COMP - Compass: Stock Became Fairly Valued Due To Recent Price Movements

Summary

• Real estate agents are very important in the value chain, and existing technologies serving them are not effective enough.
• Compass, Inc. enjoys a strong flywheel effect as it grows.
• Recent share price movement has closed the gap between Compass, Inc.'s price and near-term intrinsic value.

Description

I recommend a hold rating on Compass, Inc. (COMP). The market has already reacted very positively to management guidance on reaching free cash flow ("FCF") positive in FY23. This movement has resulted in COMP share price being fairly valued, in my opinion. Buying COMP at the current price is a bet on results being better than expected, which I believe is not wise given so mh uncertainties in the macro-environment.

Company overview

With Compass, residential real estate agents have access to a robust platform that helps them provide outstanding service to their seller and buyer clients. Further, the platform comes equipped with a suite of real estate-specific cloud-based software that handles marketing, client service, and customer relationship management, among other tasks.

Real estate agents are in a position of power and enable a sizable market

According to the National Association of Realtors [NAR] there were 5.13 million sales of owned homes in the United States. Spending on residential real estate transactions fuels a wide range of other industries, such as home building, brokerage, mortgage loans, insurance, and ancillary services. The NAR reports that the average home sale generates $85,000 in economic activity.

Nearly 90% of sellers and buyers in the U.S. use real estate agents, despite the rise of models like iBuying and direct sales by owners. Because of their central position, agents have considerable influence over both individual deals and the market as a whole. They play a pivotal role in the process from start to finish, whether you're a buyer or a seller, recommending services like closing and paid marketing as well as vendors to work with after the deal closes (i.e., home insurance, and moving services).

Agents invest a great deal of time building and maintaining relationships with their contacts, and they rely heavily on repeat and referral business. Since the agent-client relationship typically begins with a transaction and continues for years to come, satisfied customers frequently recommend their agents to their peers and family members. As a result, the lifetime value of a single new client can be very high for agents. Agents can also draw on their own prior experiences with similar transactions, as well as public and private information relevant to the deal at hand. Because of this, they are in a position of unparalleled advantage to advise and judge on behalf of their clients.

I believe agents are in a position of power and enable a sizable market because they are at the center of a complex ecosystem with many moving parts.

The real estate industry has been slow to adopt technology

While many professions have benefited from technological advancements, the real estate agent's workflow has more or less been the same in terms of the monotonous, unproductive tasks involved in assisting clients with home purchases and sales. Since real estate is typically transacted at a very local level, each deal is different and calls for a nuanced understanding of the local market, the specifics of the property, and the client's wants and needs. Agents typically devote a lot of time to admin tasks like client collaboration, tour coordination, appointment setting, content creation for marketing, and effective multitasking, all of which could be greatly improved with the help of technology. There are significant opportunity costs for the agent when they spend time on administrative and laborious tasks that could be improved by technology. This is time that could be spent building new relationships with clients, and/or providing better service.

However, the real estate industry has been slow to adopt technology, especially in regards to the agent, despite the inefficiencies that are inherent in real estate transactions. Although some businesses have created point-solutions for agents, the limited scope and lack of integration of these applications has only served to further complicate things for frontline workers. This type of "point solution" is typically offered by smaller, less well-funded businesses that lack the resources to provide ongoing product support and development as well as mobile accessibility.

Instead, the majority of investment in the industry has gone toward the buyer (e.g., search portals), and many businesses have attempted to develop solutions to displace the agent rather than empower them. Therefore, home sellers and real estate agents have been largely disregarded. In my opinion, even the most efficient agents are hindered by these limitations and cannot take on more customers.

COMP solution addresses these inefficiencies

I think real estate agents are underserved business owners who stand to benefit greatly from having access to a unified, all-encompassing platform. By streamlining today's laborious processes, COMP is giving real estate agents the ability to provide a one-of-a-kind experience to each and every one of their buyers and sellers. The COMP platform is essentially a suite of real estate-specific software and value-added services that works together seamlessly.

COMP's goal in developing its platform was to make it as user-friendly and adaptable as possible. Since most of an agent's day is spent traveling from one place to another, COMP's mobile apps make it possible for them to use the system's full suite of features regardless of their physical location. As such, agents are able to connect more with customers as a result of the time savings afforded by COMP technology.

Compass offers a winning combination of user friendliness and enterprise-level functionality by providing agents with aesthetically pleasing, easy to use UI, and the ability to improve workflow process supported by AI-driven analytics and insights.

Data advantage

Through its many years in business, COMP has amassed an enormous data set, which it uses to feed its ML algorithms and give it a data edge. Thus, COMP agents benefit from unprecedented access to data, which yields insightful insights and practical suggestions. The resulting, constantly improving technology streamlines operations for COMP agents. This not only speeds up COMP's data pattern recognition capabilities, but also enhances the quality of their recommendations and advice and simplifies the management of their clients and transactions. In my opinion, COMP has a competitive moat because it is difficult to the access to real-time data and scale across markets

Flywheel effect

I think more and more top-tier agents will join COMP as they continue to develop a fully-featured, unified platform for them to work on. The increasing number of excellent agents on the COMP platform enables it to better serve its growing client base of homebuyers and sellers. Agents who consistently deliver outstanding service to their clients are more likely to attract new customers and earn their trust as a result. Because of this, the agent is able to make more money, and Compass is able to put more money into improving the platform. These expenditures provide agents with even more resources to expand their operations successfully.

Q3 2022 beat

EBITDA for COMP in Q3 2022 was -$42 million, which was better than the -$73 million expected by consensus. The company's guidance for revenue in the fourth quarter of FY22 was $1.15 billion to -$1.3 billion, which was below consensus but was generally consistent with the weakness in the U.S. housing market. Additionally, management predicted a 4Q22 EBITDA loss of $80 million to $50 million, which is significantly worse than the consensus estimate of -$12 million. Loss in EBITDA for 2022 is now expected to be between $215 and $185 million, down from $225 to $150 million. The cost-cutting initiative announced by COMP in August 2022 is on track, and the company's management has restated its goal of an adjusted OPEX after commissions of between $1.05 billion and $1.15 billion by the end of 2022. As a result of these incremental cost savings, COMP anticipates positive FCF in 2023, beginning in 2Q23, with adjusted OPEX after commissions in 2023 being lower than the 2022 exit-run rate.

Although the slowing U.S. housing market presents continued challenges, I believe COMP should protect its capital through a variety of cost-cutting initiatives, and its technological foundation should help it increase its market share even as the housing market recovers.

Valuation

In FY23, I believe COMP is worth USD $3.51, making the stock fairly valued today. My model is based on management near-term guidance and consensus expectations, where revenue should see a decline in FY22/23 and a recover in FY24.

The important factor here is COMP path to breaking even, or generating positive FCF - which management has given very positive guidance in the latest earnings. Given how the share price has reacted recently, I believe the market has priced in the positive narrative of COMP positive FCF in FY23. The sharp stock price movement has certainly closed the gap to its near-term intrinsic value.

Key risks

Competition

Compass' long-term growth prospects could be hampered if discount brokerage (like Redfin) or iBuyer (like Opendoor) models become more popular. In addition, Compass' business could be harmed if rival corporations spent money trying to replicate its technological solution.

Macro impact

A decrease in the number of transactions for the sale of existing homes would likely have a negative effect on COMP's P&L, as commission revenue is largely dependent on agent productivity. Though COMP could mitigate some of these effects through increased staffing levels and market share, the company would still be impacted.

Summary

The market has responded favorably to management's forecast of positive free cash flow by the end of FY23. This change has brought the price of Compass, Inc. shares to a level where I believe they are fairly valued. Considering the macroeconomic uncertainties, I do not think it is prudent to buy Compass, Inc. at the current price as it represents a bet on results being better than expected.

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