Matthew Hall

In the blog post titled ‘an interesting company, but is it an interesting investment’, I discussed the difficulty in justifying the proposed £1200m initial public offering (IPO) valuation of AO world. This conclusion was reached by analysing the potential market opportunity for AO world. Although the shares performed well initially, the market quickly came to the same conclusion. AO World is currently valued at £620m, which includes another £50m recently raised by shareholders.

In this blog post, the same analysis has been conducted on Purplebricks1, an online estate agent, which like AO world at IPO, is well-loved by the market. Purplebricks provide similar services to a ‘traditional’ estate agent, including a free property valuation and listing on property portals. However they charge a low fixed fee paid on completion and the property owner typically conducts viewings, whilst traditional estate agents charge a commission on completion and conduct the viewings. Purplebricks’ main competitive advantages are a low cost structure, good brand awareness, and a well-invested technology platform.

Since Purplebricks is relatively immature in the UK, it is important to consider what the business could look like (and be worth) in the future. There are five key assumptions to make; 1) number of housing transactions per annum in the UK, 2) the percentage of these conducted through online estate agents, 3) Purplebricks’ online market share, 4) the average fee per transactions, 5) the profit margin that could be achieved.

1. The average number of annual housing transactions over the past 10 years has been 1.1m2. It peaked at 1.67m in 2006 and troughed at 0.85m in 2009. For the purposes of this analysis let’s assume annual housing transactions of 1.2m, slightly above the long-term average, but in-line with the last few years.

2. Online estate agents currently represent c. 5% of total property transactions3, and are likely to continue to gain share given their price advantage vs. traditional estate agents. Let’s assume a figure of 20% in 5 years, but recognise that this could vary by approximately 10%+ either side.

3. Purplebricks currently has a 65% share of the online estate agent market, which has been creeping up over time. There are quite a few small competitors, such as Emoov and House Simple, which although they are losing share, continue to grow rapidly. To be conservative, let’s assume a stable market share of 65%, although this could be higher.

4. Purplebricks charges a fee of £849 per instruction as well as optional extras like conveyancing, viewings and energy performance certificates. The blended fee per instruction is currently c. £900. Management have recently increased prices, and stated that they don’t plan on increasing them again in the near-term. If prices increase in-line with inflation over the next 5 years, this would reach c. £1000.

5. As the business is sub-scale, and only just turned profitable, the profit margin assumption is difficult to make. However margins should be expected to increase as the business grows, and benefits to accrue from economies of scale. Looking at similar businesses, a margin of 30% might be achievable.

The above are clearly just assumptions, but as things stand today they are a useful starting point. Based on these assumptions, Purplebricks UK business would hypothetically be earning profits of around £40m. Given the company is a market leading business delivering attractive growth rates, it is likely the market would value this profit stream at premium to the market, perhaps somewhere in the region of £700-900m.

This compares to a market valuation today of £830m, within the theoretical range of £700-900m. However, most people would not pay £1 today for a hypothetical £1 of value at some point in the future about which there are considerably uncertainties. Any rational investor would apply a discount rate in order to compensate them for the investment of time and risk.

With this in mind, it could well be argued that it is difficult to justify Purplebricks market valuation by the UK business alone. Indeed, a significantly higher valuation would need the nascent Australian and West-Coast US businesses to perform to plan. This is certainly possible, however it is also very early days for these businesses, so it is somewhat surprising that investors appear so confident that they will be successful.

Purplebricks has an attractive business model because the company has the potential to grow into markets that are more immature and where they are the market leader. It is perfectly possible that the company will succeed, eventually becoming a much larger business. But unfortunately the valuation suggests that much of this success is already factored into the share price today. And with senior management and non-executive directors having recently sold nearly £30m in shares this year alone, one has to wonder if they agree.

Matthew Hall

 

Sources:

  1. This is no recommendation to buy or sell any particular security. This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations.
  2. https://www.gov.uk/government/statistics/monthly-property-transactions-completed-in-the-uk-with-value-40000-or-above
  3. 1.2m annual housing transactions, assuming Purplebricks has 40k listings, and a 65% share.

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