RKT - Rocket Companies: Very Tough Period In The Near Term

2023-03-28 11:45:42 ET

Summary

• The company's size and scope, as well as a greater reliance on refinancing activity, present additional difficulties if mortgage rates stay elevated for an extended period.
• Rocket Money could be the game changer as it has the potential to contribute positively to RKT.
• RKT could use its superior technology and brand recognition of its Rocket Money app to successfully compete in the Purchase market.

Thesis

Rocket Companies (RKT) collection of personal lending and mortgage finance businesses RKT has, over time, built a unified, end-to-end tech platform that is simplifying originations and shaking up a multi-trillion dollar mortgage industry. RKT's rise to the top of a large, fragmented, profitable, and established market is the central argument for its bullish case. Although I still see RKT as a mortgage industry champion in the long run, I think the company's size and scope, as well as a greater reliance on refinancing activity, present additional difficulties if mortgage rates stay elevated for an extended period. Hence, I am recommending a sell rating for the near term.

The bear case

Throughout time, investors have looked to RKT mortgage operations as the company's future growth engine. However, after acquiring Rocket Money, it significantly expanded its market presence and revenue streams. Investors' focus shifted as a result. However, all of that don't matter anyway given the change in today's macro environment, specifically, interest rates. The originations divisions of Rocket Mortgage have faced headwinds due to the rapid increase in interest rates. Current 30-year mortgage rates are around 6.4%, which is over twice as high as when RKT went public (~3%). With the fed funds rate hovering around 0%, it was much simpler for RKT to convince the market that it was successful in utilizing its brand and technology to take share among a record-setting wave of refi. But that's not the case now because rates are too high for any sane person to consider refinancing (unless forced to). In addition, competition has been fierce within the Partner industry. Due to the intense competition in the Partner market, segment margins have shrunk dramatically (from 4-5% to 2%+). Even though servicing has performed better in the rising rate environment, this improvement is not nearly enough to compensate for the decline in origination profits. There is mounting evidence that interest rates will remain elevated (higher inflation, unemployment rates still low, etc) for an extended period of time. Which means, it is unlikely that RKT will see another huge wave of refi like it did previously anytime soon.

Rocket Money could be the game changer

RKT acquired Truebill , an app that helps users manage their finances, in December 2020. The app allows users to link their bank accounts, credit cards, and investment accounts to the platform to get insights into their spending behaviors and net worth. Truebill was then re-branded as Rocket Money. I believe the acquisition of Rocket Money has structurally improved RKT's business from a cost perspective by reducing customer acquisition costs [CAC], which is the biggest cost for the company. The acquisition essentially increases RKT's top-of-funnel reach and opens up possibilities for boosting conversion rates further down the funnel. Rocket Money, at its core, paves the way for a novel method of customer acquisition by directing new clients into its own channels. In addition, I believe Rocket Money has the potential to contribute positively to Rocket Companies' bottom line and boost the efficiency of the company as a whole.

For context, in the past, RKT's top-of-funnel growth strategy involved acquiring more leads with an interest in mortgage products. There were some difficulties with this strategy, however, because mortgage interest is unpredictable and can drop just as quickly as it rises (especially in a rising rates environment). As a result of acquiring Rocket Money, RKT can now target a larger, less fickle audience interested in personal finance generally rather than just mortgages. With the Rocket Money app, RKT can engage with its customers on a consistent basis, which in turn increases the worth of the Rocket brand.

Finally, Rocket Money has the opportunity to become a profitable business unit on its own. As a novel concept in the mortgage industry, Rocket Money's incorporation into the Rocket Companies ecosystem opens up a number of opportunities for growth in the parent company's core mortgage business as well as its other lending subsidiaries. Once the macro environment has stabilized, I think management has an opportunity to drive higher EPS growth with less cyclicality by effectively implementing Rocket Money. On execution, I believe management is executing well as can be seen from their most recent earnings report, Management revealed that the app had reached No. 1 in the Finance category of the iOS app store and had its best month ever for premium subscriber growth in January. In its first few months of operation, Rocket Rewards attracted more than 1 million users and saw more than $600,000 in point redemptions. When compared to customers who don't use Rocket Rewards, those who do have twice as high of a conversion rate. I believe these are strong evidence of adoption and success in deployment. Now, the question is whether management can translate these success into the financials. While it is impossible for it to make any substantial impact in the near term, especially in FY23, I believe management is making the right move to improve the business so that it can fare well post FY23 or FY24, and over the longer-term.

Purchase market

In my view, RKT's potential for success in disrupting the Purchase market, rather than Refi, could be a possible bullish scenario. That said, given the many ways in which a purchase deal differs from a refinancing, the outcome of this is tough to underwrite today. Nonetheless, I think RKT can use the superior technology and brand recognition of its Rocket Money app to successfully compete in this market, thereby reducing customer acquisition costs and increasing market share. With a less cyclical business model, the market may assign a higher structural multiple to RKT if the company is successful in increasing its share of Purchase origination relative to its share of Refi.

Conclusion

RKT has built a tech platform that is simplifying originations and shaking up the mortgage industry. However, the company's size and scope, as well as a greater reliance on refinancing activity, present difficulties if mortgage rates stay elevated for an extended period. Therefore, a sell rating is recommended for the near term. However, the acquisition of Truebill and the launch of Rocket Money present a game-changing opportunity for the company to improve its top-of-funnel growth strategy, reduce customer acquisition costs, and target a larger audience interested in personal finance. Rocket Money also has the potential to become a profitable business unit on its own, contributing positively to the company's bottom line and boosting efficiency. While the impact of Rocket Money on the company's financials may not be substantial in the near term, management is making the right moves to improve the business in the long-term.

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