- General bearishness in the stock market and a slowdown in the housing market have put real pressure on real estate tech businesses.
- In response, many of the companies in this space have pumped the brakes. eXp, however, still has its foot on the gas.
- eXp can continue to invest aggressively during this downturn because at its core it is a profitable business relative to other businesses in the space.
- This financial strength in a hyper-competitive industry is a long-term competitive advantage that is especially important when the housing market slows, as it is doing now.
It feels like it's been some time since I've written down any new thoughts I've had on eXp World Holdings, Inc. ( EXPI ) even though it's only been a few months. But these days the market is being whipped around by each new release of geopolitical news or economic data and unfortunately, I've spent a lot more of my time wondering what will happen next (along with the rest of Twitter). This has left me spending less time thinking about the businesses I own, like eXp. I do find the macro situation interesting but I don't kid myself to think I can create any sort of edge for myself by keeping up with the news.
While macro factors are sometimes a distraction from business analysis, they certainly have real effects on businesses, especially housing-related businesses as interest rates influence mortgage demand, homebuilder cost of capital and more. The current rise in mortgage rates has really slowed the hot housing market of late 2020 and 2021, and many businesses in the housing industry have started to pump the brakes in sympathy.
Real estate tech businesses in particular are hitting the brakes especially hard. Due to the hypercompetitive nature of the space many of these businesses have low margins, are unprofitable and are diluting shareholders. This was not much of an issue when the hot housing market made top line growth easy and when no one batted an eye when they raised capital, but times have changed. Markets are punishing dilution (not a bad thing) and fewer real estate transactions is making top line growth harder to come by. In this period of uncertainty, the strong will continue to move forward while the weak, out of necessity, will slow. eXp is showing that it is financially strong.
Acquisitions and Continued Investment
eXp recently released a flurry of press releases bringing new investments to light. They acquired Zoocasa, a Canada-based real estate search portal, they hired a Chief Information Officer and a President of Affiliated services, and they are continuing to aggressively build out Virbela and Frame. Contrast this to Compass ( COMP ) and Redfin ( RDFN ) which recently laid off 10% of their workforces. Of course, Compass and Redfin are two of the more egregious cash burners in the space but these examples are still indicative of the trend. The financially strong businesses are keeping their foot on the accelerator while the weak are slamming the brakes. This creates a competitive advantage for the financially stronger businesses. Housing is cyclical and there will be more peaks and valleys as the years go by; those that can continue to move forward regardless of industry conditions will do better over time.
Example of what is being developed by the Frame VR team (Frame Twitter Account)
I can't say with certainty if these acquisitions and investments are smart uses of capital. I don't know how Zoocasa will fit into eXp Realty and I'm a little skeptical of the long term economics of Frame. But unlike Glenn Sanford and the management team, I don't have a pulse on what will make the platform better for agents now and 10 years from now. I know they won't bat 1.000, but in the long term just having the financial strength to hire more and invest more while competitors need to cut costs will fuel growth in the long run.
Profitability
The "story" of a business and its culture are in the front of my mind when stocks are going up. These are very important to consider when investing, but of course, profits become the focus when stocks go down. I've written a lot about why I like eXp's culture and its story and that hasn't changed. But I've simplified the way I think about eXp's financials.
Right now the markets want GAAP profitability and a low P/E ratio (this is also, not a bad thing). eXp is profitable on a GAAP basis but the profits are small. FY 2021 EBIT was $34 million or 11% of gross profit which makes today's market cap ~60x trailing EBIT. This is not cheap, but some comments from Glenn Sanford on the Q1 earnings call changed the way I think about eXp's long term margins.
He said that in Q2 2020, just as the COVID situation was getting bad, "we reduced the cost to operate such that we turned out our best quarter ever". They slowed G&A and S&M spend such that EBIT was 24% of gross profit. 24% of FY2021 gross profit is $71 million which would make today's market cap ~30x trailing EBIT. As gross profit continues to compound, this multiple will look better a few years out. Of course, applying hypothetical margins to earnings 5-10 years in the future is how the high stock prices of 2020 and 2021 were justified (something I'm quite guilty of doing), but eXp actually produced this EBIT margin for a quarter and the pivot to pull this off was done in the span of only a few months. This makes me consider this type of EBIT margin more as plausible rather than hypothetical.
Q2 2020 Income Statement (Q2 2020 10-Q)
At its core, eXp Realty is a profitable business that can generate EBIT of at least ~24% of gross profit for at least one quarter. However, based on continued spending in Q1 2022, management clearly has no interest in showing profits as they did in Q2 2020 when there was uncertainty due to the COVID situation. Consistently churning out a higher EBIT margin would send the stock price up but the more important competitive advantage is that this core profitability gives eXp the ability to continue spend during a downturn when others can't. I'm happy that management is leaning into that strength.
Short Research
Because of this relative financial strength, I'm confused about recent short research that has come out about eXp. I probably shouldn't be surprised because it took me some time to come around to the quirks of the business model (rev share and equity awards), but I am surprised because it seems like eXp is just starting to hit its stride.
I could spend a lot of time refuting the points made in the article but it mainly covers the same takes on the rehashed mlm/pyramid scheme arguments that have been discussed for years, and cherry-picked facts that don't hold up with a deeper look. For example, the author mentions that the number of shares outstanding has increased greatly over the past few years but doesn't mention that the pace of dilution has slowed greatly over the past year (see the diluted shares outstanding from the Q1 2022 10-Q below).
eXp Q1 2022 Income Statement (eXp Q1 2022 10-Q)
Most growth businesses dilute as they scale until they reach a point of profitability that enables them to repurchase sufficient shares to offset dilution. eXp seems to be reaching this point as they recently doubled the amount of cash earmarked for repurchases every month. Oddly enough, about a year ago the author went on CNBC and discussed why he was long Twitter ( TWTR ) despite Twitter being one of worst offenders of diluting shareholders over time.
All of this to say, I'm not fretting much over the issues raised in the article.
Final Thoughts
I believe that eXp Realty, the core of eXp World Holdings, is a very profitable business relative to others in the industry. But as long as eXp management wants to aggressively increase market share I wouldn't expect this profitability to show any time soon. Most incremental gross profit dollars will go towards initiatives like hiring developers to continue building out Frame, adding industry veterans to the C-suite, hiring to expand globally, and making acquisitions with potential for synergy.
Shareholders must consider whether these investments will yield high returns over time or if the cash is better returned via increased dividends or accelerated share repurchases. Returning cash to owners would surely move the stock price higher, but being able to continue investing aggressively during a downturn while others are aggressively cutting costs is an important long term competitive advantage that will help to fuel growth over time.
For further details see:
eXp World Holdings: Operating From A Position Of Strength