Business Breakdowns
· Geoff Collette, Matt Reustle
[00:00:00] S1: I would probably just frame it as it could be extremely lucrative for founding agents in a market. And there were often multi-year financial incentives that were part of the conversation in the early days of Compass being a public company that needed to expire effectively. And that was the concerns around what that would mean to the model were very front and center from an investor's perspective in 2021-22 for Compass, because no one knew what the level of retention and really what the stable level of commissions that would enable the company to continue to attract agents would be. And so I think that resolved in that downturn environment that we spoke of earlier and has remained in kind of a healthy place. Just to reiterate something, I think ultimately, what they can do is go to market with competitive splits against traditional brokerages that offer support but provide extra value that others have difficulty replicating. [00:00:00] S0: Rather than just compete on price in theory, for your talent, it makes a lot of sense. On the mechanics of commissions, I know it differs from one brokerage to the next, but are there tiers like your first 1 million in commissions are at this rate, above that they're at this rate? Is there any change just in terms of how the commission structure works in one direction or the other?
· Matt Reustle, Geoff Collette
[00:00:00] S0: Rather than just compete on price in theory, for your talent, it makes a lot of sense. On the mechanics of commissions, I know it differs from one brokerage to the next, but are there tiers like your first 1 million in commissions are at this rate, above that they're at this rate? Is there any change just in terms of how the commission structure works in one direction or the other? [00:00:00] S1: There certainly are tiers at certain players in the industry. I think it can actually be pretty bespoke by agent and by the level of volume that they do. The frame of reference for Compass is just, I think they publicly stated there's a 9 percentage point differential between certain bands. That is really the way to think about the mix shift over time. [00:00:00] S0: Makes sense. You mentioned before free cash flow generation in recent quarters or years. What does the operating leverage look like for this business? Because I think it had the connotation of taking in a lot of capital, spending that capital and then some. Seems like there's been some inflection. But is there inherent operating leverage in the business? How do you frame that or think about that as an investor? And if you want to put some numbers to help explain or contextualize, that's helpful.
· Geoff Collette
[00:00:00] S1: For 2025, the free cash flow margin, percent of revenue will be roughly 3% for the business. Roughly $1.2 billion in gross profit this year. That's at a high teens margin. And there's roughly a billion dollars in OPEX. And that includes almost $200 million of annual technology spend. I think it's actually somewhat easy to contextualize the operating leverage and the trajectory of the company based on the discipline and framework that they've put around it. So they've committed now for I believe several years at this point and into the future to keep OPEX growth at 3 to 4% annual increases. And there's just inflationary dynamics that feed into that. This quarter they actually announced some cost savings that while somewhat moderate, flow directly to the bottom line and can be meaningful to profit dollars. I think that they really found religion around cost discipline in 2022 and there's actually more potential for this over time. Just think about the use cases around document processing of transactions. There's a good amount of human intensity as it relates to this that could come out of the system over time with the advent of new technology. And it's also worth noting that they've acquired a company called @properties that came with Christie's business. They generate a high single digit EBITDA margin and they're really great operators. And so I think the idea really is Compass can be the low cost operator for owned brokerage. And I don't think that investors really think of Compass in this way. And then just depending on the rate of growth with production basically at that high teens margin, which can grow with the mix shift in agents as well as the attachment of title and escrow and potentially mortgage over time, the incremental free cash flow margins can be in the double digits and that can make it such that not too high levels of growth can result in very rapid free cash flow growth.
· Matt Reustle
[00:00:00] S0: Yeah, it's very interesting when you find these inflections or trajectories that are clearly moving in a different direction than they were once in on that 2 to 3% OPEX growth and more. Looking at the technology spend, does that encompass what you were mentioning at the very beginning in terms of investing in the technology for the platform? I don't know where this would fit, whether it would be in an OPEX line, a CAPEX line, wherever it might be. But how do you frame that and the capital that still needs to go towards that effort of technology investment?
· Geoff Collette, Matt Reustle
[00:00:00] S1: So it's that close to $190 million line that's inclusive of investment in new capabilities. I think what's important to understand about that is the industry is at a trough level and there's been this trend in commission splits and just the level of scale necessary to invest that makes it such that they stand alone in their ability and their stance on investing. And so others are really starved in an ability to do that and really don't have a structure to even do that. It's really a hodgepodge of third party software tools. I think where this is going for Compass is actually potentially really exciting because they own all the software that's all interconnected and all of the data which makes it such that they've announced some capabilities around AI that are in beta stage that can actually end up taking on a lot of the manual tasks that an agent will do and even proactively suggest next best actions that can transform the agent's day to day life in a manner that could be very differentiated and hard to replicate by others in the industry. [00:00:00] S0: Yeah, very interesting. I should have looked this up beforehand, but I have to ask, with this particular cohort of businesses, stock based compensation is always a focus. What does that look like here? Is it point of contention from the market? Where does that stand?
· Matt Reustle, Geoff Collette
[00:00:00] S0: Yeah, very interesting. I should have looked this up beforehand, but I have to ask, with this particular cohort of businesses, stock based compensation is always a focus. What does that look like here? Is it point of contention from the market? Where does that stand? [00:00:00] S1: Where it stands is it's basically a fixed cost now in the business and their approach to it is very similar as overall OPEX such that it shouldn't grow that materially from here on out. What that means is free cash flow per share should be very attractive. The name of the game for them is really bringing on productive capacity. They've designed their business now in a way where they can bring on agents, teams, brokerages, the franchise affiliate model. They kind of welcome folks joining their platform in any way that best fits them. It's that pace of gross profit, profit growth over the relatively fixed cost base, including the SBC. That's the framework here. [00:00:00] S0: In terms of the growth and achieving some of those numbers that you laid out before about that 30% in the 30 markets you have organic. Your agents continue to chop more wood and capture some of it. But it sounds like M&A has been a part of the DNA here for a while. How much of the growth story do you expect to come from acquisitions of brokerages, brokerages, houses, whatever it might be in terms of how they target?