Chit Chat Stocks - Opendoor (IPOB) | Deep Dive

Episode Date: November 12, 2020

Opendoor has gone public through a special purpose acquisition company with the ticker IPOB. Opendoor is meant for home sellers. Opendoor asks a few questions about the home then gives the seller their offer. Ryan will dive deeper into what Opendoor does and how they make money (1:05). Brett will explain the industry and competition (5:19). Then Ian will dive into the management team (7:07). Enjoy the episode! Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/  Follow Ian and check out his work on Twitter: https://twitter.com/IanGrayLive  Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney  Subscribe to Chit Chat Money on Youtube: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. welcome everyone this is the deep dive episode on thursday we're talking ipob today uh it's actually the open door spac we'll explain how everything works but i'll toss it over to ryan because you are heading down to head over with our colleague ian to meet in person right yeah

that's right we are uh i think we're golfing nine holes i don't know i if i were a betting man i think i'd bet on me yeah we'll see we'll see it's my home course so we'll have to see how it goes i may have a little advantage here but we'll see yeah home field advantage that that'll uh adjust the betting spreads but we're talking uh ipob it's really open door uh ryan do you want to get into the company yeah so ipob is actually one of chamath chamath polyhapitia if you don't know who chamath is uh it's one of his spack operations so uh we're kind of on a spack i don't know thread here we've done what's our second one in a row yep um but social capital is the backer of this and that's his like big fund and this SPAC specifically is called social capital head

of Sophia am I getting that right yeah they get a weird name Sophia holdings too yeah it's like social but I just called social capital too right and so they entered into an agreement on September 15th 2020 to combine with open door through a stock and cash financing that would value the company at an enterprise value of 4.8 billion dollars or one times 2019 revenue um so for anyone that doesn't know what Opendoor is, they are attempting to reinvent the real estate transaction, which that's basically what they said. They're, you know, they're taking real estate and trying to digitize it. And so they're offering an on-demand digital experience of buying or selling a home. So on the selling side, through a few clicks of a button, you can tell

Opendoor about your home to instantly see an estimated value. That part is free. So you get an estimate and then they can work with you to schedule a virtual assessment of the home. So after the assessment, Opendoor shares their final estimate of what they would give you directly in cash for the home, or you can list with a top agent through them. However, they do take a service charge that typically falls between 5% and 8% and never goes higher than 14%. So this isn't really, they're not reducing friction on the payments or the commission side as much as reducing friction on making sure you have a buyer so the demand is there and then also the time sensitivity part so if you have to sell and you're moving and you just don't want to

deal with how long it takes with the traditional broker they allow you to do it pretty quick and they give you an all cash offer based on whatever their intrinsic estimate is in that market so they measure the sales of the homes around your area and then they're like yeah this is sort of what we think it could go for and that includes them sort of repairing and changing the house in whatever way they need so once they purchase the home they refurbish it take on the necessary maintenance and then they list it on their app and on the buying side it's really easy you just use their app find a house you like then you can walk in from 6 a.m to 9 p.m and tour the house without scheduling an appointment so that's nice yeah they they really facilitate the entire

transaction and their I guess their margins or where their business really makes money is that the fees that they pay Opendoor as a seller because they're able to take that house change it a little bit and resell it and then history about the business Eric Wu is the CEO and Ian Wong was the CTO they co-founded Opendoor in 2014 apparently Opendoor was originally Keith raboy's idea but he was a vc working at coastal ventures at the time and he wasn't able to start it himself right which i mean i don't know if you've ever followed keith raboy on twitter but he's always retweeted by the vcs congratulating themselves account um and maybe he just comes off bad on twitter but apparently it was really his idea so eric woo uh was looking to coastal

ventures to raise funding for his old business which was like movity or movity and it got bought out by truly eventually but uh keith raboy was working at uh coastal ventures at the time and he said like he told him stop this you don't you don't want to do this business you want to do my idea open door i need you to be the ceo and actually after he sold his business to truly eric wu did start open door and keith raboy was one of the first to back it but because keith that boy's name was involved in the project vc dollars were just flowing in yeah and we poke fun at uh keep there because he's always on vcs congratulating themselves but he does that have reputation for being a strong vc investor so you know that probably allowed them to get all the

capital they need for this large business i'll get into the industry landscape and competition industry is registered residential real estate which everyone knows is a multi-trillion dollar business however brokerage commissions are estimated to be about 164 billion dollars and dropping, likely because of some of these iBuying people. So the commissions and the fees with this business is probably upwards of $100 billion. And that is what Open Door is going after. The main competitors are Zillow and Redfin, although there are a few others. Amazon announced they're trying to do something with this. I think there's Compass, not sure what they do, but I'll explain what Zillow and Redfin do as a comparison. So Zillow started out as that

online real estate marketplace but it's pivoted to copy open door a little bit they're trying to aggregate all that supply and demand where Zillow has the eyeballs I think like two billion website visits a year something along that lines they want to use that marketplace as their advantage to try to do this eye buying thing because I think they saw open door growing so rapidly and that was kind of the next phase of digital real estate and then Redfin is a competitor that aims to lower commissions that are charged typically there's i think the three and three as they call there's three percent on one side of the buy and three percent on the other which is high if you're selling you know a million dollar home that's what sixty thousand dollars

taken off that's a lot of money um and they hope to reduce those commissions with internet scale they still use physical uh people real people as brokers um sort of you know redfin agents as they but they get paid differently and they use the internet scale to hopefully decrease margins. That's their competitive advantage. But all these companies are likely going to converge on the iBuying opportunity over time. They're all competing with each other, but just in different ways. They're all trying to go out about it in a different style. And then Ian, you have management and ownership. Yep. So like you mentioned, Ryan, Eric Wu is the CEO and co-founder. Ian Wong is the cto and co-founder um they also you were mentioning keith um they also have this impressive

silicon valley management team though they've got people part of the management team with experience ranging from trulia amazon airbnb netflix yahoo yelp square pretty much any great silicon valley company over the last 10 years they have someone from that company so it's just it really has the buy-in of silicon valley and i think there's a lot of people in that part of the country who look at this and say, wow, what a massive market. Look at how inefficient it is. Let's go in and fix it, basically. Another thing to note about the management team is they see contribution profit as basically the key measure of their unit economic performance. And so I'd expect that to continue after the merger, that that'll be a number that they throw around a lot,

and it'll be important to understand what that number means. So typically, contribution margin or contribution profit is sales minus variable costs. And that gives you your contribution margin. In this case, what that means for open door is that it's adjusted gross profit minus the holding costs of properties and direct selling costs. So pretty much their contribution margin is going to equal whatever they sell the house for minus whatever it took them to buy the house repair the house and hold the house before reselling it that's usually really slim right like one percent yeah they they're looking historically it's been somewhere between one and four percent um for the fiscal year they're hoping that that's going to grow a little bit over time and maybe

reach levels of you know four six you know maybe even eight percent over long periods of time um to dive into the ownership a little bit i'm going to just clarify this term too if you're not familiar in these SPACs they talk about pro forma ownership which means the ownership following the merger and so after the merger this the ownership structure of this SPAC is supposed to be 9.5 percent what they call pipe investors which are private investments and public equity and so those will be large funds who basically get an extra shot to invest in this that and that don't have to invest through the SPAC and so that's going to be about 9.5 percent of this company. About 6.6% is going to be the iPod shareholders.

So the people who have bought the SPAC so far and the remaining 80% is going to be existing open door shareholders. So like I said, the SPAC only, the current SPAC only owns about 6.6% of the combined entity. One thing to another couple, just some of the key insiders, Chamath will own about 4.1% of the combined entity. Eric Wu, the CEO will own about 6.7%. Ian Wong, the CTO and other co-founder will own about 1.3%, which means the total kind of management ownership is about 8, 8.5%, which is a bit lower than I would like to see. But especially with Eric Wu owning 6.7%, it's still a significant

portion of the company. So they still should be aligned with shareholders. Right. And then that 4.1% from Chamath Paliapati would be through that pipe, right? Am I getting that correct yes it's through it it's not technically in that pipe number but it's also not coming out of that ipob shareholders it's um is it just part of the merger it's part of the merger yes okay okay just know that post all this complicated stuff afterwards this is what the ownership will be that's i guess what investors exactly there's a lot of there's a lot of like spax make it simple in one sense but they also kind of bring in money from all these different places and they have to adjust all the shares for people who've gotten shares over all the years

working for the company and then bringing in these new shareholders and so it just it gets a little bit messy yeah i'm a direct listing guy myself but uh i'll get into the valuation strike price ten dollars a share uh for the merger so make sure you reference that when you're looking at ipob shares because right now they're at 1788 so that will convert to an enterprise value of what ipob shareholders are getting at about $8.6 billion, if I'm getting that correct. So you're not actually investing at the enterprise value of what the SPAC is going to be at that Ryan mentioned earlier. If you're buying the shares in the open market, the valuation is $8.6 billion. The EV to sales then looking at the last six months, which have been affected by COVID. So they're a little

dampened is about 2.15 and that's trailing. That should come down over time. But again, their EV to gross profit is close to 30 on a trailing basis. So that shows that gross margin level is really low. It's tough to do any sort of valuation numbers on the sales growth and anything because they did have that decrease when they lowered their supply because of the shakeup with COVID this spring. But gross profit growth really is the number to look at. It's almost like they have to put uh their gmv number on their uh gap statement and in reality gross profit is the revenue they're getting in and then contribution profit is almost their gross margin number right would you guys agree yeah and that i mean that can go right into my earnings which so their

fiscal year 2019 revenue was 4.7 billion and that was up 158 percent from 2018 now there's been a big adjustment due to COVID in 2020. So I'll get into that in a second, but the gross margins on that were 6.4%, which seems incredibly low, but think about it. Like if you've ever looked at squares earnings, now they have to record Bitcoin trading as revenue. It's just volume being recorded as revenue. Like the sale of a house, it's really not like they didn't just build the house and sell it. They had to buy it right before and then sell it. So it's basically of the transaction volume that's going through there. So gross profit, like Brett said, is the number to pay attention to. They had $248 million in operating losses for 2019. The losses before

taxes was $338 million. In 2019, they sold almost 19,000 homes, now operate in 21 markets across the U.S. But for the first nine months of this year, revenue was down 33%. Gross margin was a little higher at around 7.8% than the year prior, which I guess is good to see. And then operating margin in 2019 was negative 5.2%. The first nine months of this year, it's been negative 8.2%. Not the direction you want to see it going. And then there was less homes obviously sold this year due to COVID. And so it's been heavily disrupted. I mean, do you want to expand on that a little bit? Yeah. I mean, they had to stop buying homes to increase their supply. I think they were worried about that. And then I believe they stopped selling homes. Am I correct on that, Ian? Or I think they may have, I don't know, they stopped one form, one end of their supply and demand curve, and that made sure they had to pause things. yeah yeah I can dive into that right now because I'm gonna get into the balance sheet so

one of the big things they tried to do when they entered COVID is they had about a billion dollars in inventory on their balance sheet and that's houses that they'd bought but not yet sold and they saw that especially when COVID hit as being pretty risky and so they said we're going to stop buying houses we don't want any more on our balance sheet and we're going to try and start moving those houses off of our balance sheet and go ahead and sell them which probably meant they don't really explicitly say this, but probably meant they were taking slightly lower prices than they necessarily would have initially wanted on some of those houses. So they lowered their inventory number from about 1.1 billion down to 150 ish million in inventory on their balance

sheet over the last six months. And so that's been just a really impressive de-levering of the balance sheet, making it a little less risky. So they want to be wiped out by a really strong lack of demand in house buying. And I think it's turned out that house buying actually hasn't gone down as much as people expected to at the beginning of COVID, especially with people maybe looking to get out of the cities and move to the suburbs, things of that nature. And so who knows exactly whether that was the right decision or not, but they definitely de-risked the balance sheet. Post-merger, they're going to have about $1.5 billion of cash on the balance sheet. And so it should be plenty of money to continue to buy houses, enter new markets,

ramp up marketing spend, all that type of stuff. And they only have about $300 million in liabilities. So a net cash position, plenty of liquidity, and really a strong looking balance sheet. Right, right. And we're going to hit the ad break. But before we do, we got to mention, as always, our seven investing sponsors. Ryan, do you want to talk about the partnership we got going yeah so um we do this every show but we have a coupon code ccm with seven investing who are now our partners and you guys are probably familiar with them if you've listened to our show before because they come on all the time but their offering is seven picks uh for seventeen dollars a month you get ten dollars off if you use ccm uh for your first month so i don't know i mean

and they invest similar they invest similar yeah they invest similar ways to us uh they're long term oriented uh they're buying hold uh you know price matters to them all that stuff they have all their actual things if you look at their website but yeah check it out with our promo code cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply

all right welcome back first up is competitive advantages who wants to go first ryan and sure i'll go first yeah so the digital first model presents some lower overhead costs um so If you have an Opendoor account and you're interested in a home, you get basically an access code through Opendoor to go to the house at any point from 6 a.m. to 9 p.m., and you just key in your access code, and you get to see the house. You get to tour it without having someone that Opendoor has to pay to give you a tour at a certain time. Obviously, that's just lowering expenses on Opendoor's side, much less overhead costs, as opposed to Redfin, where Redfin has to pay agents to tour houses for people. bit of a competitive advantage there yeah all right yeah and what do you got yeah i've got something somewhat similar to that but especially compared to the traditional house buying process and house selling process they're a vertically integrated platform and so it allows you to really

just sell your house and not have to worry about coordinating everything whereas with the traditional thing you're having to track down a realtor you're having to track down you know your financing um you know someone to do the repairs and you're having to manage that all yourself. Open door kind of keeps that all in one place, gives you just one flat rate. This is what you're going to get at the end and just makes it simple and really reduces the complexity in a fairly complex industry. So I think that's just a big competitive advantage, especially compared to traditional realtors. I think that's less prevalent with some of the other iBuyers, but compared to traditional realtors, they definitely have a competitive advantage.

right right and then for me i i didn't think they really had any strong ones currently but i think the economies of scale can work here that that does include the things that you talked about ian and a little bit of what you talked about ryan and then the digital efficiencies should help although i don't think it's as strong as a lot of other industries you know they claim they can make it just because it's online it can be you know 100 better i don't think it's like how netflix was to cable it's not going to be that a seamless transition there's a lot more friction that's still going to be there i think in real estate there's just a natural level of friction no matter what yeah like you can't get rid of all the friction in the process or else a company will

probably end up losing a lot of money if they try to yeah so yeah you're right it's definitely not totally upending the industry but uh future growth opportunities what do you have yeah i can go i said insurance attachment um it feels like all our future growth opportunities are either going to be just expand or do some add-ons right to their thing because they're trying to make it very simple but then have everything integrated into one spot so insurance seems popular uh their partnership with os national or actually they bought them out in 2019 that's an escrow company so i think that's part of the real estate process we're going to put some things in escrow there's some insurance associated with that. These are ways they said they can increase their gross

margin to nine plus percent and hopefully get that contribution margin into the three to five percent range. These won't be as high of revenue numbers for them, but they're going to be a lot higher margin than just buying and selling a home. Yeah. Ian, what do you have? So my future growth opportunity is more markets. Currently they're only in 21 cities and Phoenix, my home, is actually the city where they have the most market penetration and that's only four percent and i've never actually heard of anybody buying a house on open door so plenty of room to grow they've got you know people buy and sell houses all around the world and they're only in 21 cities so it should be plenty of room to grow if they can nail that process and the unit economics

and i think it also something they say and something you've touched on there brett is over time they find that their contribution margin and gross profit number goes up and so currently we were talking a lot about how gross profit is going to be the metric we really want to follow and some of them when they add new cities it's going to be natural for that average gross profit to come down a little bit and so it's going to take some time for them so once they get into a city to build the right team out to understand the market correctly so they can actually start growing that gross profit right right okay ryan last one here also to note i like that strategy it's sort of the uber strategy of get go city by city i'm sure zillow is doing the

same thing but i kind of like that better as sort of just a land as opposed to just going and branching out into the entire country yeah but uh my growth opportunity is home loans this product was launched in 2019 and it has no loan origination fees this seems like a logical next step if you're buying a home through Opendoor. You can purchase a home with as little as 3% down. Oh, that's low. That's very low. Yeah. And that creates some risk. But like Ian said, they're keeping everything in house. So from the sale to the maintenance, to the tours, to the purchase, to financing the home and to potentially insurance, like you said, it's all done through Opendoor. And I think that that

bodes well for them in the future. Yeah. That's how they provide the value where it increases efficiency, it reduces friction, saves people time. That's the value they're going to be able to provide. And hopefully that's how they get that 5% to 8% fee. But we have our last segment here, highlights and lowlights. Ian, do you want to go first? Yeah. So like I mentioned earlier, I think the vertical integration, huge market, but particularly this backing from Silicon Valley, this can be great for companies. I think sometimes there's obviously examples of companies that were backed by Silicon Valley that don't pan out, but they're able, they're being able to attract a lot of talent and investment right now, which I think bodes well for the

future. It gives them just a real headstart and trying to capture this market. My low lights kind of center around that too, though, is that this competition, it's a market that a lot of people are starting to go after, whether it's Zillow and Redfin, other startups like this, who are really focused on the iBuying process. And so they have not yet reached that point where they're synonymous with iBuying. Like I said, I've never met anybody who's bought through Opendoor. I don't know if either of you have, but it's not like that's just the clear favorite to go through your iBuying process yet. And so it's possible that they'll never reach that kind of ubiquity status. And I think one of the things that also makes it hard for iBuying in general

is that many homeowners are older buyers, less confident in internet purchases. There's this large kind of inborn just familiarity with the current real estate process, even though it's long and hard, but there's just with a purchase this big, I think some people are a little bit afraid of actually doing purchases like this over the internet. Yeah. If this shift is going to become to majority iBuying, it is not going to be overnight. It's probably going to be a 10 to 15 year process. And it feels like there's a small amount of people that are actually, maybe I'm wrong but when you're selling a house it feels like a big like a big moment that you want to take your time with and not do wrong yeah as opposed to like all right i gotta get this off

my books now and that's sort of what open door thrives on is like people that need that are time sensitive yeah and it could be people that own like 10 houses or something you know you're kind of a real estate investor in that type of way but that's not the majority of people yeah what do you economies of scale are needed here. And I think that's really important. So they have the capital to do that. So Opendoor has all this investing. And like Ian said, they have the access to the capital. They're not capital constrained. And that's, it might be the most important thing here because you have to ride the wave of maybe the housing market dipping. You got to be able to pull in supply, decrease or increase demand, all that type of things. You need that margin of

safety there low lights for me i do have a lot low margins concern me um that's just a standard thing that you'd rather have high margins than low margins um it's influenced by the housing market a lot so there's things that they can't control that could hurt their business so even if management is firing on all cylinders the housing market takes a turn open doors business could be screwed uh and i don't think they have much of a differentiation and they have tons of competitors so i honestly think zillow might have a competitive advantage because they have you know like the billion plus clicks or visits to their website every day um they're able to market the eye buying process from zillow for people that are checking this estimate all the time i mean

that's the standard for looking at housing prices is zillow even if opendoor can create a competitor to that it might be a little harder than zillow coming in and competing with opendoor yeah i agree with all that. I guess one of the only highlights that I would have is that Chamath has a pretty solid track record. And that sort of gives a level of comfort to a lot of investors that we've seen. This is also a home run play. So let's say it, you know, you make it one or 2% of your portfolio and it works out. It's a huge winner. It's not like it beats the market by 1% over five years. So it's got a massive TAM and if it does work out, it works out in a big way. However, it feels just really risky to me. And they do have so much Silicon Valley involvement that it

kind of worries me. And like the whole venture capital motto is move fast and break things. I'm not sure that's a good motto in real estate. And on top of it, it's not like people say well it's like your margin is my opportunity like no this is just low margin business and in order to create a bigger opportunity you have to go even lower margin than that like you're going you're either losing a whole bunch of money or to go after a bunch of volume that just doesn't seem like it seems like it could go wrong in a big way yeah there's a lot of tail risk here yeah it's not something that yeah people i mean we know like the real estate market goes down, they're levered up 10 to 1 with all the loans that they originated. They haven't

gotten to that point at all. But if they have that high leverage market tanks, that's a lot of obligations they got to fulfill if they're not able to sell things for even 80% of what they bought them at. There's a reason this industry moves slow. And just going after it with a bunch of VC dollars just seems explosive. Yeah, definitely. All right. Last question. Are we more or less interested in Opendoor? Ian, I'll let you join back in. I'd say I'm slightly more interested. I think a lot of the points that Ryan just brought up were great. And I think it's a huge TAM, but also concerning just about all the things that could go wrong. And as he was touching on in the end, they don't really have people in their management

team or on their board that, at least from what I can tell, that have much real estate experience. and you might be able to look at that as a good thing but um it might be nice to have one or two people in there who really have done real estate before and to understand the market and are starting to um starting to kind of shift the shift the mindset of the people investing in it yeah because i mean netflix brought in a bunch of people from hollywood you got to have a mix of like the people that are trying to disrupt this industry but you also want to know all right what they didn't this was a big industry for a reason you know what were the things that we should do um i'll i'll do mine i'm a little less interested i'm kind of 50 50 on open door i think

it could you know again it's a high risk high reward opportunity but it's not something i would typically look at um i guess that's it yeah we talked about all this stuff before yeah i'm i'm less interested um just if i'm going to invest in a real estate space it this feels super aggressive i don't mind this sort of aggressive type growth from zillow because they have a backbone of another revenue generator and the same with redfin but if you just go after it like this it feels like it could backfire in a big way and so maybe that's a little too much risk for me so i'd say i'm less interested yeah all right well that's going to do it for this episode remember to use our promo code ccm if you want to check out seven investing subscription service we have the link in

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