Compass touts its tech prowess to justify an IPO likely to seek over $10 billion. But analysts think it's just a plain old real-estate brokerage.

  • Compass, a residential real-estate brokerage, is seeking a blockbuster IPO of at least $10 billion.
  • On Monday, the firm released its S-1 filing, revealing it lost $1 billion in the last five years.
  • Analysts said they doubt the company’s tech-startup claims, high valuation, and path to profitability.
  • Visit the Business section of Insider for more stories.

The residential real-estate firm Compass followed a well-worn script for success in the startup world.

It raised hundreds of millions of dollars, including money from major venture capital backers like Softbank, grew rapidly, and touted that its technology platform had upended the staid business of brokering homes sales.

It also — like other young companies that have sought lofty IPOs before it — hasn’t earned a dollar of profits.

On the cusp of that much-anticipated public offering, Compass will now test the bounds of a frothy market and the willingness of investors to continue to lavish heavy premiums on companies that bill themselves as technology firms.

Analysts worry, however, that Compass’ financial performance invites comparisons to another Softbank-funded company, WeWork, whose IPO in 2019 was derailed. Both companies have boasted of unique tech tools, best-in-class operations, and access to growth in lucrative ancillary businesses. But both remained stubbornly unprofitable despite scaling their revenue. (In recent months, WeWork suggested that it will again attempt to go public.) 

In private funding rounds, Compass rose to a roughly $6.5 billion valuation. It has lofty ambitions to significantly exceed that sum in an IPO, a value that would far exceed traditional brokerage businesses that some analysts see as its closest peers. 

“Maybe there is real tech there, but Compass has more of the qualities and attributes of a legacy, incumbent brokerage than a revolutionary new platform,” said Tom White, a senior research analyst at D.A. Davidson who covers public companies in the residential sales industry. “We can all debate the future of brokerage, but there are other companies that have more of the elements of what that is likely to be than what Compass has today.”

Compass declined to comment for this story.

Outsize ambitions persist despite outsize losses

Founded in 2012 as Urban Compass by Robert Reffkin, a former Goldman Sachs executive, and Ori Allon, a technology entrepreneur, the company charted a meteoric rise in the ultra-competitive business of selling residential real estate.

In an S-1 filed with the Securities and Exchange Commission on Monday, Compass stated that its revenue rose 20 times from 2016 to 2020, from $187 million to $3.7 billion, and calculated that its market share grew fourfold to 4% of US home sales by dollar volume between 2018 and 2020. With roughly 19,000 agents, it has significantly outgrown rival brands such as Corcoran, Douglas Elliman, and Sotheby’s that have dominated the residential brokerage business in major urban markets for decades.

Compass has not yet disclosed what valuation it will seek in its IPO, but most observers believe it will be an eye-popping sum closer to solidly tech-focused firms like the $30 billion plus listing platform Zillow that apply their know-how to real estate, than brokerages that simply use tech to boost business. 

“Certainly IPOing at $6.5 billion would be a failure,” said Clelia Peters, a investor in real-estate tech startups and a board member for Side, a rival brokerage platform. “They need to be at $10 billion at least. Even that would be good, but not great.”

One source suggested that Compass would seek a valuation as high as $20 billion, although that figure could not be immediately corroborated.

Even a $10 billion value would be major premium to brokerage competitors such as Realogy, the owner of brands like Corcoran and Sotheby’s, which has nearly double the revenue of Compass and a market capitalization of around $1.7 billion.

Of particular concern for investors is the way Compass has scaled profit-erasing expenses seemingly as quickly as it has grown revenue. Compass lost $270.2 million in 2020, $388 million in 2019, and about $1.1 billion since its founding in 2012, according to its S-1. The company laid out an uncertain runway to profits.

“We expect that operating losses and negative cash flows from operations will continue in the foreseeable future as we continue to invest in the expansion of our business, research and development, and sales and marketing activities,” the S-1 said.

The S-1 also said that the company is beginning to create economies of scale and control costs, citing a “decrease in sales and marketing expense as a percentage of revenue in 2019 compared to 2018.”

The company pays brokers handsomely, which eats up 78% of its revenue

The company’s largest expense, however, appears unavoidable: large commission payments to its brokers, which totaled over $3 billion in 2020.

Ironically, observers credit the company for touching off a bidding war for top brokerage talent that likely exacerbated the size of the commissions it has had to pay out. To lure agents from other major firms, Compass granted richer splits, allowing brokers to keep a larger share of their commissions while funneling away potential proceeds for the company.

“In 2016, Compass paid out 78% of its revenue in commissions,” said Tommy McJoynt-Griffith, an analyst with Keefe, Bruyette & Woods. “By 2020, it’s up to 81% as the commissions have become more favorable.”

McJoynt-Griffith added that it will be difficult for Compass and other brokerage firms to walk back those lucrative splits without losing top-earning agents and damaging revenue.

Meanwhile, the nearly $100 billion pool of commissions nationally has been shrinking as disruptive brokerage platforms such as Redfin have begun to charge lower rates, creating competitive pressure for rivals to cut their own fees.

“Five to seven years ago, the industry average commission a home seller would pay would be around 6%,” White said. “Today it’s closer to 5%.”

Compass has touted its tech, but its peers have similar tools

Compass has said its tech allows agents to become more efficient and productive, which some potential investors may read as a pathway to scale revenue enough to begin to achieve profitability. The company said in its S-1 that its brokers were able to complete 19% more transactions in their second year versus their first with the company and sell homes 21% faster.

Compass’s description in the S-1 of exactly how its platform surpasses rivals, however, is murky.

The company stated it has developed customer relationship management (CRM) software powered by artificial intelligence that can generate leads for agents and predict potential sellers and buyers before they come to market. Compass also said in the document that it has developed a comparative market analysis tool that can better pinpoint the best asking prices for properties and expedite transactions. The firm added that its platform simplifies the business and tedium of brokerage, streamlining tasks such creating “digital ads, videos, listing presentations, email newsletters, print advertising and signage.”

Many of the company’s peers claim they have similar systems and tools.

Compass is banking on new revenue sources, but they may not be enough

To broaden its revenue sources, Compass disclosed that it anticipates reaping as much as tens of billions of dollars from ancillary business connected to the real estate transactions it brokers, such as selling title insurance, arranging mortgage financing, and helping sellers and buyers pay for home improvements that will boost the values of their properties. Last year, for instance, Compass acquired the title and escrow firm Modus for an undisclosed sum.

Like the residential brokerage business, those arenas are also packed with competitors and Compass’ own brokerage peers have said they are seeking to similarly diversify.

“They’re not the only one doing these things,” McJoynt-Griffith said. “It’s a very competitive landscape.”

Compass conceded in the S-1 that its efforts to grow these business lines has so far been “immaterial” to its bottom line.

“While revenue from these services was immaterial through 2020, we expect revenue from these services to grow over time as we expand existing and add new adjacent services to our platform,” the document said.

The IPO froth may be settling

The hot market for initial public offerings in recent months has been enough to foster optimism for almost any company seeking a large valuation in the public markets. Short-term rentals site Airbnb, cloud-data firm Snowflake, and food-delivery service Doordash, for instance, saw not only blockbuster IPOs, but subsequent trading that vaulted their values even higher.

There are signs that that froth may be settling, experts said.

Jay Ritter, a finance professor at the University of Florida who studies and tracks public offerings, pointed out pricing for special purpose acquisition companies, or SPACs — an analogue to the IPO market — has begun to cool. Shares of the 189 SPACs that Ritter calculated went public in January and February, jumped on their first day of trading by an average of 6%. Of the 15 SPACs that have begun trading this month, that appreciation has fallen sharply to 0.6%, he said.

He also pointed out that recent IPOs, such as Oscar Health, have dipped after trading.

“The market has been very enthusiastic about rapidly growing tech companies,” Ritter said. “But the higher the valuation, the more the company has to deliver in terms of growth and eventual profitability. Oscar Health was high touted but it has dropped.”

“It shows that investor sentiment has its limits,” Ritter added.

With reporting by Alex Nicoll

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