Business Breakdowns
· 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?
· Geoff Collette
[00:00:00] S1: I think it could be very material. Just to kind of reiterate, the industry is very fragmented. There have been changes and we're in a trough environment that make it difficult and make it that the propensity for folks to want to invest in, enhance their value proposition to be able to grow is very real. And so you'll see announcements somewhat often of smaller brokerages joining really getting from here to 30% market share will require meaningful M&A. They've acquired meaningfully sized brokerages in Tennessee, in Louisiana, the @properties Christie's deal that was very sizable, that came with title and mortgage joint ventures. That multiple was 9 times EBITDA with synergies that are running ahead of plan, that should bring it down to five to six times. In general they're targeting four to six times EBITDA. That could fall to two to three times post synergy, all while keeping OPEX flat. And there's also a dynamic where there are quote unquote walkover situations where a brokerage can shed its costs and join Compass. And so I think that it's a very central part of the go to market strategy. And I think that if you step back and think about the advantages that the company brings, plugging in productive capacity actually has the ability to strengthen the overall value proposition and actually incent more people to join.
· Matt Reustle
[00:00:00] S0: Interesting. And then on the risk side, I guess you just have general macro risks. We talked before about housing market and to the extent that you had major downturns that would obviously impact the business. But is there anything else that stands out? It feels like what they're doing, I wouldn't expect a competitor to try to capture all this money, spend on tech, spend on brokerages, maybe nip at the heels a little bit. But is there any other risk that really stands out to you besides maybe some of the more obvious?
· Geoff Collette
[00:00:00] S1: The foundational assumption is that the agent remains central to the home transaction. I think that in years past there were companies and investments made to disrupt that and that has largely not panned out. Even in a largely digital world, close to 90% of home buyers use an agent in 2023. The listing agent is probably even more structurally sturdy. That 89% reference is up from 83% in 2010. The truth is that residential real estate transactions are an infrequent, high-stakes situation where consumers overwhelmingly prefer expert guidance. I think where there's some risk to this is in a world that has increasing levels of AI capability. But Compass is basically on the verge of arming its agents with AI-powered capabilities that should actually be both offensive and defensive. And so I think that risk is there but has not shown to be overly concerning. Then there's execution risks on just their ability to grow and retain productive agent capacity. They need to continue to deliver meaningful value with technology, training, support, differentiate themselves beyond commissions. The AI functionality here could be very impactful to the overall value proposition and the productivity to agents. M&A, as you referenced before, the execution there matters. I wouldn't say that there's huge amounts of integration risk associated with this, but culturally and operationally, they want to bring on folks who stay and perform. And the other risks are relating to this pre-marketing flexibility. I'd say that the trend has been in the direction of greater flexibility. To the extent that went the other direction, that would not help them differentiate. And then from a macro perspective, housing turnover and home prices are really key. At today's level, around 4 million existing annual home sales, that's a 30-year low. Mid-cycle's about 33% higher. I think that there's a lot more upside than downside there. There could be temporary dislocations, but mortgage rates are important. A recession without inflation could actually help mortgage rates. Consumer sentiment and employment are also key. But I think that we're kind of at a trough cyclical level and so there's a lot more upside than downside from that perspective.
· Matt Reustle
[00:00:00] S0: A lot of points in there. I think the agent retention and attracting the best agents and even the dynamic of having 30% of a market means some agents in the same territory. You can definitely get synergies from working together, but you can have some fierce battles as well over some of these things. But it's an interesting thing to monitor and I think you've teased out the importance of that in terms of their mission really well. This has been very interesting. It's a name I will admit I had a very specific view on and as we've talked more and more, it's opened up my mind into the reality of the situation. But we close out these conversations, as you know, with the key lessons that you can take away. What stands out the most to you from Compass in terms of a lesson or framework that you could potentially apply elsewhere?
· Geoff Collette
[00:00:00] S1: A few thoughts. For a lot of investors, I think residential real estate brokerage triggers an immediate hard pass. Low margins, agent churn, regulatory uncertainty. All of these factors are very understandable. But sometimes downturns reshape companies in ways that are easy to miss. Today, Compass is not the Compass of a few years ago. The housing downturn forced it to find discipline financially, strategically. And the results are pretty consistent of them outpacing the market, growing free cash flow, increasing their margins. Kind of a clear strategy forward that's relatively unique for the industry. The stock is up 4x from its lows. I would say that there's a few questions that come to mind that will dictate the future lessons learned. Has Compass already reached a tipping point where the strategy is already working and it's really just the pace at which it's able to grow? That's the major question mark. Was the downturn for housing the best thing that could have happened for them? How much potential upside do these court cases that it's involved with have for the company? And what's the real downside risk? Has the trough transaction environment created an environment that allows them to stand out even more from its competition, incenting them to join at greater levels than they would otherwise? What other brokerages are really competing on the same terms and how are their trends looking relative to Compass? I'd say long term, if they keep executing the way that they are and the market values it accordingly, does that open the door for larger M&A transactions? And longer term, if there's flexibility on pre-marketing and Compass is able to achieve its stated goals of market share, could it evolve into a home search destination not just an agent platform? And what would the economic situation look like then? Those are the things that I'm watching and I really appreciate the opportunity to have this conversation with you today, Matt.