#2 Real estate player at 0.11x P/S and 10x potential

Seizing the real estate opportunity at a historic market low with a cheap company

---

• Valuation: Trades at 0.11x P/S

• Growth: 5-year Revenue CAGR of 35%

• Strategic Sale: Recent divestment worth 37.5% of market cap

• Profitability: EBITDA turning positive in 2024

• Financial Health: Net cash position

• Insider Activity: Significant insider buys during 2024

• Real estate industry: Lowest point since 2009 —> BIG opportunity

Dear Readers,

Thank you for your continued support! I'm thrilled to share what I believe is one of my best articles yet, highlighting a potential 10x investment with controlled risk. This piece is packed with valuable insights and thorough analysis. I hope you find it both informative and enjoyable.

Before proceeding, I would like to disclose that I currently hold a position in Fathom Holdings Inc. ($FTHM) bought at 1.9$.

If you’re thinking about signing up for Seeking Alpha, you can do it through this link: Seeking Alpha. It helps me keep writing content like this—thank you for the support!

Overview:

Fathom Holdings Inc., based in Cary, North Carolina, is a technology-driven real estate services company operating through a cloud-based platform. It offers residential brokerage, mortgage, title, insurance, and SaaS solutions. Despite industry challenges, its innovative model and strategic acquisitions position it for significant growth. Fathom's focus on expanding market presence and integrating technology with traditional services, combined with robust revenue growth and a net cash position, poises it to capitalize on opportunities in a recovering market.

Investment Highlights

• Undervalued stock: The stock has plummeted 96%, trading near its all-time low with a market capitalization of approximately $40M and a P/S ratio of 0.11x, indicating significant upside potential.

• The Worst May Be Over: We are currently at the nadir of the most negative real estate market scenario since 2009.

• Growth and Strategy: Fathom's innovative business model offers greater profitability for agents compared to traditional brokerages, positioning it for rapid growth. This advantage is expected to attract more agents, increasing both its agent base and revenues.

• Catalyst: A potential reduction in interest rates and transition to positive EBITDA could dramatically improve the company’s financial performance, unlocking substantial value for shareholders.

• Management Alignment: CEO Marco Fregenal holds 1,336,262 shares (6.6%), and the founder, now a board member, holds 4,512,913 shares (21.55%), ensuring strong alignment with shareholder interests.

Industry highlights

The recent surge in interest rates has significantly reduced home sales in America, creating a challenging environment due to the higher costs associated with mortgages. This increase in rates has led to a drop in transactions, with current home sales volumes at their lowest since 2009, following the 2008 financial crisis.

The accompanying chart illustrates the evolution of home sales units since 1968, highlighting this recent decline. Elevated mortgage costs have caused many potential buyers and investors to adopt a wait-and-see approach, further slowing down both home purchases and sales.

Despite the drop in transactions, home prices have remained stable (can be seen in the chart below) due to a significant housing shortage in the U.S., estimated between 4.5 and 6.8 million homes. This shortage continues to support prices despite higher borrowing costs.

The current market conditions suggest that housing transactions may return to normal levels once people adjust to higher interest rates or the Federal Reserve lowers rates. The underlying demand for housing remains strong, with many buyers waiting on the sidelines. This pent-up demand could drive a resurgence in home sales when financial conditions improve.

Given the current state of housing transactions, the industry is facing its toughest period since the 2008 financial crisis. This challenging market has also led to a significant drop in real estate-related stocks, potentially making the most favorable time to invest in real estate stocks since 2009.

Fathom Business model

In the United States, hundreds of thousands of real estate agents are required by law to be affiliated with a real estate broker. Brokers provide essential support, resources, and training, oversee transactions, ensure compliance with state laws, and offer marketing and administrative support. This mandatory affiliation creates a steady demand for brokerage services, which contributes to the industry's growth.

Brokers compete to attract agents to their firms. Traditional brokers typically take a percentage of the agent's sales commission, which can significantly reduce earnings. Fathom Realty’s business model stands out by operating on a flat-fee structure. Agents pay a $550 flat fee for their first 15 sales each year, and this fee is reduced to $150 per transaction beyond that, a limit known as the 'CAP'. This model allows agents to retain a larger portion of their commissions, making Fathom highly attractive and driving its rapid growth.

Here is an example comparing the earnings of a real estate agent affiliated with a traditional broker versus Fathom Realty:

Additionally, Fathom Realty offers a referral program that further incentivizes agents. Agents receive stock grants of $250 for each new agent they refer. If an agent recruits four agents, their flat fee per sale drops to $150; recruiting eight agents eliminates the fee altogether. This program encourages agents to expand Fathom’s network, enhancing the company’s competitive edge.

Fathom’s flat-fee model, combined with its investment in technology, provides cost-effective brokerage services. The company has developed a platform that simplifies the process for agents and supports its rapid growth. Real estate transactions account for approximately 94.2% of Fathom’s total revenue, with additional income from mortgage services, technology solutions, and insurance. Fathom has strategically acquired smaller companies in these areas to expand its service offerings and increase revenue per agent.

Later in this article, I will discuss the impact of these stock grants on shareholder dilution.

Operational overview

Firstly, let’s talk about Fathom Holding revenues:

The company's compound annual growth rate (CAGR) in revenues has been an impressive 35.55% since 2017, underscoring Fathom's effective strategy in recruiting new agents and sustaining revenue growth.

Why did revenues decline in 2023?

The decline in revenues during 2023 is primarily due to a significant drop in transaction volume, as Fathom’s revenues are closely tied to the total commission from each transaction. Fewer transactions directly lead to reduced sales.

What about the number of agents?

Despite the revenue decline in 2023, Fathom's number of affiliated agents increased by 14%. This growth highlights the company's success in attracting agents even amid a business contraction.

Growth Thesis

Fathom is a growing company capturing market share from traditional brokers by offering a cost-effective, technologically advanced model. Unlike traditional brokers that have reached market saturation, Fathom’s low-cost model continues to attract agents and expand market share. Although not yet valued as a high-growth, innovative company, Fathom's increasing revenues and scale suggest future profitability growth.

Gross Profits and Margins

Fathom's gross profit comes from subtracting the agent's fee from the total commission and collecting a $550 flat fee per agent per sale, along with revenues from other services. Gross margins have been improving since 2018, reaching 10.3% in Q1 2024. This improvement is driven by:

1. Increased Revenues from Other Services: Higher-margin services like mortgages and insurance are contributing positively to gross margins. The increase in these revenues in Q1 2024 has further enhanced margins.

2. Annual Fixed Fee Inflation: The company has periodically raised the fixed annual fee per agent from $600 to $700 in 2024, which also supports margin improvement.

Operating Margins

Traditionally, Fathom has prioritized expansion over profitability. However, due to the recent economic downturn, the focus has shifted towards improving profitability and efficiency. Since 2023, management has been enhancing EBITDA and reducing cash burn.

Q1 2024 Performance

In Q1 2024, Fathom reported an EBITDA of -$1.5M, with guidance for a positive EBITDA of $200,000 to $500,000 in Q2. This improvement is partly due to a 55% increase in mortgage business revenues, which has contributed to better margins. Management is optimistic about continuing this positive trend by increasing revenues from other services.

Outlook and Stockholder Impact

The shift towards profitability is crucial for stockholders. As revenues grow and gross margins expand, EBITDA is expected to improve over time. Fathom aims to reach 100,000 transactions per year in the medium term, which they project will lead to an EBITDA of $40 million. Achieving this target could significantly boost the stock’s value, making the company's growth potential appear very promising.

Projection of Fathom’s Value

Fathom is projected to increase its number of agents by 20-25% annually. Assuming this growth directly translates to a proportional increase in transactions (with a potential for higher growth given the current low point in the cycle in transaction per agent), the company could achieve significant milestones.

In five years, Fathom could potentially reach 100,000 transactions and generate $40 million in EBITDA. With a 10x EBITDA multiple, this would value the company at $400 million—representing a 10x increase from its current valuation and a 58% compound annual growth rate (CAGR).

This projection is based on Fathom’s historical success in agent growth and its business model, which is designed to support continued expansion.

Debt

Fathom maintains a low level of debt, which enhances its financial stability and growth potential. Below is the detailed table illustrating this:

Source: Fathom 2023 Annual report.

In 2023, Fathom issued a $3.5 million convertible bond with a maturity date in April 2025 and an interest rate of SOFR + 5%. The bond's strike price is set at $6, mitigating concerns about dilution for investors. Despite the high interest rate, it is manageable for the company due to its sufficient liquidity from the sale of Dagley Insurance, which allows it to pay off the bond in full.

Sale of Dagley Insurance

The following information is extracted from the 2021 Annual Report:

On April 16, 2021, the Company acquired E4:9 Holdings, Inc. (“E4:9”), which included three operating subsidiaries: Encompass Lending Group (mortgage), Dagley Insurance Agency (home and other insurance), and Real Results (lead generation). The acquisition, valued at $26 million, aimed to provide agents with growth opportunities and offer consumers a comprehensive range of housing-related services. At the time, E4:9 was generating approximately $15 million in revenue.

Currently, Encompass Lending Group alone generates nearly $8 million in revenue and is experiencing rapid growth. Fathom sold Dagley Insurance primarily to:

1. Raise liquidity for future operations.

2. Reallocate capital more effectively for expansion and growth.

The sale of Dagley Insurance provided substantial liquidity and bolstered the company's overall value. Given that Fathom's market capitalization is $40 million, the $15 million sale of this subsidiary, which contributed minimally to overall revenue, represents about 37.5% of the company's market value.

Management alignment and insider buys

As of July 25, 2024, the insider ownership of Fathom Holdings Inc. is as follows:

• Joshua Harley

  • Role: Founder and former CEO

  • Shares Owned: 4,512,913

  • Percentage of Total Shares: 21.55%

• Glenn A. Sampson

  • Role: Director of the Board

  • Shares Owned: 1,534,086

  • Percentage of Total Shares: 7.33%

• Marco Fregenal

  • Role: President, CEO and Director

  • Shares Owned: 1,336,262

  • Percentage of Total Shares: 6.38%

• Scott N. Flanders

  • Role: Director of the Board

  • Shares Owned: 681,210

  • Percentage of Total Shares: 3.25%

• Ravila J.D. Gupta

  • Role: Director of the Board

  • Shares Owned: 678,937

  • Percentage of Total Shares: 3.24%

The total percentage of ownership by these insiders is 41.75%. ​​This is exciting by itself, but lets look at recent insider buys:

As evident from the table above, there has been significant insider buying, particularly by Scott N. Flanders, with no insider selling recorded. This suggests that insiders believe the company is undervalued at current prices.

Additionally, in 2023, CEO Marco Fregenal opted to receive a substantial portion of his base salary in stock rather than cash. This choice reflects a strong vote of confidence in the company's future prospects and a preference for increasing his ownership over immediate cash compensation.

With the high level of insider ownership and recent insider buys, it is clear that management is well-aligned with shareholders and likely to act in their best interests.

In 2023, Fathom approved a share repurchase program at its annual shareholder meeting. Although the program has not yet been executed, possibly due to limited liquidity, there is potential for future stock buybacks or dividends if the business thesis proves correct and EBITDA turns positive. The significant insider ownership further strengthens the likelihood of shareholder-friendly actions.

Potential Acquisition of the Company

While not the primary basis of our investment thesis, there is a possibility that the company could be acquired in the future. The M&A market is expected to gain momentum in the coming months and years, especially within this sector. Given the company’s current valuation, growth trajectory, and relatively small size, it could become an attractive acquisition target for a larger brokerage firm.

Additionally, with the management team approaching their 60s and holding significant ownership stakes, an acquisition could offer an appealing exit strategy for them.

It is important to note that this scenario is hypothetical and not anticipated in the near term. However, it remains a potential outcome worth considering.

Stock-Based Compensation

Currently, stock-based compensation (SBC) totals approximately $12 million. While this might seem substantial relative to the current valuation, it is not necessarily concerning.

This $12 million in SBC comprises two main components: the executive compensation, which is likely to remain stable, and the agent referral program, which is expected to increase. Currently, SBC related to the agent referral program is $4 million.

If we apply the same 25% growth rate used for agent base growth to the agent referral SBC, the projected figures would be as follows:

---

Projected Evolution of Agent Referral SBC:

• Current (2023): $4,000,000

• 2024: $4,000,000 × 1.25 = $5,000,000

• 2025: $5,000,000 × 1.25 = $6,250,000

• 2026: $6,250,000 × 1.25 = $7,812,500

• 2027: $7,812,500 × 1.25 = $9,765,625

• 2028: $9,765,625 × 1.25 = $12,207,031.25

---

This analysis assumes a 25% annual growth rate for the agent referral SBC, consistent with the anticipated growth in the agent base.

In five years, the company's SBC is projected to reach approximately $20 million, combining both executive compensation and the agent referral program. Given that the agent referral program is expected to grow at a 25% annual rate, this growth would be accompanied by increases in the agent base and revenues, leading to an estimated EBITDA of $40 million.

At this point, if the company is valued at 10x EBITDA, this would result in a valuation of $400 million. In this scenario, the $20 million in SBC would represent just 5% of the company's total valuation. This percentage is relatively modest, considering that SBC is a crucial tool for attracting and retaining new agents.

Additionally, as the company's revenues increase, the SBC would become an even smaller percentage of total revenues, making it a manageable expense relative to the overall financial performance.

In the future, the company may address the potential dilution from stock-based compensation (SBC) by repurchasing shares equivalent to those issued through the referral program. This approach would mitigate the impact of dilution on existing shareholders. Given management’s incentives and focus on shareholder value, this possibility aligns with their goal of maintaining shareholder equity.

Legal Settlements

The Burnett Settlement involves an industry-wide legal settlement where brokers were accused of charging unfair fees to home sellers. The plaintiffs claimed that the National Association of Realtors (NAR) and certain brokers conspired to inflate commission rates, forcing sellers to pay high fees to buyer's agents.

The Burnett Settlement impacts brokers in the following key ways:

1. Prohibition of MLS Commission Listings: Brokers can no longer list offers of compensation on Multiple Listing Services (MLS). This means that commission details must be negotiated directly between buyers and their agents, rather than being disclosed on MLS platforms​

2. Written Agreements: Brokers must now have written agreements with their buyer clients before showing homes. This requirement aims to clarify the services provided and the associated costs upfront​.

3. Transparency and Negotiation: The changes are designed to make commission structures more transparent and to give home sellers more control over the costs associated with selling their homes.

These changes will likely lead to more direct negotiations about commissions between brokers and clients, altering how brokers communicate and agree on their fees.

The industry-wide legal settlement has caused a decline in broker stocks, but it could present positive opportunities for Fathom Holdings following this settlement:

Competitive Advantage: Fathom's flat-fee model is unique and well-aligned with the settlement’s emphasis on transparency and direct negotiation of commissions. This model can make Fathom more attractive to agents and clients seeking clear and fair commission structures.

Recruitment and Retention: The settlement enhances agents' control over their commissions. Fathom's agent-friendly model, which allows agents to retain a higher percentage of their earnings, can help attract and retain high-performing agents who value transparent and predictable compensation terms.

Market Differentiation: The focus on transparency and fairness in the settlement can bolster Fathom’s reputation as a brokerage that champions these values. This differentiation from traditional models can attract more clients and agents, enhancing Fathom’s market position​.

Main Risks

1. Prolonged High Interest Rates: Sustained high interest rates could negatively impact the real estate market, reducing transaction volumes and affecting Fathom's revenue.

2. Challenges in Agent Recruitment: If Fathom's business model does not attract agents as anticipated, this could hinder growth and limit market expansion.

3. Potential Legal Settlement Penalties: If legal settlements result in significant fines for Fathom, this could impose substantial financial burdens and impact overall profitability.

Rivalry Between eXp World Holdings and Fathom Realty

eXp World Holdings (EXPI) stands as the primary competitor for Fathom Holdings Inc. The fundamental difference between the two companies lies in their commission structures. eXp Realty charges a percentage of the commission, whereas Fathom Realty operates on a flat-fee model.

eXp Realty:

• Commission Structure: eXp Realty takes a percentage of each agent's commission, providing agents with revenue-sharing opportunities and equity awards as additional incentives.

• Incentives: The company has effectively utilized stock-based compensation (SBC) to incentivize agents, resulting in significant growth and agent retention over the years​​.

Fathom Realty:

• Flat-Fee Model: Fathom Realty charges a flat fee per transaction, allowing agents to retain a larger portion of their earnings. This model can be particularly attractive in light of the recent industry settlement, which emphasizes transparency and direct negotiation of commissions​.

• Competitive Advantage: The flat-fee structure could provide Fathom with a competitive edge over eXp Realty. As the industry moves towards greater transparency and fair commission practices, Fathom's model aligns well with these trends, potentially making it more appealing to agents who prefer predictable and fair compensation terms​​.

Stock Comparison

When comparing the stocks of eXp World Holdings (EXPI) and Fathom Holdings Inc. (FTHM), it is notable that EXPI trades at a significantly higher valuation. This premium is likely due to eXp Realty's position as a pioneer in the virtual brokerage space and its rapid growth trajectory.

eXp World Holdings (EXPI):

• Higher Valuation: eXp Realty's innovative business model and substantial market presence contribute to its higher stock price, reflecting investor confidence in its continued growth and industry leadership​.

Fathom Holdings Inc. (FTHM):

• Attractive Valuation: Fathom trades at a lower valuation compared to eXp, which presents a potential opportunity for value investors. Given the company's strong business model and the potential favorable impact of the industry settlement, Fathom appears to be undervalued and poised for significant growth​.

In summary, while eXp Realty has successfully grown by leveraging a percentage-based commission model and substantial stock-based incentives, the evolving industry landscape might favor Fathom Realty's flat-fee approach. This model not only promotes transparency but also offers agents greater financial predictability, potentially giving Fathom a significant competitive advantage. Additionally, the current valuation disparity between the two companies makes Fathom an attractive option for value investors, particularly in light of the potential benefits from the recent industry settlement.

Conclusion

Fathom Holdings Inc. has faced significant challenges in the stock market recently, driven by multiple factors including the worst real estate market conditions since 2009 and legal settlements. Despite these setbacks, I believe Fathom is highly undervalued. The company’s unique business model positions it for sustained growth, offering a competitive advantage in the evolving real estate landscape post-settlement.

Currently, Fathom has no risk of going bankrupt as it has secured ample cash reserves following the sale of Dagley Insurance. Additionally, the company is expected to achieve positive EBITDA next quarter and has ceased its cash burn. These factors combined position the stock as a compelling investment opportunity with the potential for substantial returns, possibly as high as 10x, with minimal risk in the current situation.

If you’re thinking about signing up for Seeking Alpha, you can do it through this link: Seeking Alpha. It helps me keep writing content like this—thank you for the support!