Following the delay of WeWork’s initial public offering, will the SoftBank-funded Compass struggle when it finally decides to go public or beat the odds?
Slightly more than a month ago, WeWork was barreling toward an initial public offering and valued at nearly $50 billion. Compass was continuing to grow, had freshly raised $370 million and was continuing to snatch up rival brokerages.
This week and last, however, WeWork’s IPO was delayed, its CEO resigned – while staying on as chairman – and it’s valuation has greatly diminished. So where does that leave Compass, a startup that, like WeWork, is also backed by the SoftBank Vision Fund?
In the past week, Compass, too, has weathered the loss of several top executives, including Chief Operating Officer Maëlle Gavet who is set to leave for another opportunity, and head of communications Jason Post, who’s headed to a new position at Google.
The two have grown at different trajectories, but both represent big bets by SoftBank within the real estate space.
Massive valuations fueled by fundraising, growth
Both WeWork and Compass are backed by SoftBank, with multiple funding rounds led by the SoftBank Vision Fund, the collaborative tech investment vehicle started by Japanese company SoftBank and a host of big international players.
“On the one hand, I think the biggest ingredient here is that they’ve both raised massive amounts of capital from SoftBank at multi-billion-dollar valuations,” Mike DelPrete, a real estate tech advisor and Inman contributor, told Inman.
DelPrete explained that, when you raise that much money, especially from SoftBank, an IPO is an inevitability. When WeWork finally opened the books ahead of its IPO, however, public opinion soured.
Steve Murray, the president and founder of real estate publishing and analytics firm Real Trends – who has consulted with at least one brokerage that sold to Compass – said the only similarities between the two companies he sees is their huge valuations.
“I think Compass has a fundamental business that can be grown and made profitable with proper leadership and management,” Murray said, before adding that the jury is still out on whether it can turn enough profit to justify that valuation.
Compass hasn’t necessarily reached the point of a massively inflated valuation. There were reports earlier this year, that WeWork could be a $65 billion company, a number that’s shriveled since it filed its intention to go public. But WeWork, unlike Compass, doesn’t have a lot of historical precedents on which to compare its fundamental business.
During its latest $370 million funding round, the company cited its valuation at $6.4 billion. Yes, that’s more than twice the market cap of RE/MAX, Redfin and Realogy – which is suing Compass – combined, but it’s not too far past the enterprise value of Realogy, and even smaller than Apollo’s $6.65 billion deal to acquire Realogy in 2006, a SoftBank source told Inman.
The SoftBank source said Compass has simply, “built a better mousetrap,” – a business term used to indicate that the company offers a better product or service – through the automation of back-office tasks, customer acquisition, customer relationship management tools, comparable properties, valuations, marketing and communication.
As Compass moves deeper into systemizing those tasks through the build-out of software, agents can focus more on the consumer relationship and the consumer-facing experience of guiding homeowners through the process.
“We believe, in the next two years, Compass will pass Realogy to be the largest residential real estate brokerage in the United States because they have a better mousetrap,” the source said.
The source also explained that Compass is valued at more than Realogy’s enterprise value because Compass’ revenue is growing precipitously while Realogy’s is mostly static. Realogy reported a 5 percent year-over-year revenue decline in the second quarter of 2019.
“The public markets are valuing growth,” the source said. “You have a better mousetrap that’s growing at 100 plus percent versus shrinking at 5 percent per quarter.”
“The multiple in which you would pay on something like Compass should be slightly more than an established player like Realogy, because it has momentum and should pass them in two years,” the source added.
The charismatic leader
Compass CEO Robert Reffkin and Neumann both come from wildly different backgrounds. Reffkin started Compass after a stint with McKinsey & Company – coincidentally, Realogy CEO Ryan Schneider also worked at McKinsey & Company – as well as roles in the Obama White House and Goldman Sachs. Neumann is a serial entrepreneur and founded both a shared workspace and children’s clothing company before WeWork.
But still, both have been synonymous with their respective companies’ successes.
“If there wasn’t a charismatic leader like [Reffkin] in front of that company, would it be worth 6.4 billion?” asked DelPrete, drawing the parallels.
The SoftBank source told Inman that at least part of the reason SoftBank invested in Compass is because of Reffkin’s authenticity, growing up in a single-parent African American family where his mother was a real estate agent, so she could have control over her schedule and provide for her family.
“Part of the reason that any equity investor invests in a company is the ambition and the vision of the founder and the skillset of the management team and their ability to attract, retain and grow a leadership team,” the source said. “It doesn’t matter what business you’re in, ultimate it comes down to human capital.”
The source said Reffkin’s passion – just six years into his quest of leaving a cushy job to pursue his dream of making real estate agents more effective – has not dulled, it’s rather increased. SoftBank’s confidence in Reffkin remains high, as a passionate, steward for Compass, the source added.
“The business is on fire and he is growing as a leader,” the source said.
The source did, however, acknowledge the job of a board of directors is really only four main duties, one of which is to hire and fire the CEO, but also to approve the annual strategy and operating plan, to effectuate good corporate governance and to protect the assets of the firm,
“If you come to a point where you don’t have the right person at the helm, it is both within the boards duty of care and duty of loyalty, as well as fiduciary duty, to act on one of the four responsibilities you have,” the source said. “You never make an investment assuming that, but if you come to that point either because of lack of skills for the next level, inappropriate behavior, changing dynamics etc., then the board needs to make hard calls to protect the shareholders’ and debt holders’ interest.”
A path to profitability?
Compass, like WeWork, is not currently profitable. It’s impossible to know what Compass’ operating costs are, as a private company, but WeWork lost $1.9 billion in 2018, according to filings.
Inman asked Compass CFO Kristen Ankerbrandt if the company is focused on being profitable right now, or if growth and the development of agent tools was the main focus.
“Our goals are aligned with the success of our agents and focused on developing tools that make them more productive, which drives both growth and profitability,” Ankerbrandt said. “The productivity software we have developed alongside our agents helps them run their businesses more efficiently.”
Ankerbrandt cited offerings like Compass’ proprietary search technology, CRM, listing and marketing tools and a mobile app to communicate with clients and manage open houses. The company has long billed itself as both a brokerage and a technology company.
“With a focus on delivering value, we will continue to improve our technology to enhance our client-focused programs, such as Compass Concierge, which our agents leverage to drive improved service,” Ankerbrandt said.
The SoftBank source told Inman that Compass has a path to profitability and a timeframe in mind, but declined to disclose those details.
“Compass has a clear visibility to profitability and what the levers are that they need to pull there,” the source said. “Right now it’s in the market share gain and growth phase.”
“I can’t give you a specific date,” the source added.
Right now, internal conversations at Compass are focused on finding the right balance between growth and profitability, a conversation that wasn’t happening more than a year ago, according to the source. It’s a matter of examining what the value of discrepancies in top-line growth are, as well as investing in technology, ancillary businesses and geographic location.
Will a recession wreck Compass?
One of Compass’ biggest strengths to guard itself against a recession, contrasted against WeWork, is that the company does not have debt, which Ankerbrandt confirmed to Inman. WeWork has partially used debt financing to fund its operation. Compass has not.
Both companies pay out the vast majority of their revenues as a cost of sale, according to DelPrete. But in WeWork’s case, it’s longterm leases, which they then rent out to short-term tenants. For Compass, those are agent costs, and according to multiple sources, Compass agents are usually signed up on an initial two-to-three-year contract.
“Both of these businesses pay out the vast majority of revenues as a cost of sale,” DelPrete said. “WeWork leases things long term and rents them out short term. Their biggest expense is at cost of sale, it’s rent, they’re paying out rent. Same thing with Compass. All of their revenue, they’re paying out 80, 85, 90 percent of that directly to agents.”
If so much of Compass’ cost is tied to the agent – and Realogy’s lawsuit claims Compass’ offers inflated compensation packages that are sure to make them operate at a loss – then that makes retention even more key and almost necessary to survive. If agents are hypothetically fleeing in droves – and there’s nothing to say they are – at the end of their short-term contracts, it likely ramps up the costs to acquire more.
Ankerbrandt confirmed that agent retention is an important key to Compass’ business when asked directly.
“Retention of great agents is core to our business and we are fortunate and humbled to experience incredibly high retention among our agents, which we believe is a testament to our culture of focusing on agents as our most important client, investments in our technology platform and the quality of our brand,” Ankerbrandt said. “We will continue to work incredibly hard on behalf of our agents and engage them in every decision we make to propel their belief in Compass.”
The SoftBank source said yes, Compass’ business will likely slow down during a recession. But if the company’s revenue was growing at only 40 percent instead of 100 percent, the company could shift its focus from topline growth to cost management and product growth. The source said SoftBank did its due diligence, analyzing housing data back to 1890, to price out the recession risk.
“We understand what the risk is and we priced that risk against the asset base, against the business model,” the source said. “We have sensitivity analyses for every type of recession.”
Geographic growth also helps Compass – and many of the other industry giants like Realogy, HomeServices of America, RE/MAX and Keller Williams to name a few – because recessions impact different areas differently.
When asked by Inman if a recession would greatly impact Compass’ path to profitability, Ankerbrandt said the company doesn’t believe so.
“Nearly every company is affected negatively in some way during tough economic conditions and we are no different but we do our financial planning assuming there could be a downturn,” Ankerbrandt said. “For those reasons we do not believe a recession would greatly impact our path to profitability.”
“We have focused on depth versus breadth in 2019 to drive profitability and our investments in software allow us to grow more efficiently, make our agents more productive,” Ankerbrandt added. “As we increase our profits over time, we can use those funds to invest more in tools and programs to help our agents. It’s worth noting that in an economic downturn, we are less exposed than other companies who rely on large amounts of debt to fund their business models.”
Ankerbrandt also doesn’t believe a recession will force Compass to shift the way it operates its business.
“Yes, we feel confident our business can weather an economic downturn without shifting our operating strategy,” Ankerbrandt said. “We have a strong capital position, having raised over $1.5 billion, that enables us to plan ahead and continue operating the business without having to reduce our investment in the tools and resources that we provide to our agents.”