Low Margins Make Opendoor Stock a Lackluster Investment

Real-estate tech company Opendoor (NYSE:OPEN) is officially listed on the Nasdaq after completing its merger with SPAC Social Capital Hedosophia II. It has raised approximately $1 billion from the transaction, which it will use to fund its development plans. Many would consider this a perfect time for Opendoor stock, amidst a booming American housing market.

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Despite the euphoria surrounding its merger, Opendoor stock remains a speculative play with thin margins and sluggish revenue recovery.

Opendoor is essentially a digital platform that provides an online marketplace for buyers and sellers of various properties. Additionally, it also provides financing services to buyers. It provides a frictionless experience for its users and aims to minimize as many costs as possible.

Last year, 18,799 homes were sold on its platform, which helped generate roughly $4.7 billion. The massive revenues last year represent a 161% increase from the prior-year period.

Hence, the company has massive potential to disrupt the real estate industry, but there are weaknesses in its business model that need to be addressed. Its mounting losses are another problem, and it would have to increase its margins to break-even in the near future.

Understanding Its Business Model

Opendoor’s business model revolves around flipping properties to earn a profit. It is unique in the sense that apart from letting sellers list their properties, it makes offers to buy those properties based on a calibrated price.

The company then refurbishes the house and sells it after a few months. However, its majority income comes from the commission fee it charges its sellers on the gross purchase price.

The company purchases the properties based on a specific price it computes using its unique proprietary pricing algorithm. This algorithm evaluates 145 features of a particular property and compares it with several variables such as market data and underwriting information to arrive at a price.

Though the business model looks interesting, I have a few concerns which raise questions about its sustainability. Foremost, the pricing system gives a negative incentive to Opendoor in convincing the buyer at the calculated price. The company could use selected information in arriving at the results from the algorithm.

Moreover, most sellers would want to test the open market, which further limits the attractiveness of Opendoor’s valuation.

Path to Profitability

Since it was founded, Opendoor has racked up over $900 million in losses. Many believe that its business model makes it incredibly tough to generate healthy margins.

The company’s gross profit margins had dropped from 9.3% in 2017 to 6.3% last year. However, if you subtract holding, financing, and selling expenses, it leaves a significantly low contribution profit for the company.

Margins should improve once the company cross-sells services and builds economies on the purchasing side. The company states that it could generate roughly $458 million in contribution profit by 2023. That equates to a margin of approximately 4.7%, which is still exceptionally low.

Opendoor is targeting a long-term EBITDA margin of 4% to 6%. With Opendoor heavily relying on debt financing in purchasing inventory, such margins are incredibly thin. Moreover, such a highly levered company is susceptible to weaknesses in its external environment. For example, a housing crisis or rising interest rates could easily wipe away its thin margins.

Bottom Line on Opendoor Stock

Opendoor plans to disrupt the real estate market through its robust platform, which painlessly connects buyers and sellers of various properties.

Its house flipping business model is a novelty in the sector with a lot of scope for expansion. However, its intermediary business model carries minuscule margins, which complicates its path to profitability. Its margins are also highly susceptible to external forces. Therefore, Opendoor is a speculative stock at best with a bleak future, at least in the near-term.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article