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As the short-sellers circle, is Purplebricks really as safe as houses? PURP

Stock market ‘success story’ and estate agent ‘disruptor’ Purplebricks (LSE:PURP) has been one of just a few companies backed by star investor Neil Woodford not to collapse this year. But the Woodford curse looked set to strike again earlier this week when the firm dropped 8pc after revealing a £8.2m group loss for the six months ended 31 October 2017.

Despite Purplebricks also reporting that group revenue grew 150pc to £46.8m and that UK operations swung into maiden profits, a large number of institutional investors have taken up short positions in the company.

With a launch into the tough US market, a slowing UK housing market, and calls for more transparency on the horizon, the market seems to have agreed that the stock is looking seriously over-valued.

What profit?

Launched in 2012, Purplebricks has challenged traditional UK estate agents – who take a percentage of a house’s final sale price as their commission – by charging a flat up front fee. It has become enormously popular with investors since launching, and shares have increased from 93p to 386p (last seen) over the last three years alone. As a result of this, Purplebricks’ market valuation currently stands at a whopping £1bn.

When you consider that the firm’s £8.2m loss in H1 2018 compares to a loss of just £2.8m in H1 2017, this valuation looks strikingly expensive. The company seems to be moving further away from profitability. On top of these widening losses, analysts expect Purplebricks to generate revenues of just £98.6m for the full-year 2018, giving the firm a price to sales ratio of nearly 10X. This is far too rich for many people’s tastes.

What’s more, the firm has also vowed to keep establishing itself in Australia and the US. Creating and maintaining a presence and staff in these markets is going to detract further from profits without any guaranteed success for potentially many years. The firm spent £12.9m on marketing last year alone, and this only looks set to increase.

Indeed, analysts believe the firm will report a loss of £10.2m over the full year, and do not expect the firm to start generating profit until 2019. Michael Bruce, group chief executive of Purplebricks himself, told analysts that there was still a ‘question mark’ around whether the firm will be profitable in the next two years following the release of this week’s results.

UK stability

The big story for Purplebricks this week was its relatively strong performance in the UK (compared to last year), where it generated profits of £3.2m over H1 2018, its first ever profitable period in the region. This compared to a loss of £300,000 in H1 2017. Furthermore, it saw its average UK income per instruction increase by 14pc to £1,138 and upgraded its revenue guidance for 2018 in the UK by 5pc to £84m, in order to reflect strong first half performance.

The firm has undoubtedly gathered some impressive momentum in the UK, but, perhaps worryingly, the UK property market has begun to cool recently, due in part to tough conditions in London. House prices dropped 0.5pc in October, according to the Office of National Statistics. This led the annual growth rate from 4.8pc to 4.5pc. If people become less confident in selling their house, one would assume that the upfront payment option that Purplebricks offer would become less attractive, given the reduced chance of a sale.

Bruce shrugged off the concerns, claiming ‘the overall market is flat I would suspect, but nevertheless for us it’s growing’, adding that the firm is more concerned with growing market share. That’s fine, but whether or not you want to buy Purplebricks at a sky-high valuation as its key market starts to decline is another question.

American dreams

Purplebricks has also placed a huge amount of weight on its success in the US, where it claims there is ‘substantial opportunity’ to modernise the market due to sky high average commission fees of between 5pc and 6pc. It launched in Los Angeles and began marketing in September and plans to launch in San Diego, Sacramento, and Fresno in January 2018, adding that it has been ‘greatly encouraged’ by responses so far.

However, many have already pointed out that the US retail market is highly fragmented and radically different to Australia and the UK, allowing US realtors to make money as either listing agents or buying agents. Purplebricks believes this offers an additional revenue stream but, with several flat fee firm already in existence in the country, it remains to be seen whether the Yanks will buy into the firm’s model.

With Purplebrick’s launch in the US already driving shares up sky high, any failure in the country is likely to significantly dent its market valuation.

Reduced visibility

For analysts, one of the most worrying things about Purplebricks since its launch has been its refusal to disclose how many houses it has actually sold.

For example, in its latest results, the company said it sold and completed on £4.6bn of property in the UK in H1 2018, with a further £3.8bn in the pipeline. There is no way of translating these figures into a number of houses sold, and as such, there is no way of working out how successful the firm’s agents have been..

Analysts at Jefferies accused the firm of ‘speaking in riddles’, adding: ‘How many homes they sell … remains the key KPI by which, in our view, Purplebricks will succeed or fail. We believe this early stage disruptor has yet to prove the efficacy of its business model. Should the model stumble, the share price may do likewise.’

It would seem that Jefferies are not the only ones who have been left concerned either. Some retail investors found that there was a borrowing restriction on Purplebricks this week, which is a strong indicator that the stock is being heavily shorted elsewhere.

One look at the FCA’s register of short positions shows that GLG Partners, JP Morgan Asset Management, Numeric Investors, and Wellington Management Company all have significant short positions in the firm.

Furthermore, a number of the firm’s founders sold off huge amounts of their shares itself in August, suggesting Purplebricks itself think the ride is coming to an end.

This is less a question of whether or not Purplebricks will fail; indeed, everything seems to be moving in the right direction as it stands, bar some visibility issues. The real question here is whether the 349p you currently have to pay for a share is worth it given the fact that the firm itself has admitted that group profitability is a long way off.

The fact that such huge, institutional names are betting against Purplebricks will be enough to put many investors’ off. For retail investors prepared to take a punt, it is possible to short this company using the spread betting firms, such as IG Index or SpreadEx. This could be a tempting play as we enter 2018.

 

DISCLOSURE

The author of this piece does not own shares in any of the companies covered in this article.

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