Description

Background 

Fathom Holdings (FTHM) is a full-service cloud-based virtual real estate brokerage that utilizes a proprietary software-based platform (IntelliAgent) which allows the company to operate virtually while still providing agents with all the major functions they would get from a traditional brick & mortar brokerage such as training, website creation, lead generation, transaction management, marketing, accounting, compliance, as well as back office tools. 

Prior to FTHM’s recent IPO (7/30/20 at a price of $10 per share) CEO Josh Hartley began the business in 2010 and bootstrapped the company to its current market presence. As of 2Q’20 Fathom operates in 24 markets in the US representing 110 cities. The company targets urban or suburban cities/regions with a population of at least 50k, which represents 775 markets in the US. Roughly 63% of 2Q revenues were generated from the company’s top 2 markets (also its oldest markets) – Texas and North Carolina – down from 67% in FY’19. As of 2Q’20 the company had ~4.5k agents on its platform (classified as independent contractors) representing a y/y increase of 39%.

Revenue is recognized via commissions that FTHM agents charge their clients (home sale price x commission %). From this gross revenue amount FTHM keeps a flat fee with the remainder paid to the agent. What the company calls gross profit is effectively the net revenue they actually collect from each real estate transaction. The company earns a flat $450 fee for the first 12 sales per an agent’s anniversary year and $99 per sale thereafter for sales within the year. Each year every agent also pays a fee of $500 on their first sale which covers operating expenses such as technology, error and omission insurance, training, oversight, etc. 

The company also offers agents an equity incentive program (three-year vesting period). Agents receive stock grants when they close a sale and if they refer an agent to the company and the referred agent closes a sale. Agents can also opt to receive additional stock grants in lieu of cash commissions. 

Investment Thesis

Solid multi-year growth potential as company is able to efficiently attract new agents to it’s given its competitive commission structure and scalable/asset-light business model  

The growth algorithm (in the near to medium term) is a function of transaction volume, which in turn is driven by bringing more agents on to the platform (expansion to new markets and further penetration of existing ones), giving them the resources to increase productivity (i.e. transactions per year), and retaining the most productive agents.  

FTHM’s attractive commission structure should allow them to continue to recruit and retain agents which will drive transaction volumes. Agents make significantly more money with FTHM’s fixed-fee model compared to a 20% or 30% split of a traditional brokerage. At a $250k sale price for a home with a 3% commission and 20-30% broker split an agent would make 18-35% more per transaction under FTHM’s model. 

For the most productive agents, who exceed 12 sales per year, the savings are even greater as FTHM’s fee drops down to $99 for incremental sales. Importantly, agents can then reinvest some of these savings back into their own business towards marketing efforts, further increasing their sales productivity. The fixed-fee model becomes particularly beneficial in a down market as agents can lower their commissions to customers to be more competitive in a supply-constrained market. This benefit allows agents to undercut even discount brokerages.  

The cloud-based platform enables FTHM to entirely sidestep a brick and mortar presence allowing the company to expand into new markets quickly and at a very low cost (per management, only a few thousand dollars to enter a new market). By owning the technology platform, FTHM is able to limit higher costs associated with third-party technology. 

FTHM’s flat fee model allows the company to be more agnostic as to the size of markets it enters, as lower home values don’t change the unit economics. The company should have an edge in smaller markets for a number of reasons: (1) lack of competition in these markets means incumbent brokerage firms are free to charge higher splits (50/50, 60/40) which makes FTHM’s value proposition for an agent all the more attractive, (2) larger national brokerages tend to avoid these markets, instead choosing to focus their attention on markets with higher average home prices given their percentage commission fee structure, and (3) larger brokerages have to factor in the cost of opening an office in a small office which further worsens their economics in those markets. In short, FTHM can be much more aggressive and expansive with its growth strategy versus a traditional legacy broker.  

Attractive unit economics and agent retention means the company can maintain high growth trajectory while generating profits

The cost for FTHM to acquire an agent is ~$800-$900 which consists of online marketing, promotion expense, and costs associated with its talent acquisition team. The tech/platform cost per agent is around $300 per agent per year. Of the $450 per transaction that Fathom receives, $100 goes to the district director in a given market. In sum, this means FTHM will break even after an agent completes just 2 transactions in their first year. This compares to an average transaction count of 4.9 in an agent’s first full year and 6.3 transactions in year 2 resulting in substantial profit per agent. 

FTHM’s agent churn has consistently been in the 17-18% range per year (~1.5% per month) which is well below the industry average of 36% per year. This makes sense as, under a traditional compensation model, agents often hop around to different brokerages to maximize commission splits – something that’s not an issue with a fixed-fee model. The company is also purposeful and systematic with respect to expanding its agent base, specifically looking to recruit district directors that fit with company culture and then bring in like-minded agents. Share-based compensation has also been a significant driver of low attrition since its initiation several years ago. Additionally, per management, 90% of agents that leave FTHM are exiting the industry entirely (typically less experienced agents) as opposed to joining a competitor.    

With agents completing 5-6 transactions per year and assuming churn holds at roughly 18% equates to an LTV per agent of ~$12-14k and a substantial LTV/CAC of 14-16x. This means the company could be investing much more in marketing and growing much faster – post-IPO FTHM now has the capital to do so and I expect growth to accelerate in the coming quarters. 

Of note, given FTHM’s fixed fee model, turnover decreases as agent transaction productivity increases. 80% of churn is from underperforming agents who are completing 4 or fewer transactions per year. A cohort analysis shows that productivity increases substantially as tenure increases with 4+ year tenured agents completing nearly 50% more transactions vs. year 1 agents. These 2 factors (lower churn/increased productivity) are important as it suggests over time as the agent base matures the average transactions per agent per year will trend higher – which translates to a higher ROI per agent and higher EBITDA margins over time. 

Management estimates the company is breakeven on an adjusted EBITDA basis at around ~9k transactions per quarter (vs. LTM average of ~5k). I expect them to hit this run-rate before FY’21 end. 1H’20 adj. EBITDA is slightly positive at $465k but public company related expenses will add to the cost structure in the back half. Operating expense per agent will decline as the company scales up. At ~30-35k agents (roughly 200k transactions) the company should generate ~$200 EBITDA per transaction (~40% margin as % of gross profit/net revenue). At that scale, operating expense should be a roughly 20/80 split between fixed and variable.

EXPI trajectory suggests the path to 30-35k agents for FTHM could be fairly rapid. 

The best public comp for FTHM is EXPI, another virtual, cloud-based real estate brokerage. The company also operates a cloud-based tech platform (VirBELA) for other non-real estate businesses, but at this time all revenues are generated via its real estate offering. EXPI operates in 50 states and 7 Canadian provinces and had ~30k agents on its platform as of 2Q’20. Under the EXPI model agents receive an 80/20 split for the first $80k in commission income earned (i.e. the payout to EXPI is capped at $16k) and then keep 100% of commission thereafter. Agents can elect to receive 5% of commission in company stock (issued at 10% discount to market). They are also charged a one-time startup cost of $149 and pay a recurring cloud brokerage fee of $85/month ($1020 per year). The company also offers a revenue sharing program for agents that recruit new agents to the platform – when a recruited agent closes a deal a percentage of EXPI’s 20% split goes back to the sponsoring agent. 

EXPI went from ~5k agents at the end of FY’17 to ~31k at 2Q’20 which suggests a ~2.5 to 3 year trajectory for FTHM is within reason. While it’s possible that EXPI’s revenue sharing program aided this trajectory, the economics for an agent under FTHM’s model are still far better and as the market moves toward lower commissions FTHM should have an advantage in agent recruiting. In FY’19, avg transactions per agent at EXPI was 6.6. At this transaction level, an agent’s full commission amount is subject to the 80/20 split meaning they would make 18% more under FTHM’s model. 

Only need to capture a small amount of US market share for stock to work. 

Real estate is a highly fragmented market with many inefficiencies making it ripe for disruption across a number of fronts – accordingly there are many new entrants in the space and competition is increasing. That said, FTHM has a miniscule market share currently (in terms of agents and real estate transaction volume) and doesn’t need to capture much of the market for the stock to work. ~30k agents represents less than 2% of the active real estate agent market in the US while 200k transactions is 3.8% of the 5.3m existing home sales in the US per year. This is an important point given barriers to entry for this business are fairly low.

FTHM’s fee structure leaves it better positioned to withstand the industry trend toward lower commission rates

Residential real estate is becoming increasingly price sensitive and FTHM's fixed fee model makes it far better positioned than other industry players to withstand commission rate compression. The market players at most risk of disintermediation are traditional brokerages – legacy businesses with high fees and high fixed costs. Legacy brokerages make up the vast majority of the 106k+ total in the US. I don't view full disintermediation of real estate agents as a material risk and even if it were to happen, it would take a very long time to play out. Of 5.34m of existing home sales in FY’19 – 89% used an agent.

Other margin accretive growth drivers possible down the road including take-rate increase and expansion into ancillary services   

While not a part of my base case estimates, or necessary for material upside to shares, there are other avenues for additional revenue growth over time. It’s likely the company adds services like mortgage and title in the next 12-18 months via an acquisition which would carry significantly higher margins and present another element of growth and scalability to the business model. Another lever FTHM can pull is to increase the transaction fee charged to agents, something I view as likely after ~2yrs. The company already increased the fee 2 years ago from $299 to $450 and saw no significant change in agent attrition as the economics from an agent’s perspective, vis-à-vis the rest of the market, still remain superior. A $50-100 increase in the fee would be very accretive for FTHM yet unlikely to move the needle for an agent to leave. 

Valuation / Price Target

I expect multiple years of 40-50% net revenue growth for FTHM as it ramps up its agent acquisition. EXPI currently trades at 21x FY’21 gross profit (net revenue) and prior to its 35% run up in price this month it traded at 15x (EXPI uses the same gross/net revenue reporting as FTHM). 13x FY’22E gross profit for FTHM of $32m equates to a ~$32 share price in 2 years (+72% upside / 31% IRR).  

Assuming FTHM can get to ~30k agents in 2.5-3 years, this would translate to ~$40m of EBITDA by FY’23 which implies a 6.1x forward EV/EBITDA multiple. A 15x multiple on this EBITDA equates to a value of ~$45/share in 3 years (+139% upside / 34% IRR).

Catalyst

Earnings driven - multiple years of high growth in agent count, transactions, and EBITDA