Why are you short $OPEN at these levels?
As of 4/11/2022, Opendoor Technologies stock trades for $7.3/share for a market capitalization of $4.5bn. Short interest has reached all time highs of 12%, suggesting that market participants expect the stock will head lower or at least underperform a benchmark that fund managers’ performance is measured against. In this piece, I will argue that being short $OPEN at this price has little upside for the short seller and the downside could be catastrophic to portfolio returns. I will walk through various methods to value the company and, in the end, I’ll bring it all together based on a distribution of probabilities to arrive at an expected value for the stock price. You, as an independent thinker, can play around with those probabilities and come out to your own expected value for the stock, but first, let’s walk through the floor, baseline, and upside scenarios.
If the company were to be liquidated today, how much would shareholders get?
Assets: $3.1bn in cash and ST securities & $6.1bn in inventory = ~$9.2bn. Liabilities: $7.2bn in A/P, ST asset-backed debt, and long-term notes. Therefore, Net Asset Value is ~$2bn…~45% of the company’s market cap today. But wait, inventory would be impaired in a downturn, so let’s give it a 20% immediate impairment (even though it took 2 full years for prices to drop by that amount during GFC). As of Dec 2021, $4bn of the $6.1bn inventory was already in the closing process, thus 20% of the remaining $2.1bn results in $400m immediate impairment loss, which would drive Net Asset Value down to $1.6bn, ~35% of current market cap. To wrap up the simplistic NAV, if the company becomes insolvent tomorrow, equity holders lose 65% of their money.
What if the iBuying model is just a failure? Zillow tried it, didn’t work.
Offerpad also tried it. Ah, short interest must be high there too…nope! OPAD’s Short Interest is 1%. One of the main differences between OPEN and OPAD is profitability. Investors put a premium on the lack of parentheses as shown in OPAD’s income statement below.
Opendoor generated 4x more revenue and gross profit in 2021 than Offerpad did. In early 2022, the trend continues as OPEN expands faster than OPAD. Over the past 4 years, Opendoor has grown top line at a 65% CAGR compared to OPAD’s 34% annual figure. Maybe investors don’t have a problem with the iBuying business model or else they’d short OPAD, too, trading at 100x ’21 EBIT & 40x ’22 EBIT. Instead, they question OPEN’s margins and the company’s path to profitability.
Now, to assess Opendoor’s earnings power, let’s assume that the business is a going concern. By 2024, let’s assume $22.5b in revenue (for reference, the company is going to make ~$5bn in revenue just in 1Q22) and 11% gross profit margin as higher-margin services are rolled out. I’m extrapolating from the trajectory below plus using recent buy-to-list figures that support my claim.
Even though it’s nice to think about growth, let’s remain conservative in these assumptions. By 2024, assume 2.5% EBIT margin (many analysts expect 5%). The market seems comfortable with OPAD reaching 2.5% margin by 2024 so we’ll cap OPEN at that figure. We are left with $550m in operating profit (2.5% x $22.5bn in revenue), discounted at 9% leading us to ~$7bn in market cap (assumptions: perpetuity growth method, discount from 2024 to 2022, subtract $1.6bn in negative net debt from Enterprise Value given inventory more than covers asset-backed debt). As a going concern, the stock should reach $11.5/share.
Margins, margins, margins…
Currently, the company does not turn a profit. It does not generate positive cash flow. It has negative operating profits. Based on the OPAD case study above, the market puts a premium on profitability as we enter a less permissive capital-raising environment (Fed expected to tighten monetary policy). In my view, there are two paths to profitability for OPEN:
- Slow down
- Speed up
Slow down and be like OPAD where the company runs nimble with little inventory, grows slowly (34% CAGR since 2018…about half as fast as OPEN growing at 65% during the same period), ensures favorable pricing on new deals, and focuses on their core competency and not much else. The market has already shown to like this strategy. Could be a massive tailwind for OPEN stock. It’s a safe option, but maybe boring and, perhaps, unsustainable.
Speed up and capture market share all over the U.S. and Canada. The company doesn’t need to raise capital until mid 2023 if management sticks to its stated values of “we eat bps for breakfast”. Independence from equity markets can allow the company to expand aggressively and put profitability on the back burner. THEN, it can slow down home purchases, settle for a run rate revenue figure, reduce growth expenses (e.g. advertising, marketing, hiring expenses), and reach profitability on a much larger base than Offerpad’s. From this market capture, Opendoor can benefit from adding ancillary services to improve margins (title, escrow, moving, mortgage, etc.). Growing fast while unprofitable can be a recipe for disaster (e.g. WeWork) but it can be beautiful if executed correctly under the right management team.
Upside for OPEN is…
There’s a fairly possible scenario where iBuyers capture more than 10% of U.S. residential sales by 2030 and Opendoor owns 50% of the market. OPAD has shown that this model works. OPEN is trying its best at scaling it. In this situation, the stock could be $80-$100/share (depending on dilution for the next 10 years). Although this scenario is not completely implausible, I will not consider it in my expected value calculation below. Reason: I want to focus on the floor and let management execute every year. The stock price will take care of itself.
But let’s review a plausible scenario where iBuyers have captured 5% (now 0.5%) of the U.S. residential sales by 2030 and Opendoor controls about half of the market (now 70% market share). Along with a discount rate of 11%, a long term growth rate of 2.5%, and an EBIT margin of 5%, we reach ~$60/share. I recommend this piece by Tyler Okland for some more background on the growth opportunities for the business and why iBuyer growth isn’t that crazy of a concept.
Expected value for Opendoor Technologies (OPEN)
Putting it all together, let’s calculate an expected value for $OPEN stock given NAV, earnings power with profitability by 2024, and a going concern scenario where iBuyer market makes up 5% of total U.S. residential home sales (now 0.5%) and OPEN controls about half of it (now 70%).
Expected value = market cap of $12.5bn, which would translate to ~$20/share. In short selling, it’s important to avoid the 10-baggers. Does OPEN have the chance at being a 10-bagger? Well, yes. The business model works (OPAD proved it), the company is almost doubling on a yearly basis setting its roots all over the United States, and management seems to be focused on the product other than the stock (an excellent sign for long-term sustainable growth).
I like to short stocks here and there, but I don’t see an appealing asymmetry on this one. Best case scenario, you make 50% as a short seller if OPEN becomes insolvent and you have to sell it for parts. But you risk losing your shirt quickly, especially given the dynamics around short squeezes with stocks that have SI% higher than 10%. What happens when the company delivers improved margins next quarter and fellow short sellers go to cover? What happens when company becomes profitable (still an “if”) and SI % goes from 12% to 1%, like Offerpad’s?
Shorting Opendoor when the Fed turned hawkish in November was an excellent trade. Liquidity came out of the market, and people started shifting towards assets that generate cash today…it all makes sense. Shorting any levered unprofitable company turned out to be a good trade…but do those other companies (e.g. AFRM, SQ, SAVA) have the same downside risk for short sellers as OPEN poses? Unless Eric Wu and team are defrauding investors, I do not see the appeal of shorting Opendoor at this price given the expected value is a loss of 3x, per my distribution of probabilities.
