The Catch-22 Behind The Path To Profitability for Compass
Compass continued the industry’s first-quarter-earnings winning streak on Wednesday with $1.1 billion in revenue, thanks to a booming housing market stoked by low mortgage rates, robust buyer demand, and historically low inventory.
Its agents, backed by the company’s support staff and its end-to-end technology platform, increased transaction sides 67 percent year over year for a 1.4 increase in market share from Q1 2020.
Even with increased sales volume, transaction sides and agent count growth Compass is far from profitable — the earnings revealed a $212 million net loss and $942 million in commissions and other related expenses, both of which included stock-based compensation from the IPO, reveal an arduous path to profitability that puts CEO Robert Reffkin in a catch-22.
The battle between keeping agents and cutting expenses
“There’s this real and present danger that Compass’ path to profitability is directly at odds with its ability to retain agents,” real estate analyst Mike DelPrete told Inman. “[To reach profitability], Compass would have to close down some of the fancy offices, cut some of the perks, get rid of some of the technology and all this stuff that makes the company so attractive to agents.”
“Those things are appealing and they’re expensive,” he added. “They also have to reduce their commission splits, and reduce the bonuses and reduce the agent support and marketing. Those things are what make Compass so appealing to agents.”
Despite Compass closing the gap on year-over-year net losses in Q1, DePrete said they’re actually on track to be more unprofitable than last year. “Compass is the most unprofitable real estate brokerage in history,” he said while noting the company’s consistent cash infusion from investors, most notably SoftBank, that’s allowed them to spend with abandon.
“Compass lost almost as much money in Q1 2021 as it did in ALL of 2020 — $212 million vs $270 million,” he explained. “Granted, a big portion of that is stock-based compensation related to its IPO, but that just goes to show that stock-based compensation is an actual expense and not some sort of accounting anomaly you can simply exclude from your financials.”
Although DelPrete said the path to profitability is paved with budget cuts, WAV Group Consulting Founding Partner Victor Lund said Compass’ net losses are necessary for their long-term success.
“[Compass] has to continue to become a welcoming environment for top-producing real estate agents. [They’re] going to continue to have pretty massive growth and as [they] grow, the cost and overhead of that infrastructure depreciate and the margins go up a lot.”
“I know they’re losing a little bit of money today,” he added while noting the company’s Non-GAAP net loss is $64 million. “I think that’s planned because [they’re] trying to grow. [They’re] investing today for a long-term win and they’re definitely in a competitive position for a very young company.”
“I would say that as the company continues to mature and agents gain confidence with the services they provide in the market, that they’re going to be able to onboard agents for a lot less money in the future.”
Compass’ multiple paths to profitability
Lund said Compass’ value proposition, which includes staff support, its end-to-end platform, and foray into ancillary services such as title and mortgage, is the key to maintaining its impressive agent retention and productivity rate. That, alongside continued tech investments and acquisitions, is important to its eventual profitability.
“A lot of people haven’t seen the full brilliance of the technology roadmap for Compass — it takes a long time to build an ecosystem that’s going to support agents and teams, and that’s their focus,” he explained. “They’re putting a lot of money into that and where the opportunities exist to acquire technology companies that get them there faster, they do it.”
Meanwhile, DelPrete said it’s unlikely Compass’ technology or push to add ancillary services will be the deciding factor in the brokerage’s trajectory. “Don’t get me wrong. I’m not anti-Compass. I’m an independent researcher,” he said. “But there’s nothing really special under the hood that Compass talks about in its public filings or in its strategy.”
“I mean, from a business model standpoint, it’s just Realogy with a different logo, right?” he added while noting the company’s mortgage and title strategy with KVS Title could be a fool’s errand. “It’s going to try to sell people mortgages and title insurance, but like other companies have been doing that for a decade and we know exactly how that’s gonna play out.”
“It’s like if you open up a restaurant, and you said, ‘Oh, we’re going to start making more money by selling people appetizers, and I’d say, ‘Well, Marian, restaurants have been selling people appetizers for years now.’ That’s nothing new,” he continued. “Those Compass real estate agents already benefit from mortgage and title people they know and trust. They’re not going to drop them for Compass’ platform.”
For DelPrete, Compass’ path to profitability, outside of learning to balance agent retention and reducing expenses, lies in offering exclusive listings and content.
“In the same way Disney and Netflix and Apple TV are spending a lot of money developing exclusive content for their platform so consumers subscribe, Compass is kind of doing the same thing through this whole pocket listings loophole,” he said. “Compass has ‘Coming Soon’ listings and they have exclusive listings that are only available on compass.com or through a Compass agent.”
“[Those listings never hit the MLS. They never get advertised anywhere else and they never reach Zillow or Redfin — it’s exclusive content that you only get by going to Compass,” he added. “Right now nationally, about a quarter of Compass’ listings are exclusive to Compass, and if you look at one of their biggest markets, San Francisco, about 45 percent of their listings are exclusive.”
Again, DelPrete said, exclusive listings present another catch-22 with consumers. “If Compass can create a pull where people come to them and they don’t go to Zillow, or they don’t go to the MLS that gives them power. But that’s kind of anti-consumer, right? But I mean, this is what capitalism is — if it’s good for companies, it’s not necessarily good for consumers.”
Compass’ not-so-secret Wall Street weapon
Even though DelPrete and Lund disagree about Compass’ path to profitability, there’s one thing they agree on: Robert Reffkin’s power as a CEO.
“I’m independent, I’m unbiased, and I don’t invest in any of these companies,” DelPrete said. “But, Compass’ strategy is brilliant, right? They figured out how to get SoftBank to give them a billion dollars to play around with.”
“This is Wall Street 101. It’s a roll-up strategy. They can acquire all these parts and through great storytelling, a great narrative, and a charismatic founder, they can make the sum of the parts worth more than the parts are individually,” he added. “It’s brilliant.”
Lund said Reffkin’s intelligence and uncanny ability to “work the market” is reflected in analysts’ confidence in Compass, despite the company’s rollercoaster stock market performance, which experienced a third-consecutive all-time low $13.66 per share at closing on Thursday.
“The market is operating irrationally right now,” he said of the dipping trading results of multiple real estate brokerages over the past two weeks. “Outside of that, [a number of] companies are writing research on Compass and they are getting a lot of play, which is pretty unique.”
“If there was one person that I would want to represent my public company, out of all of them, I think that Robert is in a good spot — he works the market, he’s the golden guy, and I think that’s gonna pay dividends for them. It’s, it’s a unique skill,” he added. “What a CEO says to market makers and how they report their earnings, allows those market makers to inform consumers that are investing in them.”
When will Compass reach profitability?
Lund said Reffkin’s skills as a leader alongside Compass’ performance even with net losses, have resulted in high investor confidence. Compass IPO underwriters Morgan Stanley and Goldman Sachs released reports in late April that revealed the company could reach profitability as soon as 2025 and as late as 2030.
Both firms’ projections are based on the continuation of skyrocketing home sales, Compass’ expanding market share, the maturation of its agent cohorts and addition of new agents, the launch of adjacent services, and increased gross transaction value. With that in mind, Goldman Sachs expects Compass to report a profitable adjusted EBITDA by 2023.
“Goldman Sachs is indicating the company has a 12-month target of $32 a share,” Lund added. “Morgan Stanley gives a 12-month range, but they’re targeting 26. But if you’re a bull, $36 per share.”
DelPrete said he’s skeptical of Morgan Stanley, Goldman Sachs and other investment firms reports, especially if they were part of Compass’ IPO. “The thought that Morgan Stanley has an idea as to what’s going to happen in 2030 is laughable. Like, nobody has any idea what’s going to happen in 2030,” he said.
Some of the nation’s biggest companies took years to become profitable, he said while noting Zillow just became profitable after almost 17 years. Like Zillow, DelPrete said Compass could bide its time with investors through effective storytelling and marketing while they work out their finances.
“Amazon was unprofitable as a public company for four or five years and now it’s profitable, and Tesla was unprofitable for nine or 10 years and now it’s profitable,” he said. “So let’s see what happens. I don’t know when Compass will turn the corner. I mean, this is the magic of Wall Street and investors.”
“People love a good story and Compass tells a good story,” he added. “Zillow has proven that you can lead people along with a really good story and be unprofitable. You can paint this future vision that’s really exciting, that’s about growth and how you can get in the transaction and make more money.”
He concluded, “You can do that for quite a while in real estate, but I don’t think you can do it forever.”
What lies ahead for Compass in 2021
In Q2 2021, Compass expects a revenue of $1.5 to $1.6 billion with an adjusted EBITDA of $10 million. For the full year, it expects a revenue of $5.35 to $5.55 billion with an adjusted EBITDA of $225 million.
Lund said Compass is underselling their performance for the year. “Maybe they’re just cautious because there’s a lot of uncertainty in the market, but the momentum in the housing market is actually increasing from Q1 to Q2, which we would expect,” he said.
“The interesting thing about Compass is that, like all real estate companies, it doesn’t matter whether it’s a buy-side market or a sell-side market. They are in the volume business, and right now, we’re seeing a surge in volume,” he said. “After the last downturn, consumers really took a long time to become confident in the real estate market and that confidence should have a long run.”
Meanwhile, DelPrete said there’s no way of predicting exactly where the market will go, as evidenced by the two main factions of people who either believe a crash is imminent or the industry will continue to ride high against headwinds. However, he said he’s sure the current pace can’t last forever.
“I have no idea what’s going to happen to the housing market, but what’s happening now and over the past couple of quarters has been unprecedented, once in a generation activity,” he said. “You’ve seen all-time highs in terms of the financial results for real estate companies, whether it’s Keller Williams, Realogy, Zillow or Redfin.”
“But that can’t continue. This is a blip,” he added. “So in the same way that a rising tide lifts all boats, a receding tide is going to bring all those boats back down to reality.”