Compass, Inc. (COMP) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Day 4 of the Morgan Stanley 2023 TMT Conference. We're thrilled today to have Robert and Kalani with us from Compass, the CEO and CFO. There's a lot to talk about in real estate, a lot of talk about your evolving business. So thank you so much for joining us.

Glad to be here. Thanks for inviting us.

Yes. Thanks for having us.

I do the disclosures, all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures. They're also available at the registration desk. Some of the statements made today by Compass may be considered forward-looking. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. Any forward-looking statements made today by the company are based on assumptions as of today, and Compass undertakes no obligation to update them. Please refer to Compass' Form 10-K for a discussion of the risk factors that may impact actual results. Okay. I think it could be helpful for the room just to sort of -- to start and sort of talk to us about how you think about Compass's core value proposition and point of differentiation versus other real estate brokerages, both digital and traditional.

Yes. So at Compass, we need to be best in the world in making real estate agents better. There are 2 million agents in this country, and they're all small business owners. They're all entrepreneurs. My mom has been an agent my entire life, she is an agent today at Compass. And the North Star for Compass is anything an agent needs Compass provides. Obviously, that's -- it's a North Star for a reason. It's very aspirational. But software is empowering every professional to accomplish more. It's doing the same thing here. There are 700 software providers that sell to real estate agents every single day. But the -- and the problem is, if you're an agent, there's not an agent that can look themselves in the mirror and say, "I know I'm using the right tools" because there's too many things opening and closing and selling to them. There's over 30 real estate CRM, including Salesforce, which real estate agents don't really use because everything has to be customized towards the real estate vertical at the local level for local data. And so what differentiates us is that our brokerage -- traditional brokerage comes on the left. And let's call it, a tech-based brokerage come on the right. And I think on balance, there's -- on the left, it's all human support with third-party software. Over here, it's a salaried discount model that has been empowered traditional agents. And so nobody is trying to put the best of everything in one place. No one -- there hasn't been a traditional brokerage firm that was able to hire from places like Google or Apple to build for agents. We were the first company to do that. And so that's what differentiates us. And very simply from a math perspective, we aspire to be the company that makes agents more profitable than any of brokerage. If we do that, obviously, the results will follow. And at the company level, we aspire to be the most profitable brokerage as well. That means lowering our costs, keeping them low, harnessing the power of low-cost labor, invest at adjacent services attach, mortgage title, escrow and profitably growing your agents and retaining them.

That's helpful as an intro. I guess maybe dig in that a little bit more. Can you just sort of remind us what are the main software solutions and software tools that your agents are using? What are the main ones that sort of drive them in? And what ones are you sort of focused on solving pain points next for agents?

So we're the first company, the only company where an agent can go from first contact to cash in one place. So from meeting clients, putting them in their CRM, going through all the key buy-side and sell-side flows to getting paid straight through the platform with 1 code base, 1 log in, not having to go to third-party software. I'll give you the 4 big buckets of software of an agent. One is search. They search -- agents do not search Zillow or Redfin. They search the MLS. The Zillow or Redfin would be like a regular calculator that your kid would use. The MLS would be like an Excel spreadsheet or HP, what was it Kalani. HP 12?

Yes. Yes.

Maybe that's a another tool. That was like a middle school, high school. And so MLS is I want to search properties that where the -- where there's -- where the ground floor is this square footage and it's sold between this stage and there's hundreds and hundreds of different calculations, so they can give you something you can't see from the public, and they have better data. So one, we've rebuilt MLS search in every major market. It's very hard no one -- there's not a single company that has even tried to do that. That's one. So they can search your platform, not a search the MLS and taking them away from your platform. Two is, of course, CRM. Agents, the business of an agent is not helping you buy and sell a property. The business of it -- that's not their business. That's execution. The business of the agent, their book of business is making sure everyone in their sphere of influence. Whenever they are thinking about buying or selling a home, they think of them as the agent. They see their image. And so obviously, CRM is all that. And there's a team functionality and a lot of stuff with CRM. Third, and the over 30 real estate CRMs that agency use. And so we've rebuilt the best of all -- we still have some more to do there, but we have that. Third is marketing center. It was our first flagship product. It gives an agent the power of being a professional designer in their palm of their hand. The way to describe an agent because remember, they're not in the business of helping you buy and sell properties. That's just execution. They're in the business of making it so that they're in the business of marketing themselves and their properties, right? Because I want you all to know me, that's the kind of CRM. CRM itself doesn't do anything, it can be market myself to you. But then when I meet you at the listing presentation, I want you to think I'm the best marketer of properties in the world. And so marketing center, agents are addicted to marketing in the best way possible. And you cannot give them enough marketing. They're insatiable. And so that would be digital newsletter, social media, video messaging, postcards, mailers. And what we -- why -- what we did is so early a flagship product. It shows the power of integration. Right now, if I'm an agent at some other place, and I want to market my property, I need to go from my Google Drive and upload photos to a digital newsletter. They called mail champ. Then I need to do it again on social media, in Facebook, Instagram. Then I need to do it. I'm going to do a Google ad, then I want to do ad works, then I want to do it on a postcard, then I want to -- I want to do open house card. But in Compass, in -- for the photos, then they address each time, then the description each time. But at Compass, the listing -- within the listing page, because our marketing center is connected to a listing database, you never have to do it. You put it in the listing and it's automatically there populate the photos in each one of those digital assets. The last kind of flagship product is transaction management. There's -- in California, there's over 50 different files and forms in e-signature, who gets paid what, what's the percentage order title, order escrow. And so there's a lot there in every county has a different way of doing transaction management. So that's also a very difficult piece. But those are the 4 big buckets. There are other things as well like buyer collaborative search, where you have collections. There's digital tour sheets where -- on your tour, I can create a tour for you for each place, and it's a living thing we could comment on. And there's a lot of other stuff, but those are the 4 big buckets.

You might have heard a little bit of discussion of AI and large language models over the course of the last 6 months, 6 hours to 48 hours, pick your interval. It's a lot of discussion about AI. I guess maybe talk to us about those 4 core use cases. How are you already using some AI? And how do you think about adding more tools to the platform for your agents to sort of stay ahead of competitors and new players?

Yes. So it's activity, we've already through hackathon, create, made it so that you -- an agent -- you create an automated listing description as you can imagine. You can -- you can say I want a formal language. I want casual language, I want funding language, like push a button or like leave those changes. So that's an example of what everyone is talking about now. And there's a lot that can be done there. But what do we do today? Historically, the flagship AI product is likely to sell. So what likely to sell does is it takes everyone in your CRM, it tells you how likely they are to sell, and it recommends them to you. It has a higher conversion rate than leads. And that drives more listing inventory, and it uses AI in a whole much different ways to be able to make those recommendations. The second example of AI is video. When you go on Instagram, you see like a video and it's the photos and moving back and forth. So it feels like a video that's really just a photo moving on it on every photo in Compass, AI automatically tags saying that what part of the home it is. So if it's a kitchen or if it's a bedroom in those. And then it takes from the description how many beds and it puts them on top. So it will -- this example is the bedroom, it knows bedroom automatically says 3 beds. And so it just automatically creates a video, a 30-second 45-second video where on each photo, it has the thing relevant to that photo. So it combines a video with a description at the same time. Those are 2 examples, but I'm happy to give more.

Okay. Maybe...

They're all designed to make an agent faster, better, more efficient and make their time higher ROI, return of getting the client business or executing the client business in time.

Got it. Okay. Maybe to step back on the state of macro. The real estate market has been some volatile over the course of the last year plus really. I mean what is sort of the latest date of the stay and what you're seeing in the macro environment? How do you think about 2023 and what you're expecting for the backdrop?

The market, there isn't an agent that I've spoken to in the country, we have hundreds of agents a week that says things are worse or as bad as they were in November and December, then it was bad. I've said before, I'll say again, I think Q4 was the trough of pending listings. The market isn't price. We don't get paid our price compared transactions. It's pending listings year-over-year. I think it'll be December. The -- here's where the market is. Buyers are back. There are exceptions where if not a flood. But in January, most people were saying, it feels like it's a frenzy all over again, the pandemic boom, the pandemic period, it's feels like it's like that again. Buyers are accepting these rates as a new normal. There's a whole new wave of buyers. If you just started in the last 5 months, you don't even know through your time. You don't know 4%, just all you know. Buyers, there's a pent-up demand that they didn't disappear for those 6 months. They just froze because recession is being used as a word every single day multiple times because rates went up 20 to 30 basis points in a 2-month period in the fall and because they were getting greedy, they're hoping that prices will be down 10%, 15%. But look at where we are now. Prices didn't go down 10%, 15%. In December, they actually went up 6% year-over-year. In February, they went up 1% over the prior -- over January. So now they get scared, "Oh my God, if I don't buy now, they may get ahead of me." And when rates do go down, what does happen? If mortgage rates going from an all-time low in January to a 20-year high in 9 months, can't bring prices down, then what's going to happen when they stabilize or when mortgages go down. And on the -- so on the sell side, that's where the issue is. And that's where it was last year, but that's where it is, again, there's still more inventory now than there was a year ago, even with all the headlines in the market, I love these headlines. Actually we love these headlines what I'll say, prices of homes aren't growing as much as they were before. It's almost -- they almost like it seem like it's going down, but they actually weren't going down. The price growth isn't increasing it's so crazy how they try to create the fear in the market. But on -- on the inventory side, yes, there's not much new inventory, but there's more inventory than it was a year ago. Two, but we still have a lot of homeowners, 28% of homeowners are locked in below 3%. I mean, 2% of homeowners are locked in below 4%. 85% homeowners are locked in below 5%. And so if you're below 2%, that is a financial asset. And the further way the mortgage rate is from that, the more you don't want to sell because it's 7%, that's 4 points. And so that's the biggest issue we have. I think prices will be -- I think there'll be more buyers and sellers below anything below 8% mortgage rates.

Got it. Okay. It's interesting because over the -- since the company has been public, there's been this perception that Compass over-indexes far more expensive homes. And even as the real estate market recovers eventually, you need to actually have more of the $1 million-plus homes come back for them to really capitalize on it. They're not going to be able to capitalize on the average $300,000-ish home sale recovery in the U.S. We love sort of your perception and reaction to that and how you think about if the real estate market does stabilize and recover your positions or capitalize on that?

Yes. So we're #1 in -- we were the #1 brokerage in the country today at 2:00, we'll find out if we are for a second year. So not going to win the Wall Street Journal real trends. We're #1 in more major cities and any company that's ever existed. We have 18% of the top 1,000 agents in the country are a Compass. We have 30,000 agents. We do weight more towards high top markets and in those markets, higher ASP on balance. And so yes, we are a higher ASP company, but we are in Nashville, we're in Austin. Well, Austin's not as cheap as [indiscernible] -- we are in Kansas City. We are in St. Louis. But yes, we are weighted more towards California. It's our biggest market, then you have New York because we are weighted towards these markets. It helps us and it hurts us on the year-over-year comps depending on how they're doing and it usually creates some fuzziness. But one of the benefits is we are not as mortgage rate sensitive as other brokerages.

Got it. Okay.

No, I was just going to add, I think -- and we've said it before, I think we're also looking when we think about expansion of moving from a portfolio that's focused on the top 5% of real estate agents to a portfolio that's more 50%, top 50%. I think that's also going to be -- that's part of how we expand. I think it also helps us make sure we are ready for the market as it comes back at more levels than just kind of that top 5% than we were maybe a couple of years ago.

Probably good segue actually my next question around growth and how you're thinking about the growth drivers for the company, both expanding your market share in your existing markets? Sort of give us an update of where you are on your top 3 or 4 markets, however you want to think about it? And then the next 10, 20 markets, what's your market share there? And just sort of how you break apart growth market share of those markets?

Yes, I'll start and then maybe hand it off. But our top -- our big markets, we talked about L.A., San Francisco, all California. D.C., New York, I think we have a great market share. I think the way we grow market share, again, continuing to move our portfolio into a bigger mix is going to help us. It's also going to help us kind of on the profitability side as well. And then I think we have a team, a great team out there in the field working every day to keep on -- bringing on new agents. And so I think both in the markets that we already have strong market share. We'll continue to look at kind of one-for-one agents that we can continue to bring on to our teams that help both the teams as well as they want to come to the Compass platform as principal agents. On the markets that we are still growing in, I'd say we've done a really nice job over the last 3 to 5 years of growing new markets. I think a lot of those markets are still maturing, right? So we're going to continue to mature those markets as it stands as well as continue. I think we have a ton of room to continue to add agents. And we have the team that's really structured to start to not even start to actually keep the momentum of adding agents. I think that's how we add agents as well as then with that mix, I think we start to see some better economics profitability.

Got it. Okay.

The only I'd add to that is the margin on agents that do $150,000 or less of gross commissions to the company, they give us, on average, 900 basis points more we disclosed in the past, then $1 million-plus agents. So there's a huge tailwind behind us of just hiring agents that aren't only the top 5%, as Kalani mentioned, but the top 50%.

If you -- when you look at the markets you've entered where you've had more success in capturing market share versus less success, if you neutralize for amount of time in the markets, are there characteristics or points of execution where you say these are the types of markets where we have more success and have ramped faster versus others that have grown slower. Anything you've learned from that perspective?

Yes. I'd say on balanced markets that are more team focused. We've done better because teams need technology more than individuals. If you're an individual, you can write -- writing a book, you can write on any platform, kind of a piece of paper. But if you're a team writing, I don't know, like some big article document -- writing an S-1, like you're going to need some type of technology where you can start someone else to comment, didn't comment that you have a footnote over here. And so across everything that I brought up of like search, collaborators, doodle tours, all those different marketing agents are -- teams are passing the workflow onto the other person. And so team functionality is super important to be efficient. And so that's one. The second, I would say, is markets that are more -- more modern where the population of the agent is more tech forward. They -- that's where -- and modern in terms of brand, that's where we can grow faster. So in a market, I don't want to call it any market in particular because we have agents everywhere, but a market that's super, super conservative doesn't like change. That's a hard market. These are hard market growing. Fortunately, there are very few markets like that.

Got it. Okay. Kalani, anything else on that.

No.

Okay. Let's talk about the revenue and the take rate a little bit. In 2022, gross revenue, if I say gross revenue divided by the gross transaction value, I think comes out to 2.5%, 2.6%, something like that. Maybe just sort of walk us through the drivers of that "take rate" between commission and other products. Then how do you think about that evolving over time with escrow and title and other things that you're rolling out?

Yes. No, I think we have room. I think you folks put out in Q4 of '21 kind of our march to 10% margin. I think that's still the right way to think about it. When you look at that page, particularly on the platform contribution commission line, 2 big things stand out. I think we have room something almost like 200 to 250 basis points of room to move on our commission rate. Two big things we talked about 1 of them, which is just the mix. So moving from that 5% portfolio to 50%, as Robert said, there's about 900 basis points from the bottom of the portfolio at the top. That's a good -- it's a good driver there. The other one is we -- over the last 3 to 5 years, we've grown tremendously with -- in all of our markets, and we incentivized. And so as we think about those -- those are probably 1- to 3-year contracts. And so as those roll off, we have the opportunity to kind of bring agents back closer to market levels. That's another kind of tailwind for us. I think the other big piece of that part of our equation. I think cost is probably half of our journey there. And our ability -- our ability to take out the costs we did, keep us there as revenue comes back is probably 400 to 500 basis points. The other -- there's about 200 basis points, I think, in the math that gets us on the T&E side. So when we think about T&E, we are building that business right now, it's probably in the low single to maybe teens margin, that steady-state margin on a run rate basis for all of our competitors or something in a 20% to 25% rate. I think we can get to 25% to 30% rate through integrating some of the offerings we have into our platforms. And so I think as that matures, that's probably -- that should add another 200 basis points. And then not on the kind of the take rate side, but I think we have more room on mortgage. So our OriginPoint JV. I think as that matures, again, that's actually similar to T&E margins around 25%. So again, those 2 big, good margin businesses that theater will absolutely help the economics as we think about it.

Okay. You talked about sort of the incentives and some of the incentives you've been using in some of the markets, eventually becoming a smaller portion of the mix, the cost reductions that you made as well. Maybe can you just sort of walk us to the path to GAAP breakeven, GAAP profitability? And what type of transaction growth or gross revenue growth do you sort of need to get to GAAP breakeven?

Yes, I'll talk about from the math side of it. I think we've done a lot of the work that's needed, and it's about being diligent going forward, right? So the big pie for me is taking -- if we hit our midpoint of our range that we put out publicly, it's about $550 million of cost reductions. So if we think about that, that's the biggest pie, I think EBITDA and cash flow will be roughly in line with each other based on the kind of the puts and takes. We're obviously going to be spending kind of less on CapEx and a lot of the other cash items. So if those are in line, I think the net income will follow shortly after. There's some few things below the line that will drag that a little bit behind. But as we think about just profitability, free cash flow, that cost base is really set there. I mean it's just math, but if you took kind of the cost base guidance we've given this year on last year's revenue, the math works, right? And so I don't think we are expecting or needing revenue growth to be exponential or hope. I think we actually just need more normalized kind of revenue range. That on our cost base, right, with a similar to slightly improving commission PCM percent gets us the math that really works, and it creates tremendous value and importantly, free cash flow over time.

We're bringing down our expenses. We have the new target range of $850 million to $950 million. You said at the end of this year, we'll be just below the midpoint. And our focus is making sure that those expenses don't come back. There's upwards of $50 million of OpEx savings that would come from low-cost labor depending on how aggressive you are $50 million to $75 million. And if we're best in the world at that, that will -- that can pay for all the salary inflation for 3 years as well as vendor inflation. And so that to me is a top key priorities, just keeping our expenses low. So when the market does come back, again, it doesn't have to really grow, just go back -- when the market comes back to what it was last year, maybe GAAP income profitable. We just need to get to that period of time, and then we'll have the rewards.

Can we talk about the agent retention? You've had a pretty strong 90-plus percent agent retention for a while now. What drives that? What can you share with us about sort of agent behavior of the number of tools they start to use in the beginning? And then how does that behavior evolve over time?

Yes. So we have 98% quarter retention in Q4, 90% of quarter retention in Q3. Last year, Q3 was also 98%. And so it's been consistent. That's even an environment where our stock price went from $20 to $1, and the majority of our agents are invested in the stock. That's an environment where we had 3 risks, right? And so to be able to keep agents in that kind of environment shows the strength. The -- on an annual basis, because 98%, 99%, is above 90% agent retention. What keeps them there? The #1 reason we serve them. The number one is the platform. Number two is the culture and collaboration. Also in that list, you have Compass Concierge, and then you have the referral network. And 1 out of every 10 transactions at Compass or agents referring their clients or their agents. When that happens, if I refer you a client, I get 25%, and you get 75%. We both make money; we would have made otherwise. And so just by being here staying here, your business grows 10%. And so those are the reasons why agents stay. And it's also important to note that our agent retention metric is a very high integrity metric. The people that leave, include people -- we include people that retire or has to leave for ethical reasons, move cities that we're not in or move industries altogether. The number one reason historically we've lost to agents is retirement because, of course, we retire. I mean the last thing I'd say is of our top 25% of users of the platform, only 2% of them leave on an annual basis, as opposed to above 90% for the rest of the market. And it shows with the people if you're really using the tools, you just don't leave.

Questions for Robert or Kalani.

Can I ask about sort of the ancillary products, mortgage and everything? So when you talk to agents about pain point that they look for you to solve and other opportunities? Like, what are the main ones that sort of stand out and what are the biggest ancillary opportunities you still see to build into the platform more...?

For the agent or for Compass?

Both. Yes.

Look, I think on balance for agents, we don't need to build any new products. We've seen to continue to improve the things we have, and that's really the mission this year. And we're doing more in coaching and training using third-party coaches to coach our agents through the tools. So a free way for us to get scalable coaching development of our tools. I think the focus right now isn't on things that make agents more profitable. It's things that make Compass more profitable. And so we integrated it into the platform in Southern California to 800 agents, our title and escrow business and we're given to all agents in Southern California on Tuesday. And what that is, it's one click integration, an order of title or escrow. The quotes I get from agents that I talked about is like I can't believe, I just -- I order my premium title report and he's pushed a button. I don't have to call or anyways push the button just happened. And so that's a win-win for everyone and will drive above-average industry attach. My hope is -- the number one thing that we're talking about with investors this time next year is how we figure out how to monetize the transaction more times than any other brokerage and with higher attach, giving a sustainable financial advantage relative to the industry. And we've done that through the platform. In every industry, the winner in adjacent service attach is doing it through a platform not just through hand-to-hand human combat. We do hand-to-hand human combat like traditional broker terms. We have this unique platform to make it easier for them. And sometimes investors will say, can you pay an agent to do this? No, you can't pay them because it's called RESPA, but we don't need to pay them. They're already being paid with their time, for that -- for an agent time is money. So if I can make it so they can push a button and say 30 minutes or not having to like to write the e-mail address, right? Basically the same thing with marketing center. So easy, it's all right there. You're doing the same thing for ordering title and escrow. That is money for them. And once we do that, they won't go back.

Great. All right. Can we see what the progress 1-year from now?

Yes.

Thanks so much Robert and Kalani.

Yes, exactly.

Thanks everybody.

Thank you.