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Rocket Companies: A Good Time For Mortgage Companies - Yahoo Finance

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Rocket Companies Inc. (NYSE:RKT), a mortgage company run by billionaire Dan Gilbert and best known for its subsidiary Quicken Loans, has released terms for its upcoming IPO. The company will sell 150 million shares with the possibility of selling an additional 22.5 million more at a maximum price of $22, and will thus raise up to nearly $3.8 billion. This company could be worth $40 billion after this IPO, making it the largest of 2020.

Bigger certainly does not mean better when it comes to IPO, as a quick glance at Uber (NYSE:UBER) can tell you. But Rocket Companies Inc. is in a good position to take advantage of trends caused by the coronavirus and has solid financial numbers to boot. But the big question is whether the positives can justify such a large valuation.

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Mortgages And COVID-19

Most businesses have been devastated to some degree by the coronavirus pandemic and its result on the economy. But in Rocket’s case, one simple statistic reveals a great deal about its business. The company recorded a net revenue of $1.36 billion in the first three months of 2020. But over the next three months, as businesses in America struggled, Rocket’s preliminary estimates for its April to June revenue is over $5 billion.

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Rocket explains in its S-1/A that this gargantuan increase is due to “an increase in gain on sale margin,” which in turn was fueled by “generally favorable market conditions and the low interest rate environment which led to increased demand for mortgages and capacity constraints in the industry.” In summation, this is a really good time for those who can afford it to get a mortgage as COVID-19 is keeping interest rates low.

Those low interest rates however mean that banks find mortgages to be a riskier bet, with Fortune reporting that banks are simply not lending money to those in a more difficult situation as opposed to charging them higher interest. It is reasonable to assume that those who cannot get mortgages through a bank will then turn to mortgage companies like Quicken Loans.

The obvious question with this growth is how long Rocket can expect things to hold up. Obviously, its revenue will not nearly quadruple again in the next quarter. But the coronavirus will continue to be a problem for the next few months at a minimum, and the economic consequences will persist even after that. Furthermore, millennials and those looking to buy homes will turn towards online mortgage lenders just as we have turned to the web to buy everything. This trend will likely continue after the pandemic and favor Rocket as it has a strong online presence and marketing strategy.

Finances and Valuation

The aforementioned revenue quadrupling is an indicator of how Rocket has thrived during the pandemic, and the company was doing well financially even before then. Rocket has been consistently profitable, reporting a net income of $892 million in 2019 and $97 million in the 2020 1Q.

Rocket’s revenue has been growing rapidly since 2018 and the company has been making money. There are some concerns about its debt level, with a ratio of 0.83. But this is a time of low interest and the company will likely not need additional financing after this IPO anyways.

To summarize things, Rocket has a strong business model which should be expected to grow rapidly and has solid financials all around. But does that make this company worth over $40 billion?

Rocket has $17 billion in total liabilities and $2.2 billion in cash, which gives the company an enterprise value of about $55 billion. If we use its 2019 revenue of $5.1 billion, this means we are looking at an EV/revenue ratio of 10.78. However, Rocket’s estimated revenue for the 12 months ending June 30, 2020 is closer to around $10 billion, meaning a ratio of 5.5. This is an extremely reasonable value compared to other bank stocks.

A Great Deal to Like

Of course, Rocket Companies has its share of risk like any IPO. The company is using multiple share classes in its IPO which will keep 79% of voting power in the hands of Dan Gilbert and other institutional investors. Economic damage from COVID-19 could create more foreclosures and forbearances, though Rocket does state that only 5.1% of its total serviced client loans are under forbearances. And Rocket Companies does not have a particularly strong moat compared to other mortgage companies.

But the biggest IPO of 2020 could still be one of the best, and it arguably should be even bigger. We are looking at a company which has strong growth potential in the short to medium term at least, is reasonably valued, and is profitable. IPOs do not come around very often, and investor should consider a target value in the mid or even high 20s. While there is plenty of time for Rocket Companies to adjust its price as it launches its roadshow over the next week, this is an IPO investors should be watching carefully.

By Euan Jones

Disclosure: None

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