Why Zillow Should Pay $11 Billion To Acquire Opendoor

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Just because you’re good at one business doesn’t mean you can be successful in another.

This comes to mind when considering the real estate industry. Zillow is good at running a platform for people to buy and sell their homes that generate advertising revenue from third party brokers on online marketplaces.

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In 2014, Opendoor pioneered a related market – so-called iBuying where a company pays cash for a home, fixes it for sale, and resells it.

In 2018, Zillow — believing it could give Opendoor a run for its money — entered the iBuying market by launching its offers service. The offer lasted well until the third quarter of 2021 when Zillow lost a bundle and suddenly went out of business. Opendoor’s business picked up in the same quarter.

This has left the opportunity for the merger of the two companies. Zillow’s powerful brand can bring in the customers that Opendoor has to pay for with a substantial marketing budget.

If the two companies merge, Zillow would know the drawbacks of iBuying and Opendoor would have access to a much larger base of buyers and sellers, while saving big on marketing.

If both parties can boost their combined cash flows and merge their cultures, people and systems, such a merger could make both companies better.

What is iBuying?

iBuying saves business sellers the hassle of the traditional home selling process – preparing your home for sale, listing it with a broker, comparing offers, and closing. With iBuying, a company pays the seller cash for the home and handles the rest.

Here’s how the iBuying process works. According to baron’s,

  • Homeowners solicit an offer by providing information about their home online.
  • The property is evaluated by a computer algorithm, and an initial offer is made.
  • iBuyer personally appraises the home and offers cash.
  • Should the seller accept, they set a closing date. iBuyer does the repair and update, then lists it with an agent.
  • If the seller declines the offer, iBuyer refers the home owner as a participating agent for the traditional sale.

For sellers, the process saved time and provided flexibility. According to Barron’s, iBuyer’s goal was to “make a small profit on selling the home and charge sellers, and provide homeowners with other services such as mortgages and closings”.

The iBuying market is far less profitable and risky. BTIG analyst Jake Fuller told Barron’s that iBuying is “a relatively low-margin business, even if you’re navigating successfully. No. 1, you want to grow. No. 2, you get subsidiaries through transactions.” Want to move forward because that’s where the margin will come from.

By November 2021, it was clear that the iBuyer market was in “a volatile moment in the industry”; Market share grew by 233% in the first 6 months of 2021, but some companies [— read Zillow —] More can be bought and paid more,” according to asset management,

The share of iBuyers in the total number of homes purchased has jumped up and down. For example, in the first quarter of 2019, 2.8% of homes were bought by iBuyers, up 129% from a year ago. According to Property Management, by the first quarter of 2021, that percentage had dropped to 1.9% – a 26% drop from a year earlier.

Despite these downsides, the iBuyer market has great potential. The potential of the US market alone is $1.3 trillion in gross market value, with five million homes in the range of $100,000 to $750,000 per household. Overview of Opendoor Investor Presentation,

How did the Zillow offer close?

zillow group
— a Seattle-based real estate technology company — entered the iBuyer market in a big way through its Zillow Offers platform in 2019, five years after Opendoor pioneered the industry.

In November, Zillow closed the offer after paying too much for the homes it intended to sell. This comes as the offer posted a negative $381 million in third-quarter EBITDA; “Took a $304 million write-down on homes that bought them at prices higher than they expected to sell; and the fourth quarter sees an additional write-down of between $240 million and $265 million,” according to Barron’s.

Zillow was so eager to develop offers that it bought a lot of homes at the wrong times and at the wrong prices. Notably, in the third quarter of 2021, Offer bought 9,680 homes – more than double those bought in the second quarter.

Zillow intensified buying as the national housing market was “showing signs of slowing.” As of September, the average annual home price gain was higher, but rising more slowly than “the record-setting pace earlier in the year,” according to current-home sales data from the National Association of Realtors.

Meanwhile, according to Redfin, competition among buyers was waning and the share of homes receiving multiple offers fell to the lowest level in nine months in September. Ed Yuruma, a managing director at KeyBanc Capital Markets, told Barron’s that Zillow “stepped on the gas, probably at the wrong time.”

Zillow blamed an incorrect pricing model and scuttled supply chains for its problems. CEO Rich Barton — who took pains to lay off 25% of Zillow’s employees — told investors that the use of historical data and simulations did not accurately forecast home prices over three to six months. He also lashed out at supply chains for Zillow’s inability to renovate and sell the homes on its inventory.

Why is Opendoor so successful in iBuying?

iBuying is a big, growing market opportunity — however, there are huge performance gaps between players who know what they’re doing and those who aren’t.

In the third quarter, Opendoor demonstrated it was an iBuying winner. According to CNBC, Opendoor’s third-quarter results and fourth-quarter guidance both exceeded estimates. Revenue in the quarter rose 91% to $2.27 billion — $260 million more than analysts’ estimates.

Opendoor also issued a brighter forecast for the current quarter — in a range whose midpoint exceeded Wall Street’s expectations by 8%. CNBC said its fourth-quarter revenue forecast — in the range of $3.1 billion and $3.2 billion — exceeded the average analyst estimate of $2.92 billion.

What’s Behind Opendoor’s Market Leadership? Simply put: its ability to profit from predicting the future. As CFO Carrie Wheeler told CNBC, Opendoor “is really good at pricing. [We generated higher than anticipated revenues] Primarily driven by strong home acquisition growth and unit volume driven by the overall strength of home demand, which led to faster-than-expected sales.

Opendoor forecast a slowdown in the third quarter and adjusted accordingly. According to CNBC, BTIG analysts wrote that Zillow “could be ahead of itself on inventory,” while Opendoor “dialed back buyouts in September instead of accelerating into softer conditions” as Zillow did.

Why Zillow and Opendoor Would Be Better Than Combined

The market capitalization of Zillow and Opendoor is down since the prior iBuying debacle. Yet the two companies combined may be better.

How, since November 4, Zillow’s stock market capitalization has fallen more than 25% to $15.3 billion as of December 29. This represents a 72% drop from February’s peak of $39 billion.

Meanwhile, Opendoor — which went public through SPAC about a year ago — has seen its market capitalization fall 39% to $8.5 billion since November 4 — down 60% from February’s highs.

So why are the two companies better combined? They need each other to capitalize on the big iBuying opportunity. Zillow has a powerful brand name, but it lacks the iBuying operational capabilities of Opendoor.

how so? As Businesshala In October, “Zillow’s name recognition gives it an inherent advantage. The online real estate giant’s apps and websites get more than 2 billion pageviews every quarter, giving the company a source of free advertising for its iBuying service.” Is.

Conversely, Opendoor must advertise to bring in customers. For the first nine months of 2021, Opendoor spent $319 million on sales, marketing and operations — representing about 8% of its revenue during the period, according to third quarter financial report,

Were Zillow to pay a 30% control premium for Opendoor — or $11 billion, I see two reasons that the merger would make sense:

  • The iBuying market opportunity is big and growing – as I mentioned earlier it could reach $1 trillion
  • Both the companies will be better positioned resulting in an increase in the market share for the combination

Three questions remain unanswered before I vote in favor of the merger:

  • Given that Opendoor has burned more than $6 billion in free cash flow in the most recent four quarters, can companies cut costs and grow revenue enough to make up for the present value of future cash flow that is $6 billion? 11 billion more than the purchase price?
  • Can the companies agree on who will do what in the combined company?
  • Can companies integrate their systems to drive a smooth transition in the eyes of customers and other stakeholders?

I would advise both companies to work on addressing these questions so that they can move forward together.


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