Real estate technology companies Opendoor Technologies (OPEN -0.23%) and Zillow Group (ZG -1.84%) recently made headlines when they announced a multi-year partnership to work together.
The two companies were former rivals in the iBuying space before Zillow pulled out of the race late last year. Wall Street seems skeptical of Opendoor's business, judging by the share price. Here is why Zillow is quietly betting big on the company's long-term future.
Why would these two work together?
Both Opendoor and Zillow competed in iBuying, but the two companies are fundamentally different. There are two sides to a housing transaction: the buyer's side and the seller's side. Zillow has long ruled the buyer's side; the company's mobile apps and websites had a combined 234 million unique monthly active users just in the second quarter of 2022. Just about everyone has probably browsed homes on Zillow at some point.
Opendoor sits at the other end of the transaction. Its iBuying business has become a hit with sellers, prompting Zillow to enter the iBuying space in 2018. Opendoor made 78K home offers in 2017, which exploded to 2.1 million by the end of 2021.
Each company has tried to become a one-stop-shop for real estate, which would mean offering solutions for both the buy and sell sides of a transaction. Zillow tried getting into the sell side with iBuying, but infamously quit because it incurred massive losses. Opendoor's working on growing its buyer-side services, but it's way too early to judge its success, and it comes nowhere close to Zillow's reach.
In that respect, the partnership makes a lot of sense. Zillow will offer an opportunity for its users to get an Opendoor offer on their homes, and Opendoor will pay a fee for the business Zillow brings it. Zillow's happy because users can work through a Zillow agent, which keeps users in Zillow's ecosystem. Opendoor is satisfied because it gets an enormous boost in eyeballs, helping it further establish its footprint in the industry.
The vital detail most miss
The partnership passes the sniff test for common sense, but the little details make things interesting. Opendoor is giving Zillow equity in the business as part of the deal, which has a five-year term.
Specifically, Opendoor gave Zillow stock warrants, which are the right (but not the obligation) to purchase shares for up to 6 million shares of Opendoor. The warrants go by a weighted average share price over 30 days, meaning the stock has to sustain a price and can't be a fluke price movement, with a floor of $15 per share and a cap of $30 per share.
In other words, Zillow is betting that Opendoor's share price will exceed $30 per share by the end of the agreement -- otherwise it wouldn't be any different than purchasing the shares on the open market.
How much upside is there in the stock?
The stock trades at a little over $6 per share today, so you can calculate the potential upside that Zillow is banking on. If the stock took the full five years to hit Zillow's target price of $30, investors would enjoy 38% annual returns between now and then. Remember, Zillow is betting that the price will be higher than that!
Such a rise will probably outperform the broader market by a solid margin, so Zillow doing the partnership on these terms speaks volumes about its belief in Opendoor's long-term direction. Now it's up to Opendoor to endure the volatility of today's market and continue executing its long-term plan to expand across the United States.
