Bull markets and low interest rates can make the stock market irrational. Anyone who has been following stocks for the past five years knows this all too well, with pre-revenue "businesses" routinely getting multibillion-dollar valuations. There were 613 special purpose acquisition companies (SPACs) that went public just in 2021 -- almost two per day! Most of these stocks have lost shareholders' money and are significantly underperforming the market.
Opendoor Technologies (OPEN -6.41%) went public via a SPAC in 2020. The real estate start-up pitched itself as a technology company, but all it was doing was buying and selling residential real estate directly from consumers, otherwise known as home flipping. That's not exactly a revolutionary new technology. Now, with the housing market stagnating after mortgage rates doubled over the past year, the cracks are continuing to widen on Opendoor's financial statements.
Opendoor's business model looks broken. Can the company fix it?
Q1 earnings: More of the same
Since Opendoor's business is just buying a home from someone and then (hopefully) selling it at a higher price, it only earns a tiny slice of its revenue as gross profit, giving it a slim gross margin. At the peak of the 2021 housing boom, the company sported a gross margin of 12%. Last quarter -- the first quarter of 2023 -- gross margin fell to just 5.4%.
Combine this margin contraction with revenue declining 39% year over year in Q1 and Opendoor's gross profit generation has fallen off a cliff, generating just $170 million last quarter. After accounting for $188 million in marketing spending, $66 million in overhead, and $40 million in technology development expense, Opendoor posted an operating loss of $124 million in Q1. Over the last 12 months, Opendoor's operating loss was over $1 billion, an all-time record for the company since going public.
OPEN Operating Income (TTM) data by YCharts
Opendoor has not proven adept at buying homes with its algorithmic model. The company continually takes losses and write-downs on the real estate it purchases, even with low interest rates and the work-from-home catalyst spurring buyer demand in 2020 and 2021. Now, with these tailwinds turning into headwinds (high interest rates and a normalizing housing environment coming out of the pandemic), it is going to be much harder for Opendoor to earn a positive spread on its home-flipping operation.
Things could get even worse if housing prices start falling in the United States, which many forward indicators are pointing toward over the next few quarters. On top of a housing market that is turning over, Opendoor is going to struggle with rising interest rates affecting the cost of its debt facilities, which is what it uses to fund real estate purchases. Combine these two factors (high interest rates and declining home prices) and it feels likely Opendoor's losses will only get worse from here.
Where does the company go from here?
It is hard to see a path to profitability with Opendoor's current home-flipping business model. The company failed to generate a profit during a historic housing boom in 2021, so why would it start generating a profit with interest rates soaring and the housing market turning over? Of course, management could pivot and completely change the business, but there's no indication this is happening yet, and that's entirely unpredictable. Either way, betting on a pivot is a silly reason to invest in a stock.
Honestly, the best move for shareholders may be for Opendoor to just liquidate its balance sheet. It has a book value of over $1 billion once you net out its cash, real estate inventory, and debt, compared to a market cap of $1.6 billion. If management decided to stop buying homes and liquidate its inventory, it could return some cash to shareholders and close up shop. Because if it continues down this path of destroying hundreds of millions in shareholder value each year, this stock will eventually be worth zero.
