The internet-based real estate brokerage Redfin filed its IPO last week, and the question investors are asking is: “Will the third consumer internet IPO this year be a hit or a flop?” So far, trading trends in consumer internet IPOs haven’t been encouraging. Snapchat shares are down 40 percent since its first day of trading, and Blue Apron may no longer remain a “unicorn” (its shares have declined almost every day since its down-round IPO). One common thread among these IPOs has been a continued high cash burn. Clearly, these companies seem more concerned with satisfying their capital needs than their valuations. We expect a number of similar companies relying on “people powered with technology” to go public. This cohort includes ride-sharing, home-sharing, and last-mile delivery companies, among others. Thus, we will be closely watching Redfin to gauge investor appetite and sentiment surrounding these types of companies.
We have gathered a series of data points, including Redfin’s cap table and mutual funds holding Redfin shares, on the SharesPost platform. Below, we illustrate Redfin’s cap table waterfall. For more information, please log on to your SharesPost account.
Source: SharesPost Research; Based on certificate of incorporate as of May 11, 2016; Excludes common stock split announced as part of the IPO filings.
What’s to Like About Redfin? Redfin has been around for almost 15 years. Founded in 2002, and subsequently rebranded as Redfin in 2006, it has a straightforward business model. Its management team has been recession-tested, and they have demonstrated a steady execution in line with their original mission: to redefine the buying and selling of a home. Redfin addresses a large market opportunity that is currently served by a fragmented army of agents and brokers with limited technology. Redfin’s agents are four times more productive than typical real estate agents – and this productivity implies a sustainable competitive advantage driven by technology. At the high end of its IPO price, Redfin would be worth $1.13 billion. Assuming a mid-40-percent top-line growth rate in 2017 (with slight acceleration due to its Redfin Now service), followed by a slight deceleration to mid-30-percent revenue growth in 2018, we anticipate a revenue multiple of 2.0x to 3.0x. This falls substantially below Zillow’s revenue multiples, which were in the 7.0x and 8.0x range. We believe the primary reason for such a valuation discount – despite Redfin’s arguably higher expected revenue growth – is Redfin’s structurally lower potential profitability. In the charts below, we compare a series of financial metrics; apart from Redfin’s expected revenue growth, the key metric that will likely drive near-term valuation multiples is that, in the most recent quarter, Redfin’s gross margin was 11 percent, while Zillow’s exceeded 90 percent.
SharesPost Research; Estimate 45% growth in Redfin revenues in 2017 and 35% growth in 2018; Assume Redfin IPO price at high-end of the pricing range
Where Could It Go Wrong? Redfin’s ability to grow significantly beyond its private valuation depends heavily on its continued execution in its core target market. Most crucially, a premium valuation rests on the assumption that Redfin will continue to grow the number of real estate agents and consumers on its platform, as well as the engagement levels between consumers and agents. If Redfin is successful on these fronts, that will indirectly help the company with operating costs and pave the way to profitability. However, the risk lies in the fact that Redfin competes with larger, well-capitalized players, including Zillow, Realogy, RE/MAX, and Coldwell Banker. Competition may lead to substantially higher marketing expenses. Furthermore, Redfin’s potential profitability margin is structurally below its peer, Zillow, largely due to real estate agency costs. In addition, Redfin’s end market – U.S. home sales – is inherently cyclical in nature. We are arguably moving towards the tail end of the current growth cycle, so Redfin needs to layer on peripheral revenue streams to mitigate the risk posed by an impending recession.
What Does the Redfin IPO Tell Us About the Private and Public Valuations? During the second quarter, there were seven VC-backed tech IPOs, a clear uptick from the prior several quarters. On a YTD basis, there have been ten such IPOs. Of those, four have been down-round IPOs, and the rest have priced at or above their respective private valuations. If Redfin prices at the high end of its IPO pricing range, it will receive a roughly 35 percent premium to its most recent private valuation. In the chart below, we illustrate the premium or discount of IPO valuations compared to their private valuations. We estimate that roughly one in six VC-backed tech companies that go public do so with a haircut to the private valuation. Put another way, the proportion of down-round IPOs has increased in 2017. All in all, a valuation reset approved by a relatively efficient public market could be a healthy sign for the company and the overall VC ecosystem. Nonetheless, we continue to believe that the IPO window is wide open, given the recent uptick in both offerings. In fact, we’d argue that a lukewarm reception to the class of 2017 IPOs could drive other VC-backed unicorns and CEOs to test the public waters soon!
Source: SharesPost Research; Assume Redfin IPO price at high-end of the pricing range
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