The stock for real estate services company Redfin (RDFN +0.00%) has been on a wild ride over the past three years. At its peak in early 2021, the stock reached a market cap of $10 billion, but it has since fallen 95% to $547 million. While that 2021 high was artificially inflated by overall market exuberance, today's market cap is significantly lower than the company's average during the years leading up to the pandemic.
There's no doubt that part of Redfin's fall from grace is due to business performance, but it could be argued that the market has overreacted. This is especially true recently as management made some important decisions that could reverse the company's fortunes in 2023.
Exiting the iBuying business
Started in 2017 as an experiment and expanded in the years since, RedfinNow was the company's iBuying business. The iBuying business model is simple: Homesellers take a cash offer from Redfin, and the company tries to flip the house for a profit. The homeowners take a bit less money for the sale of their house in exchange for the speed and convenience a quick sale offers.
NASDAQ: RDFN
Key Data Points
The third-quarter results, reported in November, showed how much of a drag RedfinNow had become on the business results. Redfin reported a net loss of $90 million, and its adjusted loss of $51 million based on earnings before interest, taxes, depreciation, and amortization (EBITDA) was worse than the company's guidance.
These shortfalls were attributed entirely to RedfinNow. That segment of the business is now expected to post a gross-profit loss between $22 million and $24 million for the full year.
With rising interest rates already cutting into what homeowners can sell their homes for, the incentives for taking less money via iBuying have dried up. This is the primary reason for the decision to close the RedfinNow business. Management expects to have the remainder of its inventory sold by the second quarter of 2023.
Focusing on the core business
With the closing of its iBuying business, Redfin can focus on the core business that has made it successful over the years. It has been a disruptive force in the real estate industry, most notably by employing its own agents and charging home sellers a commission in the range of 1% to 1.5%, rather than the 2.5% to 3% most other companies charge.
Redfin also added a mortgage origination business as well as title and settlement services, making it a one-stop shop for real estate transactions.
Third-quarter results for Redfin were mixed. Revenue increased 11% year over year to $601 million, which was above the low end of the company's guidance. Breaking that down further, real estate services revenue was $212 million and properties revenue was $300 million. Both of these figures were also within the range of guidance given.
On the bottom line, it was a different story. The third-quarter net loss of $90 million was significantly worse than the year-ago net loss of $19 million and was lower than the company's guidance. This was largely due to the properties segment selling through inventory at unfavorable prices.
Why there's a reason for hope
The good news about these net losses is that they should be temporary now that the company is closing the RedfinNow business. In fact, management expects to make significant progress toward profitability in the next two years. The company expects to generate positive EBITDA in 2023 and net income in 2024.
There were bright spots in the third-quarter results that can serve as indicators that improved profitability is a realistic goal. For starters, operating expenses as a percentage of revenue dropped to 24%, an improvement of 350 basis points from the year-ago period.
Engagement and market share also continued to improve. Average monthly visitors rose by 3% and U.S. market share by units grew 2 basis points. At first glance, these might seem like modest gains, but considering the environment, they're more impressive than they appear.
Redfin's gains in monthly average visitors also led to an increase in the company's share of listing-search traffic. This is important because growth in search share is Redfin's most reliable indicator of transaction-share growth.
These slight improvements mean home sellers and buyers continue to use Redfin, even as the housing market slows. Management believes that in a difficult housing environment, the company's growth will come primarily from taking share from other companies. In an environment where sellers and buyers are looking for cost savings, the company's lower commission rate could be a compelling reason for customers to use it over a competitor.
Why is Redfin stock undervalued?
All the uncertainty with the housing market, Redfin's results, and the overall bear market have absolutely hammered the share price. While there are certainly risks with the stock, the market might be overreacting and taking a short-term view of the company's potential.
There are also some balance-sheet concerns. As of the third quarter, the company had $1.2 billion in convertible senior notes. This could be dilutive to shareholders down the road.
There's almost no growth baked into the current share price. At recent prices, Redfin trades for roughly 0.9 times 2019 real estate services revenue. Even with the risks, that seems deeply discounted to me. At this valuation, the risk-reward balance is compelling enough to view today's share price as wildly undervalued.
