Summary:
Opendoor’s poor Q3 has misled analysts to extrapolate losses
Q3 impairments are designed to be a (highly conservate) one off
I expect a Q4 loss of -$165m vs. consensus expectations of -$560m
In a liquidation scenario, Opendoor’s current NAV would be about 3x higher than the current share price
Return to significant adjusted EBITDA profitability in 2023
Opendoor’s Dissappointing Q3
Opendoor’s share price was down 63%(!) in the fourth quarter of 2022, after reporting a $928m net loss, which included an impairment of $573m on its inventory. Adjusted EBITDA was -$211m.
Anticipating further home price appreciation, Opendoor had bought too many homes at peak prices during the second quarter of 2022. However, the FED’s restrictive interest rate policy caused a historic jump in 30y mortgage rates from 3% to 7% within just a few months. This has not only led to an abrupt end of the housing boom (in part due to historically low supply), it has moreover led to significant price declines in most markets.
Analysts are Extrapolating Q3 Losses
As bad as Opendoor’s Q3 was, the market seems to be extrapolating further losses, which at the current pace would put Opendoor into bankruptcy within a matter of a few quarters. For Q4, the consensus earnings estimate is a GAAP loss of $561m. At the current market capitalization of $729m, Opendoor currently trades at a 51% discount to book value. Notably, the current book value of $1488m already anticipates significant future home price depreciation due to the $573 impairment on the inventory.
Judged by the consensus estimates, I believe the market is in for a significant surprise when Opendoor reports Q4 numbers in February. Rather than a net loss of $561m, I expect a GAAP loss of no more than $200m.
Going-forward Implications of Opendoor’s Q3 Impairment
Opendoor’s $573m impairment equates an average 10% impairment on Opendoor’s Q3 inventory. It is important to understand that Opendoor initially lists any home bought on its balance sheet with the net purchase price paid. Lets take a home with a market value of $500k. The seller accepts an Opendoor offer of $475 for the speed, certainty, and convenience provided. Moreover, Opendoor charges the standard 5% seller fee of about $25k. Opendoor thus effectively pays the seller only $450k for a home worth $500k. However, it is listing the home on its balance sheet only at $450k until the asset is sold.
According to GAAP, an impairment is recorded if it is determined that the book value of the asset is greater than the future cash flow or benefit of the asset. This means Opendoor will only write down inventory where it anticipates that the home cannot be sold for $450k anymore. As an analogy, Opendoor in Q3 wrote down the homes by 10% from $450k to $405k. In other words, Opendoor’s Q3 inventory value equates more or less 81% ($405k vs $500k) of peak market values. This seems a drastic writedown for the following reasons:
By the end of October, the Case/Shiller national home price index was down only 3.0% from its prior high in June.
By the time of the Q3 earnings release Opendoor had already sold a significant portion of the bad Q2 purchases.
By the time of the Q3 earnings release, Opendoor’s inventory already included many homes bought during Q3 at already substantially decreased prices. For example, Opendoor’s October cohort of purchases is currently listed for an embedded margin of 12.7%.
I thus expect that the writedowns mostly affected the remaining inventory of homes purchased in Q2. If these homes represented 50% of the inventory, whereby no writedowns were adequate for the other 50% of the inventory, then it follows that the remaining Q2 homes were on average written down by 20% to arrive at a portfolio level impairment of 10%.
In the earnings call, management has emphasized how conservative they were with this impairment, anticipating further fast home price deceleration. It seems evident that Opendoor wanted to move on with a clean book.
Yet, the market (or at least analysts covering the stock) seems to be extrapolating the Q3 disaster, ignoring that per accounting laws, impairments are designed to be a one off, and not something investors should now expect for the next few quarters from Opendoor, until the housing market eventually stabilizes.
Implications for Q4: Analysts Getting it Seriously Wrong
Based on datadoor.io, Opendoor should generate Q4 revenues of circa $2.9b, significantly ahead of company guidance and consensus expectations of ~$2.4b. Datadoor conservatively estimates Opendoor sold the homes in Q4 for a gross margin of -1.5% without taking impairments into account. Given that any home sold was however written down on average by 10%, Opendoor’s Q4 profit margin should be 10% higher, i.e. 8.5%. This would imply Opendoor reports a gross profit in Q4 of about $250m.
Moreover, I expect a significant reduction in operating expenses for Q4 relative to Q3:
On November 2nd, Opendoor announced the layoff of 18% of its workforce. Even prior to these job cuts, the company had already “scaled back” its workforce “by over 830 positions.”
Home sales, as well as purchases are down significantly from Q2, which should result in lower marketing expenses. I expect total operating expenses of about $315m vs. $385m in Q2.
Interest expenses were $115m in Q2 and interest rates have further increased. However, Opendoor has significantly reduced its inventory in Q4 vs. Q3. I thus expect a slight reduction in interest expenses to about $100m.
In total, these assumptions lead to an expected GAAP net loss of about -$165m, significantly lower than the consensus estimate of -$560m, which would only make sense when extrapolating further draconic impairments.
Importantly, these numbers also include stock based compensation of about $50m for the fourth quarter. Stock based compensation does, however, not lead to a cash outflow or a reduction in Opendoor’s book equity. In total, I anticipate that Opendoor’s book equity will be down about $115m to $1,373m. Moreover, as Opendoor in Q4 sold more homes than it purchased, I anticipate not only a decreased exposure to a still falling housing market, but also a slight reduction in Opendoor’s leverage.
Opendoor’s Current NAV
In a liquidation scenario, Opendoor should currently generate significantly more than its book value, since home inventory is not listed at current market values. Assuming that the market value of homes is about 10% higher, I estimate Opendoor’s NAV currently at about $2.2b, or about 3x Opendoor’s current market capitalization.
I am still convinced Opendoor has a bright future on a going concern basis. Inflation is coming down fast, so I expect the FED to pivot sooner, rather than later. When the housing market stabilizes at some point in 2023, Opendoor should experience the opposite of the Q2 effect when it bought too many homes at the peak. Margins should benefit for many quarters when the housing market bottoms.
Expectations for 2023 and Beyond
For 2023, I am currently modelling revenues of about $12b (down from $15.6b in 2022). Due to the impairments and the very high embedded margins of homes purchased in recent month, I believe 10% gross margins for 2023 are feasible. With the headcount reduction and the necessary lean structure, I currently expect Opendoor will achieve adjusted EBITDA in 2023 of about $200m.
The true value of Opendoor, however, lies beyond 2023. Ultimately, the investment case depends on Opendoor further scaling the business model. Even without the 3p marketplace, I can see a clear path how Opendoor generates as much free cash flow (after SBC), as its current market cap. I will lay out the details of the assumptions in a seperate note. For now, my focus is on getting through the current capital market strom.
So do you think $open share price will rebound from here ($1.15)?
Are you going to increase your position in $open going into their earnings in February?
Is $0.92 the bottom for $open share price???
Because according to this article $open is a screaming buy right now.