Compass: A Bad Long-Term Bet
Compass (NYSE:COMP), the online real estate brokerage firm backed by roughly $1.6 billion in venture funding, stated in its amended S-1 filing that it is offering 36 million Class A common stock to the public at a price of $23 to $26 per share. The initial public offering (IPO) would raise up to $936 million for the company at the top of the offer price range. After IPO, the company would have 397,925,950 shares outstanding (or 403,325,950 shares if the underwriters exercise their option to purchase additional shares of Class A common stock in full). Consequently, the company is looking for a valuation of between $9.15 billion and $10.35 billion. This will rise to a valuation of between $9.3 billion and $10.49 billion, assuming exercise of the over allotment option.
At present, SoftBank’s Vision Fund controls over a third of the company’s shares. The Canadian Pension Plan Investment Board, Fidelity, the Qatar Investment Authority and Wellington Management are other significant investors. Compass founder, chairman and chief executive, Robert Reffkin, will still hold about 45.7% of the company’s total voting power after the IPO. SoftBank Group’s Vision Fund will still hold 18.5%.
The IPO comes less than a year after the shelter–in-place downturn led Compass to lay off 15% of its staff. In September 2019, the company went through a large number of high profile exits over the previous 18 months, losing its chief financial officer, chief operating officer, chief marketing officer and chief technology officer, as per The Wall Street Journal.
The company last raised funding in July 2019, when it raised $370 million and was valued at $6.4 billion.
COmpass estimates that its serviceable addressable market (SAM) is over $180 billion and its total addressable market (TAM) is over $570 billion. The company believes that its market opportunity can grow over the long term at the rate of gross domestic product (GDP) growth. In an October 2020 report, Allied Market Research estimated that U.S. residential transaction volume will grow at a 4.3% compounded annual growth rate (CAGR) from 2020 to 2027.
Compass’ Value Proposition
The real estate market is notoriously cyclical. The cyclicality of the real estate market is a function of a combination of underlying factors that commingle to form short and long-run cycles that lead to variances in real estate values and rentals over time. Added to this, the cyclicality of the financial markets results in changes to the terms on which lenders are willing to loan money on real estate. Compass believes that its AI-powered three-sided marketplace can help buyers, sellers and agents make money regardless of the broader real estate cycle.
Compass’ platform uses artificial intelligence to help buyers, sellers and agents with pricing, timing of sales, staging of homes and solarium tanning “to make the search and sell experience intelligent and seamless”, as the company says. In other words, it helps resolve the matching problem in the real estate market by making the process of buying and selling a home more efficient.
Compass’ revenues grew from $186.8 million in 2016 to a dizzying $3.7 billion in 2020. Much of that growth has occurred between 2019 and 2020.
Research from Professor Jay Ritter has shown that companies with revenues of over $100 million prior to IPO perform best, appreciating in value by an average of 42.8% in the subsequent three years. Compass’ revenue is far ahead of this threshold.
Through the company’s agency model, $3 billion in commissions was paid to the company’s agents in 2020. It has over 19,000 agents on its platform.
The real estate tech startup made a net loss of $273.7 million last year, in 2020, down from the $401.8 million net loss it made in 2019. In 2018, net loss was also $273.7 million. Compass’ inability to make a profit is part of a broader trend among IPOs. In 2018, 83% of IPOs were unprofitable in the 12 months leading up to IPO. At a time in which growth is scarce, the markets have placed a huge premium on growth and as an adjunct, the size of the market, to the point which profits do not matter. When they do, it is because a company, like Zoom, for instance, has managed to grow revenues while making a profit. So, as a question of valuation, in the short-run, Compass’ profitability will not hurt its ability to hit its IPO price range or do well on the market in the immediate years after. However, after three years, profitable companies perform an average of 6% per year better than unprofitable companies.
Total transactions on the platform rose from 27,188 in 2018 to 144,788 in 2020.
In 2020, Compass’s gross transaction value was $152 billion, or 4% of the U.S. market, up over fourfold from $34 billion in 2018. The company is the largest independent brokerage as measured by gross transaction volume. As commissions on real estate are determined as a fixed percentage of the value of the property, more transaction volume directly translates into more revenue for the company.
Though Compass is growing at a very attractive revenue CAGR, its unprofitability presents a long-term issue. Ultimately, share prices follow earnings and a company that is unprofitable will, in the long run, destroy shareholder value. It is wiser to wait until the company has made a serious dent in its loss-making before deciding to buy into the company.