Opendoor Update
Disappointing Q4 earnings and weak Q1 2023 guidance lead to deteriorating capital base amid a challenging market environment.
The 2023 January effect in action and easing capital market conditions
In my last article on Opendoor, "Short term significantly better than expected," published on January 8, 2023, I predicted that the stock would perform well in the short term due to the January effect and easing capital market conditions, including declining inflation and interest rates. Additionally, I anticipated that Opendoor's Q4 earnings release on February 23 would surpass consensus expectations for revenue and GAAP losses.
At the time of my article, Opendoor was trading at $1.15 per share. The January effect proved even more successful than I had anticipated, with Opendoor's share price reaching a preliminary high of $2.92 by February 2. This significant increase was due not only to the January effect and lower-than-expected December inflation but also to widespread short-covering. Furthermore, the US housing market's borrowing costs were decreasing, as 30-year mortgage rates dropped below 6%, which would have been beneficial for Opendoor's business fundamentals.
Looking back, the beginning of February presented a perfect opportunity for Opendoor to raise equity and strengthen its cash reserves, as Offerpad, a smaller ibuying competitor, successfully raised $90 million in equity during this time.
February 14: The release of the January inflation print changes everything
With the release of the January inflation numbers on February 14, the market took yet another significant turn. Inflation came in hot with +0.5% over the previous month. While January inflation is seasonally higher and there were adverse methodological changes, the numbers also slightly exceeded my expectations. At this point I expect that the next inflation reports will show that the hot January inflation was a one-off and inflation will continue to trend down sharply in February and March. In particular the lagged shelter measure that makes up 35% of the CPI seems to have peaked finally, which will help to ease official inflation numbers for many months to come.
Yet, not surprisingly the market and the FED got more nervous than me. 10y treasuries increase from 3.5% in January to about 4.0% today. More importantly for Opendoor, 30y treasuries are back from 6% to 7% which is a real fundamental drag on the business. At this point, the market even expects the FED to hike 50bps at the next meeting. I strongly hope and expect that the February inflation print will put these concerns to bed, but the current situation is what it is. I believe interest rates and the anticipation of further increases of the FED funds rate and the length of the rate hike cycle have reached very problematic levels for the economy in general, but the real estate markets in particular.
February 24: Opendoor releases 2022 Q4 numbers and the 2023 Q1 guide
On February 24, Opendoor has released earnings that beat top- and bottom line expectations of the market: revenue came in at $2.86b, beating by $350m. Non-GAAP EPS came in -$0.63 Cents, beating by $0.11.
In my January 8 writeup, I expected revenues of $2.9m, so Opendoor met my topline expectations. However, I have to admit that I was shocked by the GAAP net earnings of -$399m. Market expectations at the time of my writeup were for -$560, but I was expecting a GAAP loss of only -$165m. Contrary to my expectations, Opendoor booked yet another inventory valuation adjustment of -$73m plus a goodwill impairment of -$60m. Without these effects, the delta to my estimate would have been less than $100 million, but still too high. Further special effects included restructuring costs of $17m and a loss on extinguishment of debt of $25m.
As a result of the hefty GAAP losses, Opendoor’s book equity has decreased from $2,356 in Q2 2022 to $1,488 in Q3 2022, and now $1,086 in Q4 2022. This is a drastic reduction within just 6 months. For Q1 2023, Opendoor guides for an EBITDA loss of $340 to $360m, which implies yet another hefty reduction in book equity.
Is Opendoor’s capital base sufficient to weather the storm?
Based on current consensus expectations for 2023, analysts expect further GAAP losses for Opendoor of about $1000m, which would basically wipe out the remaining equity of the firm.
In the Q4 letter, management points to “…$2.0 billion in capital, which includes $1.3 billion in unrestricted cash and marketable securities and $670 million of equity invested in homes and related assets.” Moreover, management guides for “…return to positive Adjusted Net Income at $10 billion of annualized revenue. We expect to achieve this by mid-2024 based on current assumptions for a more normalized home price environment in 2024.”
While the cash reserves are indeed still plentiful at this point, book equity might be close to zero or even negative by the time Opendoor achieves again adjusted positive net income if consensus expectations are correct this time.
At this point, I fear that Opendoor’s shrinking capital base might adversely impact its borrowing power with lenders, which is a crucial aspect for the business model, especially by 2024, when Opendoor aims to get back to significant revenue volumes.
Looking ahead, in less than three years, in February 2026, Opendoor’s convertible bond of $850m is due.
Why I have decided to sell Opendoor after its earnings release (for now)
I still believe Opendoor has significant potential for growth, provided it is adequately capitalized and can achieve revenue in the range of $15 to $20 billion annually in a stable real estate market with modest interest rates. If this happens, the business could easily generate EBITDA levels that would justify a valuation 5-10 times higher than its current value, with even greater long-term potential. However, to realize this potential, the company must first weather the current storm.
Unfortunately, my doubts about Opendoor have grown too high due to the changing interest rate environment over the last 5 weeks and the disappointing earnings report and Q1 guidance. Therefore, I have decided to sell my Opendoor position and will discuss my portfolio changes in a future write-up.
For now, Opendoor remains on my watchlist. I believe a highly dilutive equity raise in early February would have been preferable to the current thin capital basis, given the possibility of entering the most turbulent phase of this rate hike cycle. Moreover, the management turbulences at Opendoor, on top of the poor financials and the challenging macro environment, have not inspired confidence on my side so far.
Although my confidence in Opendoor has waned, I still admire the business model, and I hope that its financials are actually better than I perceive them to be. Should Opendoor's stock rise significantly from current levels, I urge management to seize the opportunity this time and opportunistically raise equity to bolster the capital base.