Blend Labs: Expecting Strong Growth And A Transition To Positive FCF

seekingalpha09-04

The company stands to benefit from falling interest rates, which should benefit its mortgage segment through increased refinancing and home purchases.Its consumer banking segment is growing rapidly, ...

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The company has more than a 20% market share pertaining to US mortgage applications. Leveraging its technology platform and its large customer base, BLND has expanded its B2B offerings to include various banking products, such as opening savings accounts, among others. This segment has seen strong growth in recent quarters, even as its mortgage segment has faced headwinds from high-interest rates. Going forward, with rate cuts on the horizon, its mortgage segment is poised to benefit from increased refinancing and home purchase activity. Furthermore, the company has a healthy balance sheet with more than $100 million in cash and no debt, and cash burn reducing significantly, and expected to turn positive early next year. Besides its promising outlook for strong growth and improving profitability in the medium term, I find that the current valuation does not offer a sufficient margin of safety for investors, given the risks I see. I therefore maintain a Neutral rating on BLND shares. Snapshot of key financial highlights   Q2 Quarterly Supplement In Q2, the consumer banking business saw exceptional year over year growth of 38%, as shown above. Though revenue from its mortgage segment was down year over year, it grew over 22% sequentially, benefitting from falling interest rates. Remaining Performance Obligations grew 64% year over year, a sign of strong future demand. In addition to its strong overall financial performance, a key milestone was the $150 Million Investment that the company received from PE firm, Haveli. The investment was made in exchange for Series A convertible preferred stock, with a zero percent coupon and a conversion price of $3.25. This was a significant development for the financial stability of the company, as it enabled the payment of its existing debt, which was coming due in 2026. Looking ahead: My expectations Falling interest rates leading to higher mortgage volumes   Q2 Quarterly Supplement The increased adoption and utilization of company's attached products with mortgages, such as digital closing and homeowners insurance, has resulted in substantial growth in the economic value per funded loan, as shown above. The company's latest generation of its refinancing product is set to contribute towards overall growth, as mortgage rates continue to fall in anticipation of rate cuts by the US Federal Reserve. Management expects the economic value per loan to exceed $100 exiting this year. I expect that the company can continue to grow this value at similar rates until 2026, which combined with higher refinancing and new home purchase activity, should support revenue growth in the Mortgage segment of approximately 30% until 2026. This is slightly ahead of the company's guidance provided during last year's Investor day. Product-led growth powered by Blend Builder   Q2 Quarterly Supplement The Blend Builder platform remains its crown jewel, already having capabilities built into it that include income verification, automated underwriting, risk management etc. New services continue to get added onto this list, which allows BLND to upsell these products to its customers, driving increased revenue and solidifying its market position. BLND's customers achieve significant ROI by replacing labor-intensive processes with the company's automated solutions. The integration of AI into the platform enhances efficiency, making it faster and more user-friendly for consumers. Discussing the impact of AI on automating the processes involved, the company's CEO stated: And given the rate of improvement AI, we're now in a position to leverage it to automatically, for example, process documents provided during the workflows. Given the recent progress that I see, I expect revenue from this segment, which is starting from a relatively smaller base, to grow at a 40% CARG until 2026, reaching $65 million. Turning FCF positive Following significant expense reductions and improved revenue growth in recent quarters, the company is on track to achieve non-GAAP profitability in Q4 this year. Although FCF was -$6.9 million in Q2, I anticipate significant improvement ahead, particularly given the elimination of interest costs. I expect the company to turn FCF positive by Q1 next year and maintain this positive trajectory, provided market conditions remain stable. Additionally, the board’s authorization of a $25 million share repurchase program reflects increased confidence in the company’s path towards profitability. Valuation At the current share price of $3.5, Blend Labs has a market cap of $1.05 billion assuming that the Series A convertible preferred stock is converted into ordinary shares, resulting in an additional 46 million ordinary shares. Based on the FCF burn expected in the next two quarters, I anticipate the company end up with a net cash position of close to $100 million, giving it an enterprise value of $0.95 billion. In line with my expectations discussed above, I expect Blend Lab's consumer banking segment revenue to grow at a 40% CAGR, reaching $65 million in 2026. Likewise, I anticipate Mortgage revenue to grow at a 30% CAGR, reaching $170 million in 2026. This implies total platform revenue of $235 million for 2026. I expect FCF margins for the platform business to reach 25% in 2026, which should result in FCF of approximately $60 million. This implies that shares are trading at an EV/2026 Revenue multiple of 4.1 and an EV/2026 FCF multiple of 15.9. In comparison, nCino (NCNO), which I consider a relevant public market peer, is showing mid-teens growth rates and is valued at EV/Revenue and EV/FCF multiples, based on this year's estimates, of 6.5 and 40 respectively. Though I consider BLND's valuation to be reasonable, given its promising growth prospects and improving margins, I do not see a reasonable margin of safety for investors given the risks and uncertainties involved, which I will walk through in the next section. Additionally, BLND's stock-based compensation expense, which is currently around $30 million annually, makes shares considerably more expensive on a GAAP basis. I would like to point out that I have intentionally not included the company's Title business in my valuation model. Given its slower growth rates and substantially lower margin profile, I do not anticipate it contributing significantly to shareholder value creation in the future. Risks to consider Interest rates remain higher for longer The company's mortgage segment, which constitutes a significant portion of its revenue, stands to gain substantially from a declining interest rate environment as it encourages increased refinancing and home purchases. Conversely, if interest rates remain high rather than decrease, this could pose a challenge for the company, creating a less favorable outlook and potentially dampening its growth prospects. Customer concentration According to the company's latest Annual report, its top five customers accounted for 32% of the Platform revenue. Losing any of these customers, whether due to competitive pressures or a shift to in-house solutions, could significantly impact the company's performance. Competition BLND is a leading player with its mortgage product, where it competes with nCino and others. However, as BLND ventures further into consumer banking, it is likely to face more competition from larger players like SoFi Technologies (SOFI), through its Galileo offering. Purchase of the remaining Title365 stake According to the purchase agreement related to the acquisition of Title365 from Mr. Cooper Group (COOP), the company may be forced to purchase the remaining 9.9% ownership stake for approximately $56 million under specific conditions. Given my unfavorable outlook for the Title business, I believe this cash outflow is unlikely to be value-accretive for the company. Investors can read more about this in the company's latest Annual report. Conclusion  Overall, BLND is well-positioned for growth, as its mortgage segment is set to benefit from increased refinancing and home purchases as a consequence of falling interest rates. The company's consumer banking segment should continue to grow at close 40% in the medium term. Despite this positive outlook, I find that the current valuation does not provide a sufficient margin of safety given the risks, leading me to maintain a Neutral rating on the shares.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.26.4","shortVersion":"4.26.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2464632278"}