like Uber (NASDAQ:UBER) with little more than a fancy idea go public and raise billions on a hope and a prayer. But this year has seen profitable companies which have an actual path to success attempt to launch an IPO, such as Jamf (NASDAQ:JAMF).
Now Rocket Companies (NYSE:RKT), the parent company of Quicken Loans, seems set to follow that pattern with the largest non-SPAC IPO this year. According to the Detroit Free Press, Rocket plans to raise up to $3.8 billion by selling 150 million shares at a price range of $20 to $22. The IPO represents about 8% of the company’s total value, which is around $40 billion.
That sounds like a lot; and there is a great deal to like about this company and its IPO. Rocket Companies is in a great position to take advantage of trends created by the coronavirus. It has good financial numbers, and its valuation is reasonable. Right now, this looks to be one of the best IPOs of the year.
Rocket Companies and COVID-19
Rocket Companies is the largest mortgage originator in the United States. According to its S-1/A, its market share in the $2 trillion U.S. residential mortgage market has risen from just 1.3% in 2009 to 9.2% in 2020. Rocket attributes its success to its technology including its online platform as well as its powerful brand and marketing.
While those factors may help, the more fundamental reality is that Rocket Companies has consistently been able to take advantage and step in to help those who have trouble getting a mortgage. The Real Deal observed that Quicken Loans took off in the aftermath of the 2008 financial crisis as it filled in the hole left by banks unwilling to lend after that disaster.
We are looking at a similar scenario now. Thanks to low interest rates and economic turmoil, banks are imposing more stringent demands on potential home buyers, and those home buyers will thus turn to mortgage companies like Quicken. Furthermore, low interest rates will encourage more people to either buy homes or refinance existing mortgages.
That is one of the keys to this IPO. A bet on Rocket is fundamentally a bet on continued low interest rates. As a loan originator, Rocket wants interest rates to stay low to encourage more loans and refinancing. Given the current economic conditions, this seems like a very reasonable bet.
There are also other trends which should be expected to work in Rocket’s favor. The company has a strong emphasis on online lending, which was expected to grow rapidly even before the coronavirus made applying for in-person loans impractical. The fragmented nature of the U.S. mortgage market means that there is plenty of room for future growth without having to face a dominant competitor. Overall, Rocket is a company which looks to be well situated to take advantage of the coronavirus and thus has strong growth potential.
A Reasonably Valued IPO
Rocket’s financial numbers prove that it is in a strong position to take advantage of current trends. In fact, the company’s preliminary revenue estimates for the three months ending June 30, 2020 indicate a midpoint value of $5.03 billion. This is 267% higher compared to the previous quarter and 436% compared to the same quarter in 2019.
Rocket states that this particular increase is due to “generally favorable market conditions and the low interest rate environment which led to increased demand for mortgages and capacity constraints in the industry,” which touches upon the above observation that conditions are favorable for the company. And while Rocket will obviously not continue to triple its revenue every quarter, its revenue has been consistently growing since 2018. Furthermore, Rocket is the rare IPO which has a history of profitability, reporting a positive net income going back to at least 2017.
There are some concerns with the rest of the company’s financial numbers. Rocket Companies has $17.6 billion in liabilities against $21.3 billion in assets including $2.2 billion in cash, which means a high debt ratio of 0.83. And while the company has been consistently profitable, its cash flow history is weaker. Rocket Companies lost $6.96 billion in cash due to operating activities, though it was able to stay cash positive due to financing.
As long as the company can stay profitable and continue to grow, this should outshine those concerns. But that high of a debt level means that Rocket Companies has an enterprise value of over $55 billion. A quick calculation shows that Rocket Companies had an unadjusted EBITDA of $1.374 billion in 2019, which creates an EV/EBITDA of 40. If we use Rocket’s adjusted EBITDA of $1.939 billion, the ratio falls to 28.3.
These are high numbers and indicate that Rocket Companies should seek to improve its profitability in the future. But if we use EV/revenue instead with revenue defined as the 12 months ending on June 30, 2020, then Rocket Companies has a ratio of around 5.5. That is a key point to understand with this IPO. While Rocket will not sustain the growth it enjoyed in the 2020 2Q, even maintaining that level of revenue and profitability would easily make this company a good value.
Despite these good news, Rocket face some major challenges. Rocket is using a multiple class share structure which will keep 80% of voting power in the hands of institutional investors, most particularly owner Dan Gilbert. Investors looking for an actual voting voice in the company would thus be disappointed, though Gilbert has helped make Rocket Companies into the powerhouse it is today.
But while Rocket Companies has benefited from the economic chaos so far, there are definitely ways in which things could turn south for this company. Rocket Companies warns that an economic downturn which causes less people to buy houses or an increase in delinquencies could force the company to tap into its cash and credit lines. The CARES Act which permits homeowners to request a mortgage forbearance would also hurt Rocket Companies as well.
Still, Rocket Companies states that only 5.1% of its total serviced client loans are on forbearance plans as of June 30. If a new stimulus bill will be passed by Congress in the next week, homeowners will continue to pay mortgages. Low interest rates will attract home buyers and those wanting to refinance, and Rocket Companies has the size, history, and numbers to keep growing.
Investors should hope that Rocket Companies becomes more profitable down the future, but it is highly profitable compared to most IPOs. Given its potential under this economy, this is an IPO that investors should target at its current price.
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.