Opendoor Technologies: Near-Term Challenges, Long-Term Opportunities (NASDAQ:OPEN)

Family looking at house for sale

kali9/E+ via Getty Images

Opendoor Technologies (NASDAQ:OPEN) is a rapidly growing firm that operates a digital platform for residential real estate in the United States. The primary goal of their platform is to enable their users to buy and sell their homes online.

Due to the challenging macroeconomic environment OPEN’s share price has been on a decline since February 2021, falling as much as 86% in the last 18 months.

Chart
OPEN data by YCharts

In this article, we are going to take a look at OPEN’s latest quarterly report, published in August to understand the operational aspects and the primary dynamics of their business. Along the quarterly results, we will be highlighting a set of macroeconomic factors that are likely to have an impact on the firm’s financial and operational performance, as well as on the share price, in the near term.

Before we start, let us give a brief overview of the residential real estate market and how Opendoor positions itself in this market.

Residential real estate and Opendoor

The residential real estate is an enormous offline market, with transactions reaching as much as ~$2.3 trillion last year. At the same time, online penetration based on iBuyer (companies that use technology for online residential real estate transactions) volumes accounted for less than 1% of the 2021 real estate transactions.

The current residential real estate market is highly fragmented. 90% of the transactions involve an agent, which can make the transaction process lengthy and complex. To speed up and to simplify the process, consumers are often shifting their spending online and demanding digital-first experiences for greater efficiency and certainty.

And this is where Opendoor comes into play.

Opendoor defines itself as “an end-to-end real estate platform enabling consumers to buy and sell a home online”. The firm provides the following services:

1.) Opendoor Complete

The firm launched their Opendoor Complete service in late 2021, which brings together all of their products and services into a single, streamlined experience.

2.) Sell to Opendoor

Homeowners can directly sell their properties to Opendoor. The process is simple and seamless: Using Opendoor’s website, sellers receive a preliminary offer online. Then a virtual interior home assessment and a contact-free exterior assessment is conducted to verify the home data information. Last, a final offer is given by Opendoor, accounting for the conditions of the property.

3.) Buy with Opendoor

By using this service, through Opendoor’s app or website customers can self-tour or virtually tour both Opendoor and non-Opendoor homes at their convenience, shop for financing and submit an offer backed by Opendoor’s cash.

4.) Opendoor home loans

The home loans services is described as a tech-enabled mortgage platform for customers looking to buy or refinance a home.

5.) Title and escrow

Opendoor offers their customers integrated title insurance and escrow services through their subsidiaries.

With these services and products Opendoor aims to provide its clients and customers a better, faster, and less complex home buying experience.

After this brief introduction, let us take a look at how the firm has been performing recently, to see whether there is any demand for these products and services at all.

Starting with the top line:

Revenue

Opendoor has published quarterly results and a letter to shareholders on the 4th of August, with impressive growth figures year over year.

The reported revenue for the quarter reached $4.2 billion, representing an increase of 254% versus 2Q21; with 10,482 total homes sold, representing a growth of 201% year over year.

bar char revenue

Revenue (Opendoor Technologies)

Revenue growth has not only been fuelled by the increase in unit sales, but also by the increasing revenue per home sold, which has increased by as much as 18% compared to the year ago period.

While these figures appear impressive, looking forward, the main question becomes: is this growth sustainable in the short- and long-term?

Let us start with the short term.

Short-term sustainability of revenue growth

We believe that there are two primary catalysts driving the demand for new and existing housing units in the United States in the near term.

1.) Rising interest rates

Interest rates have a pronounced impact on the demand for residential real estate. Most of the homes purchased are financed partially with debt (mortgages).

The Fed has started increasing interest rates in 2022, to get inflation under control.

line chart interest rate

Interest rate (Tradingeconomics.com)

During the July Fed meeting, the target range for the Fed funds rate has been increased to 2.25% to 2.5%. Rising interest rates make mortgages more expensive, and with the four consecutive rate hikes this year, borrowing costs have reached their highest level since 2019, leading to a potential decline in demand for homes.

The uncertainty regarding further rate hikes remains high. The Fed is likely to keep increasing interest rates, therefore making mortgages even more expensive and home financing even less affordable, until they see a sign of moderating inflation. The recent, higher than expected increase in payroll, make the likelihood of further aggressive rate hikes substantially higher.

Several economic indicators have been actually already signalling the decreasing demand for homes, including the number of building permits, the construction spending, new and existing home sales.

line chart building permits

Building permits (tradingeconomics.com)

line chart construction spending

Construction spending (tradingeconomics.com)

line chart home sales

New home sales (tradingeconomic.com)

lien chart home sales

Existing home sales (tradingeconomics.com)

All of these indicators are clearly showing a change in trend. Home sales, along with construction spending and the number of building permits issued have been falling steadily in the first half of the year.

Opendoor has already been impacted by the rising interest rates and the declining demand to a certain extent in the second quarter. They have stated:

While we had anticipated a slowdown in the housing market from peak levels, the rate of deceleration in HPA was steeper than expected. We typically observe month-over-month HPA to be zero or slightly negative in the back half of the year given housing seasonality. In contrast, the speed with which it got there this year from peak levels early in Q2 was faster than our expectation and sharper than typical seasonal home price declines. For example, we saw one-month HPA (non-seasonally adjusted, weighted by Opendoor’s markets) move from approximately 300 basis points per month in early May to negative 100 basis points in mid July. We are beginning to observe a flattening out of the month-over-month change in HPA and may continue to see HPA trend in line with normal seasonal patterns for the remainder of the year.

In our opinion, the headwind created by the rising interest rates is likely to remain meaningful in the near term, potentially negatively impacting the financial and operational performance of OPEN for the rest of 2022. This could also create further downside risk for shareholders of the firm.

2.) Consumer confidence

Consumer confidence is often defined as a leading economic indicator, which can be used to predict changes in the consumer spending behaviour in the near future. Consumer confidence is dictated by several different factors, including inflation, energy and fuel prices, the geopolitical situation.

Inflation has been steadily rising in 2022, along with energy and fuel prices. At the same time, the geopolitical tension between Russia and Ukraine has also escalated, while the U.S. – China relationship also seems to be deteriorating.

As a result, consumer confidence has been steadily declining in 2022, even falling below levels that were observed during the financial crisis in 2008-2009.

line chart confidence

U.S. Consumer confidence (tradingeconomics.com)

A low consumer confidence is an indication that people are becoming reluctant to spend larger sums of money. They are likely to start saving more as they feel that their financial outlooks are getting worse. Such a behaviour could lead to reduced spending on durable, discretionary, non-essential goods. Buying a home is also likely to be delayed to a later date when the macroeconomic environment may be more favourable for. potential homebuyers. As a result, the demand for homes is likely to decrease.

Long-term sustainability of revenue growth

To get a feel for the long-term sustainability of revenue growth, we will take a look at demographic trends.

The following chart shows the age distribution and its change in the United States over the last decade.

table age distribution

Age distribution (Ben Carlson – awealthofcommonsense.com)

Two age groups are important to point out here: 30-39 and 60+.

A study has found that the average age of first-time homebuyers is 33, which falls in the category of 30-39. This age group over the last 10 years has seen a more than 4% increase and as of 2020 about 13.6% of the U.S. population fell into this group. We believe this could be an indication that the number of potential first time homebuyers has increased, which could result in an increasing demand for homes in the years to come.

On the other hand, people after retirement are likely to be downsizing and moving into smaller homes to lower their costs of living.

pie chart downsizing

Downsizing vs. Upsizing (retireguide.com)

The downsizing trend is also likely to lead to increased number of transactions, potentially turning out to be a positive catalyst Opendoor’s business.

Net income and adjusted EBITDA

Moving on from the revenue and demand side of the analysis, potential investors also have to understand the profitability of the business.

bar chart EBITDA magin

EBITDA margin (Opendoor Technologies)

Adjusted EBITDA reached $218 million in the second quarter compared to $25 million in the same period a year ago. As a percentage of revenue, adjusted EBITDA reached 5.2% in 2Q22, in contrast with 2.2% in 2Q21. The growth was primarily driven by the outperformance on unit margins, which provided incremental leverage against the firm’s operating expense base.

bar chart net income

Adjusted net income (Opendoor Technologies)

GAAP net loss was ($54) million in the second quarter, compared to a loss of ($144) million in 2Q21. As a percent of revenue, GAAP net loss was (1.3%) in Q2 in contrast with a net loss of (12.1%) in the year ago quarter. Adjusted Net Income reached an all-time high of $122 million (2.9% of revenue) in Q2, versus $3 million (0.2% of revenue) in the year ago quarter.

In our opinion, despite the challenging macroeconomic environment, OPEN executed well in the second quarter of 2022. The firm has managed to grow their revenue, along with the adjusted EBITDA and net income, leading to improved profitability. Also, important to mention that the firm has ended the second quarter with $2.5 billion in cash, cash equivalents, and marketable securities. It also had $11.3 billion of financing availability across non-recourse, asset-backed facilities. The availability of cash and financing is especially important in the current macroeconomic environment, in order to maintain financial flexibility, which has been also pointed out by the firm:

We believe that our financing structure, combined with our strong cash balance, provides us with significant financial flexibility and liquidity to support our inventory levels and navigate this period of macro uncertainty.

Guidance

To react to the rapidly changing market environment, OPEN has taken 3 key decisions in the first half of the year, to optimise their financial and operational performance in the second half. These decisions were:

1.) Substantial increase on the spreads charged on acquisition offers starting in May

2.) Adjusted down listed prices on inventory to stay in line with the market, leveraging real-time market signals paired with home-level pricing optimization

3.) Persisted with substantially higher spreads for new acquisition cohorts

As a result of these pricing decisions, the firm’s guidance is the following for the third quarter of 2022:

  • Revenue is expected to be between $2.2 and $2.6 billion

  • Adjusted EBITDA is expected to be between ($175) and ($125) million

  • Stock-based compensation is expected to be in the range of $60 to $65 million

We believe that the current macroeconomic headwinds are likely to be temporary and OPEN is well-situated to tackle the challenges with its newly implemented pricing and strategic decisions, and to eventually address a growing online housing market. While risks are inherent to any investment, both in the short- and long-term, in our view Opendoor could be an attractive addition to a growth portfolio.

Valuation

Valuing firms with limited or no history of demonstrated, stable profitability is often challenging, requiring a large number of assumptions with relatively high uncertainty. Opendoor also falls into this category.

We will be elaborating on two techniques in our article to determine the fair value of Opendoor’s stock.

1.) Price-to-sales ratio

The price-to-sales (P/S) ratio is a valuation method that compares a firm’s stock price to its revenues. It is an indicator of the value that investors have placed on each dollar of a company’s sales. While it is easy to compute and is widely used for technology firms, which do not yet have positive earnings, it completely ignores the fact that the firm may never achieve profitability.

chart p/s ratio

P/S ratio (Macrotrends.net)

The P/S ratio of OPEN has been steadily declining along with the declining stock price. As the share price have fallen more than 80% in the last 18 month, the valuation of the firm, from a P/S point of view, became significantly more attractive. Opendoor’s price-to-sales (TTM) ratio is 0.23x. This ratio by itself, however, is not meaningful. The following table compares the valuation metrics of firms in the real estate services industry.

table valuation

Valuation metrics (Seekingalpha.com)

Based on the P/S multiple, OPEN appears to be one of the most attractive firms from a valuation standpoint as its P/S of 0.23x is about 50% below the industry median of 0.49x.

Due to the limitations of this approach, we decided to calculate the potential fair value of the firm using a discounted free cash flow model.

2.) Discounted free cash flow model

In short, this is a method of valuation used to determine the value of an investment based on its return or future cash flows. The main advantage of the model is that it projects a series of future cash flows or earnings, which can capture the growth potential of the firm, and then discounts the cash flows for the time value of money.

For our evaluation, we have created three scenarios, to determine a range of fair values, using conservative and aggressive assumptions for growth.

The following table and chart summarise our free cash flow assumptions for the next 5 years.

table fcf forecast

FCF forecast (in $mln.) (Author)

line chart forecast

FCF forecast (Author)

The appropriate discount rate can be sometimes tricky to determine. We often prefer to use the company’s weighted average cost of capital. Opendoor’s WACC is estimated to be in the range of 10.25% to 12.50%. For our calculations we will be using a discount rate of 11.5%.

WACC table

WACC (finbox.com)

Using the forecasted figures, while assuming a perpetual growth rate of 2.5% beyond 2027, combined with a required rate of return of 11.5%, results in the following range of fair values:

table fair value

Fair value range (Author)

Due to the high uncertainty of the forecasts, we always recommend subtracting a margin of safety to the calculated fair values. We decided to use a margin of safety of 25% in this case, resulting in an ideal entry price range of $1.6 to $12.4 per share.

According to this approach, OPEN’s stock also appears to be fairly valued at the current price range with substantial upside potential.

We believe that due to the attractive valuation and the long-term housing market dynamics, the company could be an interesting long term investment opportunity for growth investors. Before investing, however, be aware of the short-term macroeconomic headwinds mentioned before that could negatively impact the stock price in the near term.

Key Takeaways

Opendoor is a rapidly growing, small-cap, technology firm that operates a digital platform for residential real estate in the United States, enabling users to buy and sell their houses online.

While the firm’s revenue has been increasing fast, the current macroeconomic headwinds are likely to slow the growth in the near term. Declining consumer confidence, declining number of existing and new home sales, declining construction spending are all factors that are indicating a weaker demand for residential real estate. In the long term however, we believe that the demographic dynamics in the United States, and the gradual shifting of the housing market from offline to online, are likely to favourably impact the demand for homes and for Opendoor’s services.

After a more than 80% decline in share price during the last 18 months, we believe that OPEN’s stock appears to be attractive from a valuation point of view. However, keep in mind that a large number of assumptions needed to be defined in order to estimate the fair value. These assumptions can be highly uncertain and the firm may never even become profitable.

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