I’ve been skeptical toward Social Capital Hedosophia II (NYSE:IPOB) stock since it announced its merger with online real estate company Opendoor. From a short-term perspective, that call hasn’t played out.
Indeed, I’ve called SCH II one of the SPACs (special purpose acquisition companies) investors should avoid. Yet IPOB stock has rallied nicely since early November and is challenging all-time highs at the moment.
Admittedly, this has not been a market for skeptics. But from a longer-term perspective, there are still many questions surrounding Opendoor. Competition is intense. The business model is unproven. Valuation looks stretched at best, and extreme at worst.
For growth stocks like IPOB, the market consistently has looked past those questions, as long as the company delivers. And with Opendoor not likely to deliver earnings again until as late as February, IPOB stock (which soon will be Opendoor stock, starting on Monday) can continue to run. If 2021 earnings reports impress, next year’s trading could be strong as well.
So I’m not recommending that investors short IPOB stock. Opendoor isn’t a fraud. It isn’t already doomed.
Rather, the stock seems priced for perfection, like so many other names in the market. And it does seem like if anything less than perfection arrives, Opendoor stock will struggle.
The Monster Valuation Behind IPOB Stock
To look at publicly traded sources, Opendoor’s valuation seems potentially reasonable. SCH II currently has a market capitalization of about $1.35 billion.
But the implied valuation is far higher. SCH II shareholders only will own about 6.6% of Opendoor, according to the merger presentation. Existing shareholders are keeping roughly 79% ownership. Post-merger, there should be about 630 million shares outstanding.
At a current IPOB stock price of $26, that gives Opendoor a market capitalization of $16.4 billion. That is a huge number.
Bear in mind that Opendoor expects revenue of about $2.5 billion this year. 6.5x revenue doesn’t necessarily seem like a big multiple — but Opendoor’s revenue is not all that profitable. The company is targeting EBITDA (earnings before interest, taxes, depreciation and amortization) margins of just 4% to 6%.
To use a comparable from a very different industry, Chewy (NYSE:CHWY) should be able to reach even higher margins. It’s been one of the best growth stories in the market and trades at less than 5x trailing twelve-month revenue.
Opendoor is not cheap. It’s not close. And that seems like a concern given two other risks to the story.
What Does the Market Look Like?
The most obvious risk is that Opendoor’s market remains unproven. The company’s algorithms ostensibly can find the “right” buying and selling prices for real estate — but it will be far from a perfect process. It’s well possible that enterprising customers figure out how to game the system, or that Opendoor suffers occasional (and large) losses as weaknesses in its methodologies are discovered.
In other words, as Opendoor does, that real estate is ripe for disruption. But it may well be that the idiosyncratic nature of most homes, along with the importance of the transaction to buyers and sellers, makes that disruption far more difficult in practice.
If the market is real, meanwhile, Opendoor likely won’t have it to itself. At the moment, Opendoor is the leading “iBuyer” in the U.S. by a healthy margin. But Zillow (NASDAQ:Z,NASDAQ:ZG) is moving aggressively into the space. Redfin (NASDAQ:RDFN) has an offering. So do Offerpad and other startups.
The concern isn’t necessarily that those rivals will knock Opendoor out of its top market share perch. There’s also a risk that the flood of capital into the industry will lead to lower pricing. With EBITDA margin targets topping out at 6%, a point or two of pricing pressure suggests significantly lower peak earnings power. And that in turn suggests a much lower valuation for Opendoor stock.
Those skeptical arguments get to one of the more interesting aspects about IPOB stock: its relation to the market as a whole.
Investors and analysts can question valuation, worry about competition, or hold skepticism toward the long-term model. In this market, those factors simply haven’t mattered. Growth has been rewarded, and whether it’s CHWY or Amazon.com (NASDAQ:AMZN) or Tesla (NASDAQ:TSLA) or Growth Stock XYZ, skepticism has not paid off.
Opendoor may not be much different. Luke Lango argued on this site that the company could become the “future Amazon” of the real estate market, which on the whole is worth $1.6 trillion annually. Lango makes an intriguing argument. Success in buying and selling real estate could allow Opendoor to expand its services, and its revenue potential.
And so, there is a parallel here between Opendoor and other growth winners. Selling IPOB stock because Opendoor is just a low-margin real estate play is like selling AMZN because Amazon was just a bookseller (or later, just a retailer), or selling TSLA because it’s just a car company. It’s the long-term opportunity that investors are buying, and paying up for, even if that opportunity can’t yet be perfectly quantified.
Is This a Bubble?
I’m sympathetic to that case, but I also wonder if the market has taken that case too far. There are risks to that case. Not every company is Amazon or Tesla; not every CEO is Jeff Bezos or Elon Musk.
Meanwhile, at some point, valuation has to matter. Bear in mind that not only is Opendoor valued at $16 billion, but Zillow has added roughly $13 billion in market value just this year. Redfin has tacked on almost $4 billion.
Those gains mean investors are paying a much higher price for any iBuying opportunity than they were 12 months ago. And the gains suggest that the market is minimizing, or even ignoring, the very real risk facing all three companies: that someone is going to be the loser. Maybe it’s Opendoor, maybe not. But at this price, that risk, among many others, just isn’t priced in.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.