When Betting on a Hot Real Estate Market Backfires

One of the great disconnects over the past year has been the stock of almost any company directly involved in the sale or financing of residential real estate... Almost all of them have pulled back sharply, even though housing prices keep hitting new highs. Perhaps the most notable is Zillow (Z), whose foray into home-flipping... […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] When Betting on a Hot Real Estate Market Backfires By Herb Greenberg One of the great disconnects over the past year has been the stock of almost any company directly involved in the sale or financing of residential real estate... Almost all of them have pulled back sharply, even though housing prices keep hitting new highs. Perhaps the most notable is Zillow (Z), whose foray into home-flipping... flopped. It seems home prices were rising too fast, even for its computer algorithms to keep up. Or so says the company. Plenty of others think it was nothing more than a stupid idea. As a result, despite the still-sizzling real estate market in many parts of the country, rather than going through the roof this year, its stock has crashed through the floor. But as the chart below shows, Zillow is hardly alone in the real estate space... Among them, the one that caught my attention most is one that gets talked about the least... frontdoor (FTDR), which is in the business of selling home warranties. These are little more than extended-service plans for appliances, plumbing, electrical, and HVAC systems, and frontdoor – through such brands as American Home Shield – is the biggest. If you've ever sold a home, a real estate agent has probably coerced you into providing one of these plans an added "peace of mind" enticement to make the sale... as a "gift" to the buyer... which means if you've bought an existing home, you've probably had one – and like most of their customers who received one with their home, you didn't renew after a year. ► But the story here is why betting on a hot real estate market can backfire... And I can't think of a better example than frontdoor... You would think that when the real estate market is hot (as it has been), frontdoor would be, too. As it turns out, when the market is hot, frontdoor goes cold. That's especially true for the part of frontdoor's business tied to real estate sales, which also happens to be the company's biggest source of new customers. Think about it: In a sellers' market, when there are multiple offers on a home, there is no need to gift anything to the buyer. To fix the problem, frontdoor is trying to convince buyers to purchase the warranties. But buyers, often already stretched to the max from bidding wars, don't appear to be taking the bait. That's a problem since the "growth" part of frontdoor's story has been its direct-to-consumer business. You've probably seen the TV commercials or ads online trying to convince you that you need to purchase a home warranty "for when things go wrong." --------------------------------------------------------------- Recommended Links: [Were you in Vegas last week?]( Last week, Professor Joel Litman spoke at Stansberry's Conference in Las Vegas. If you were there, then you already have access to the stock with 10x potential that he revealed on stage. If you missed it, I highly suggest you [check out his full presentation right here](. --------------------------------------------------------------- [World's richest man orders 100K units of radical new technology]( CNBC reports that the world's richest man has ordered 100,000 units of a technology that could soon change his business and your life. Legendary investor Whitney Tilson explains the full story and his No. 1 stock to profit (including ticker symbol) [here](. --------------------------------------------------------------- And that's yet another thing that's going wrong for frontdoor... Customers who buy directly also tend to renew at a higher rate than those who are gifted a policy. And that business also has slowed. In response, on its most recent earnings call, CEO Rex Tibbens said (emphasis added) ... The team understands D2C is our biggest lever for new unit growth, and we simply must execute our plan more quickly and flawlessly going forward. This is a channel that can return to double-digit revenue growth next year. But again, it will take a few quarters for our volume improvements to show up in reported revenue. To which I say: Houston, we have a problem. "Must execute" in the same sentence as "quickly and flawlessly" along with "it will take a few quarters" suggests failure is not an option. That's something no investor wants to (or should want to) see. I give the company credit for candor, but it also makes me wonder... Is frontdoor's model breaking... or already broken? After all, it's not performing in a hot market, and it warns in its filing that it might not do well in a cold market. What's more, this was the second straight quarter where the company struggled and guided down. Even bulls on the stock have thrown in the towel. Among them, our sister company, Altimetry, which had recommended the stock in part because of what it believed should be a great market for its business. But after two straight quarters of disappointments, my friend and colleague Joel Litman wrote: Any company can have these sorts of short-term execution issues... But when frontdoor missed again this quarter – and this time, for what it claims is a completely different reason (new sales issues with its direct-to-consumer market) – it's time to step aside. Maybe something else is at work here... Could it be that prospective customers have been checking out the Better Business Bureau ("BBB") before buying? It's quite an eye-opener. [According to the BBB]( 22,609 complaints against American Home Shield were "closed" in the past three years... roughly half of them in the past year, when things must've broken more as more people who were stuck at home were using them more. That's nearly triple over the equivalent three-year number in 2016, the last time I did a dive into the company... To be fair, frontdoor is much larger than it was back then, but the rise in complaints doesn't correlate with its growth. It's way more. None of this is meant to say the company doesn't eventually get its act together enough for investors to roll out the welcome mat once again. But if it does, it'll want to make sure the problems haven't been merely wallpapered over. In the mailbag, a reader writes in about my essay on the buyback bubble at Oracle (ORCL)... I had quoted a friend who was short Oracle as a hedge against his long in Salesforce (CRM). He was concerned that Oracle's ability to juice its earnings per share with stock buybacks was on borrowed time. That prompted Dan A. to write in... "I've been a fan of ORCL's buyback strategy for more than 3 years, arguing that it's the right corporate finance strategy for a company with sticky, recurring, high margin revenues in a ZIRP/QE world. Especially when by any realistic measure the cost of debt is a tiny fraction of the cost of equity (I view a high FCF yield as a proxy for a high cost of equity). "Sure, ORCL could get into trouble if bond yields are 5,6,7% when they come due for refinancing. However, the world in which that happens is also a world of runaway inflation in which Oracle is renewing software contracts at 5-10% price increases. Also, imagine an asset-price-addicted U.S. economy in which corporate bond yields are 5-7%. It's very difficult. If the Fed was willing to pump $120B a month of QE in the 2021 economy, with financial conditions looser than ever, then it stands to reason that they'd nationalize the bond market to forestall the economic consequences of yields that high. That's why, ultimately, I think the U.S. is heading for a higher-inflation, less-culturally-cohesive version of the Japanese economy post-1990, with markets becoming ever more like public utilities because 'everyone's retirement is counting on it.' "On your friend's point about Salesforce revenue growth vs. Oracle... "I argue that metrics like ROIC and FCF yield are more relevant to a buyback strategy. If revenue growth doesn't ultimately translate into free cash that can be delivered into shareholders' hands, it isn't ultimately worth very much (will Tesla's revenue ever be worth very much? I think the jury's still out, but the history of auto OEM revenue says 'no.'). Salesforce has had to rely on a long, long list of acquisitions to keep its revenue growth rate high. Sure, Oracle has as well, but not nearly to that extent, to my knowledge." Herb comment: Thanks for the e-mail, Dan. I shared your e-mail with my friend, who wrote back to me saying... Thanks so much for sharing this. It's always good to see the other side. He's right that ORCL is like a printing press for money. The cost to switch from ORCL is high, so they will only lose customers slowly. If ORCL can't maintain their rate of share buyback, EPS growth will slow and investors will be disappointed. That's the basis for my bet. With revenue growth in low single digits and valuation at a 15-year high (EV/Revenue), at least my risk of being short isn't huge. (Famous last words for a short seller...) The ratings agencies are paying attention to ORCL's increasing debt load [with downgrades earlier this year.] While ORCL's BBB+ rating isn't going to scare anyone, it might signal that there is a limit to buybacks that exceed ORCL's current cash flow generation. ORCL's recent stock buybacks have exceeded their cash flow generation, requiring them to issue debt to fund the buybacks. To which I say: Two smart people, same set of number and facts, two different opinions. That's what makes markets. As always, feel free to reach out via e-mail by [clicking here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Herb). And if you're on Twitter, feel free to follow me there at [@herbgreenberg](. My DMs are open. I look forward to hearing from you. Regards, Herb Greenberg November 5, 2021 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2021 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](