{"id":4403,"date":"2023-06-05T13:00:00","date_gmt":"2023-06-05T13:00:00","guid":{"rendered":"https:\/\/www.realtrends.com\/blog\/2023\/06\/05\/the-stakes-are-high-for-compass-in-q2\/"},"modified":"2025-03-13T02:51:30","modified_gmt":"2025-03-13T02:51:30","slug":"the-stakes-are-high-for-compass-in-q2","status":"publish","type":"post","link":"https:\/\/www.realtrends.com\/blog\/2023\/06\/05\/the-stakes-are-high-for-compass-in-q2\/","title":{"rendered":"The stakes are high for Compass in Q2"},"content":{"rendered":"\n

For nearly its entire history, growth was the name of the game for Compass<\/strong><\/a>, even after going public in April 2021<\/a>.<\/p>\n\n\n\n

\u201cWe grew faster than any other company, and that is why we were able to raise $2 billion to invest in our agents,\u201d CEO and co-founder Robert Reffkin said at an industry conference in late-January 2023.<\/a> \u201cIf we decided not to grow and instead said, \u2018Hey, we are going to be profitable in year two,\u2019 I could not have raised $2 billion.\u201d<\/p>\n\n\n\n

Reffkin\u2019s focus on growth led the brokerage to burn through cash at a rapid rate. In the first quarter of 2021, venture-backed Compass reported its cash and cash equivalent assets at $810.7 million. At the end of Q1 2023, Compass\u2019 cash and cash equivalent assets totaled $363.6 million, up slightly from $361.9 million reported in the fourth quarter of 2022.\u00a0<\/p>\n\n\n\n

As of April 2023 Compass had incurred about $150 million in debt as part of a $350 million revolving credit and guarantee limit with Barclays Bank PLC and \u201ccertain other lenders.\u201d This debt is due in March 2026, but Rory Golod, the senior vice president of growth and communications at Compass, said the firm could pay the debt back now with no issue.<\/p>\n\n\n\n

\u201cWe feel great about our cash position,\u201d Golod said. \u201cThat money we tapped the revolver for, right now, is sitting in short-term treasuries bonds, so we didn\u2019t spend it and it is not being used for financing activities for the business. It is just sitting there. We could tomorrow turn around and pay that back, so it isn\u2019t like we need to come up with the capital from operations to pay that back. We withdrew the money over an abundance of caution with everything going on in the world the last few months. We figured why not just have the extra capital there just in case?\u201d\u00a0<\/p>\n\n\n\n

With the housing market slowing<\/a> to a crawl, Compass has cut back its spending, and as Reffkin <\/a>has repeatedly reiterated, the focus has shifted to profitability. For Compass executives, the first step to achieving profitability is becoming free cash flow positive, which they have said the firm will achieve in the second quarter of 2023. In Q1 2023<\/a>, Compass recorded a free cash flow loss of $59 million.<\/p>\n\n\n\n

Compass\u2019 goal to be free cash flow positive this quarter is not the first time the brokerage has made a promise like this. After reporting an adjusted EBITDA of $2 million in 2021<\/a>, the firm said it would continue to be adjusted EBITDA positive in 2022, but the shifting market conditions waylaid those plans. In the end Compass reported an adjusted EBITDA loss of $210 million in 2022, a year Reffkin called \u201cvery difficult\u201d during Compass\u2019 fourth-quarter 2022 earnings call<\/a> in late February.<\/p>\n\n\n\n

\u201cObviously it didn\u2019t happen because of the market,\u201d Jason Weaver, the managing director of Compass Point Research & Trading, LLC.,<\/strong> said of Compass\u2019s 2022 commitment to adjusted EBITDA profitability. \u201cThey don\u2019t take this commitment [to becoming free cash flow positive] lightly.\u201d<\/p>\n\n\n\n

Despite Compass losing $602 million overall in 2022, analysts are optimistic about the brokerage\u2019s shot at being free cash flow positive at the end of the second quarter. (The company’s earnings call will likely be in August.)<\/p>\n\n\n\n

\u201cYes, I think they will be free cash flow positive in the second quarter,\u201d Steve Murray<\/a>, the president of RealTrends Consulting<\/strong>, said. \u201cGiven what I can see in terms of their cost reductions internally, quarter over quarter, and the second quarter is usually the best financial quarter of the year in our industry, absent anything else that disrupts the housing market, I don\u2019t see anything preventing them from achieving this.\u201d<\/p>\n\n\n\n

In shifting focus to profitability, Compass has placed high priority on reducing operating expenses. With the firm\u2019s quarterly operating expenses ballooning to $2.12 billion in the second quarter of 2022<\/a>, Compass began making cuts, announcing its first of what would become four rounds of layoffs in mid-June 2022<\/a>.<\/p>\n\n\n\n

During the first quarter of 2023, Compass reported operating expenses of $1.10 billion, its lowest quarterly operating expense cost since becoming a public company.<\/p>\n\n\n\n

\u201cThey have put into place a lot of substantial expense cuts on the OpEx side that have really been the driver to them getting to profitability,\u201d Weaver said. \u201cThey have made a lot of progress there and, in fact, they are ahead of schedule for the cuts they plan to make. So, in concert with the revenue implications of what you see out there with the Q2 market, and the impact of the expense cuts, I think they are going to get to free cash flow positive for this quarter and the ongoing year absent any major changes in the market.\u201d<\/p>\n\n\n\n

In addition to the four rounds of layoffs between mid-June 2022 and early January 2023<\/a>, Compass has also worked to cut costs by ending all of the firm\u2019s agent recruitment incentives<\/a>, including signing bonuses and favorable commission splits, last August; shutting down Modus Technologies<\/strong>, a Seattle-based company that Compass bought<\/a> in October 2020, heralding its entry point into the title and escrow space; and shopping around to sublease its New York City headquarters<\/a> near Union Square.<\/p>\n\n\n\n

However, to John Campbell, a research analyst at Stephens<\/strong>, the cost cutting measure that stood out the most was the staff cuts made to Compass\u2019 technology team<\/a>, including the absolution of the firm\u2019s chief technology officer position and resulting dismissal of CTO Joseph Sirosh<\/a> in late August 2022.<\/p>\n\n\n\n

\u201cI could tell how serious these guys were with cutting costs, when the surprising news came out about Joseph Sirosh,\u201d Campbell said. \u201cI think at one point he was a very instrumental part of the team and a kind of thought leader in building the platform.\u201d<\/p>\n\n\n\n

In addition to Compass letting Sirosh go, Campbell also highlighted the brokerage\u2019s declining research and development spend, which totaled over $360 million in both 2021 and 2022. In Q1 2023, Compass spent $48.9 million on R&D, for an estimated annual spend of under $200 million.<\/p>\n\n\n\n

\u201cThey have already spent well over a billion dollars in building out their platform, but there is a big difference in a build versus maintenance and I think they are kind of wrapping that up, so naturally we should be seeing a reduction in OpEx because of that,\u201d Campbell said.<\/p>\n\n\n\n

In a February 2022 regulatory filing, Compass said it had over 1,500 product and technology employees<\/a> across the world. After the September 2022 round of layoffs<\/a>, the firm said it still had over 700 members on its technology team.<\/p>\n\n\n\n

Since ending its recruitment incentives, Compass has touted its technology<\/a> as its main calling card for agent recruitment. And while the firm is optimistic that this will be enough to continue attracting agents, stating that over 1,000 agents have come to Compass since August 2022, Campbell feels that it is still too early to tell what the long-term implications of this cost cutting measure will be.<\/p>\n\n\n\n

\u201cIt is too early to definitively waive the victory flat, but they have put themselves in a good position,\u201d Campbell said. \u201cWhen you cut costs to that extent you do have to worry to some degree about building for the long term. \u2018Do we have the right technology? Do we have the right support costs? \u2018Do we have the right incentives to keep the recruiting machine going?\u2019 And again, it is early, but so far so good. But if you keep cutting deeper and deeper it could affect agent growth and it certainly could affect the responsiveness and effectiveness of the technology that they are building.\u201d<\/p>\n\n\n\n

However, deeper cuts are exactly what David Trainer, the CEO of investment research firm New Constructs, LLC<\/strong>., says Compass needs to deliver on to reach its cash flow goal.<\/p>\n\n\n\n

\u201cGiven how negative free cash flow has been during its life as a public company \u2014 they have burned over $1 billion dollars since 2020. And the cash flow burn at this point on a trailing 12 month basis is $320 million, which means they are burning around $80 million a quarter,\u201d Trainer said. \u201cSo that would require rather drastic improvement in operations when they are trying to take market share and they are still trying to build out a business. It just seems like a very difficult feat.\u201d<\/p>\n\n\n\n

Trainer also cited concern over the \u201cmaterial weakness over internal controls over financial reporting\u201d Compass disclosed in its March 2023 10Q filing <\/a>with the Securities and Exchange Commission<\/strong>.<\/p>\n\n\n\n

The SEC defines a material weakness as \u201ca deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company\u2019s annual or interim financial statements will not be prevented or detected on a timely basis.\u201d<\/p>\n\n\n\n

\u201cThe auditors are willing to make a public statement that they are not sure that the numbers the company is reporting to them are 100% accurate,\u201d Trainer said. \u201cTo us, this is a big red flag.\u201d<\/p>\n\n\n\n

If Compass fails to achieve free cash flow positivity for the second quarter, Trainer believes it will have a negative impact on the stock price.<\/p>\n\n\n\n

\u201cIt has been an overpriced stock for a long time, but who is to say that this ends up being the straw that breaks the investors\u2019 backs,\u201d he said.<\/p>\n\n\n\n

According to an analysis by Trainer\u2019s firm New Constructs, with its current cash reserves and quarterly revenues, Compass can only sustain its current trailing 12 month cash burn rate for 24 months from the end of February 2023, making the company\u2019s goal of achieving free cash flow profitability in the second quarter of this year all the more important.\u00a0<\/p>\n\n\n\n

While Weaver believes Compass will make good on its expectations, he agrees with Trainer that investors will not be pleased if Compass falls short of the free cash flow expectations.<\/p>\n\n\n\n

\u201cInvestors would start to price in a very big credibility discount if that were to happen or if we weren\u2019t showing ongoing progress toward becoming free cash flow positive, like if they just break even or come up slightly below,\u201d Weaver said.<\/p>\n\n\n\n

Reffkin argues that Compass can maintain its lead as the biggest brokerage in America<\/a> by sales volume while adjusting to the market cycle and cutting costs.<\/p>\n\n\n\n

\u201cAmazon went from $103 a share to $3 a share and now they are worth thousands of dollars [a share], and many great companies have gone from $2 to $20 and beyond. Why shouldn\u2019t Compass be able to do that?\u201d Reffkin mused in late January. \u201cWe are entrepreneurs, and we have to shift with the market. With the IPO I invested every dollar I have in the company. I didn\u2019t take money out. I am all in on this company, and I\u2019m there with our agents every step of the way, and I will not be going anywhere.\u201d<\/p>\n","protected":false},"excerpt":{"rendered":"

Compass has shifted its focus from growth to profitability, and executives say the first step is to become free cash flow positive in Q2.<\/p>\n","protected":false},"author":34740,"featured_media":4822,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[3255],"tags":[],"coauthors":[1760],"class_list":["post-4403","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-archive"],"acf":[],"yoast_head":"\nThe stakes are high for Compass in Q2 - RealTrends - Blog<\/title>\n<meta name=\"description\" content=\"Compass has shifted its focus from growth to profitability, and executives say the first step is to become free cash flow positive in Q2.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.realtrends.com\/blog\/2023\/06\/05\/the-stakes-are-high-for-compass-in-q2\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"The stakes are high for Compass in Q2\" \/>\n<meta property=\"og:description\" content=\"Compass has shifted its focus from growth to profitability, and executives say the first step is to become free cash flow positive in Q2.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.realtrends.com\/blog\/2023\/06\/05\/the-stakes-are-high-for-compass-in-q2\/\" \/>\n<meta property=\"og:site_name\" content=\"RealTrends - 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