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Blend Q1 2022 Earnings Review: navigating mortgage lending collapse
Blend (BLND 0.00%↑) , a company that helps mortgage lenders with digitizing and automating their lending processes, is going through a tough market downturn. Elevated real estate prices and skyrocketing mortgage rates are negatively impacting mortgage originations (especially refinancing); and thus, the company’s revenue prospects. Moreover, as per the forecast by the Mortgage Bankers Associations, things will get even worse, and the refinancing volume will keep declining throughout the year (see the chart below).
Source: Mortgage Bankers Association
However, I believe that Blend, which went public in the summer of 2021, has sufficient cash reserves to survive this part of the cycle, and might become an even more prominent player once the market returns to growth. The key factors are the company’s ability to grow its customer base (which they do) and manage the burn rate (which they promised to do). Let’s break down the company's Q1 2022 earnings!
Let’s start with the positive. Blend continues onboarding new customers and finished the quarter with 351 companies using its products. Moreover, the company keeps delivering close to a 100% Gross Retention Rate (meaning, it is not losing customers or their spending despite the market downturn).
My thesis is that mortgage lending will return to growth at some point (it always does), and Blend can be a major winner if they keep building its customer base and increasing its market share. Just look at the chart below. Blend processed 15.2% of all mortgage applications in the country in H2 2021 and they keep growing.
Blend solution improves the efficiency of the lending process through digitization and automation; thus, the current market conditions should act as the tailwind for the company in terms of customer acquisition. As you will see below, the company’s prospects in the short term are bleak, but the long-term investors should appreciate how the company uses the market downturn to increase its market share.
Blend reported $71.5 million in revenue for the quarter, representing a 124% increase YoY. However, it should be noted that the growth came mostly from the acquisition of Title365, a title insurance broker, which Blend completed at the end of Q2 2021. Excluding Title365 (Blend platform in the table below), revenue grew 3% YoY from $31.9 million in Q1 2021 to $32.8 in Q1 2022.
As I wrote in the company’s Q4 2021 earnings review, Blend’s revenue growth cooled down, as the rising mortgage rates started negatively impacting the refinancing volumes. Given the market forecast (see above), I would expect Title365 revenue to continue declining sharply through the year, Mortgage Banking revenue to remain flat or decline modestly, and Consumer Banking revenue to continue growing as the company onboards new clients. Of course, there is a chance that Blend’s clients will fair better than the rest of the market, but given the company’s market share, we should expect its performance to strongly correlate with the market.
I believe it is important to follow the company’s buildup of Consumer Banking revenue. Thus, the company defines Consumer Banking and Marketplace revenue as the “revenue related to solutions outside of mortgage banking transactions, such as consumer banking revenue (home equity, personal loans, deposit accounts), ancillary product revenue (income verification and close products), and marketplace revenue (title, insurance, and realty products).” As can be seen from the chart below, Consumer Banking revenue grew 55% YoY, as the company upsells its existing mortgage client base with additional products.
During Q1 2022 earnings call, the company’s management reiterated the annual guidance of $140 - 150 million in Blend Platform revenue and $90 - 100 million in Title365 revenue. This guidance implies $35 - 39 million in average quarterly Platform revenue and $17 - 20 million in quarterly Title365 revenue for the rest of the year.
Blend reported $28.9 million in Gross profit for the quarter, but the growth of 37% YoY was driven by the consolidation of Title365. Blend Platform’s gross gross profit declined 12% YoY from $21.0 million in Q1 2021 to $18.6 million in Q1 2022.
Evaporation of the Title365 gross profit since the acquisition (at the end of Q2 2021) looks pretty ugly (see the chart below), and given the revenue guidance and the market forecast, it will continue decreasing through the year. Moreover, gross profit generated by the Blend Platform also decreased 12% YoY despite 3% in revenue growth due to a lower gross profit margin.
Thus, the Blend Platform delivered a 57% gross profit margin in Q1 2022, down from a 66% gross profit margin in Q1 2022. The company attributes the decrease in the Platform’s gross profit to “a $2.5 million increase in hosting costs to support the volume of transactions on our platform, and a $1.7 million increase in personnel-related expenses attributable to increased headcount.”
Mortgage transactions actually decreased YoY from 447K in Q1 2021 to 376K in Q1 2022, so the mentioned increase in the “volume of transactions” comes from Consumer Banking. Consumer Banking transactions increased from 48K in Q1 2021 to 155K in Q1 2022. This suggests that Consumer Banking delivers a lower gross profit margin than Mortgage Banking, and we might see further gross profit margin compression for the Blend Platform segment, as the company scales its Consumer Banking products.
The company’s management did not guide the gross profit; thus, let’s use some back of the envelope calculation:
Blend Platform: $35 - 39 million in average quarterly revenue in Q2 - Q4 2022 * 57% gross profit margin = $20 - 22 million in average quarterly gross profit
Title365: $17 - 20 million in average quarterly revenue in Q2 - Q4 2022 * 27% gross profit margin = $4.6 - 5.4 million in average quarterly gross profit
Gross profit is, in a nutshell, the money left to cover the operating expenses. Thus, if the above calculation is correct, Blend will generate on average $25 - 27 million in quarterly gross profit to cover operating expenses (which, as you will see below, is unreasonable to expect).
Blend reported $98.6 million in operating expenses in Q1 2022, representing a 105% increase from $48.2 million in Q1 2021. The operating loss grew from $27.2 million in Q1 2021 to $69.8 million in Q1 2022. As a reminder, Blend started consolidating Title365 expenses in Q3 2021. Operating expenses include $23.8 million in stock-based compensation, which is a non-cash expense.
Some notes from the 10Q regarding the $50.4 million increase in operating expenses:
Research and development (+$18.0 million): $8.5 million increase in personnel-related expenses primarily attributable to an increase in headcount, and an $8.5 million increase in stock-based compensation
Sales and marketing (+6.5 million): a $2.9 million increase in personnel-related expenses attributable to an increase in headcount, a $1.8 million increase due to the inclusion of sales and marketing expenses from the operations of Title365, a $1.1 million increase in stock-based compensation
General and administrative (+21.8 million): $10.2 million increase in stock-based compensation, of which $4.8 million related to the stock option award to Head of Blend, $2.9 million increase in insurance related to our public company structure, a $3.9 million increase in personnel-related expenses, and a $7.6 million increase due to the inclusion of operations of Title365.
As you can see from the notes, the increase in the operating expenses came from both, the consolidation of Title365 expenses, as well as the increase in Blend personnel and stock-based compensation expenses. In April 2022 the company announced layoffs impacting 10% of the staff primarily in Title365 and G&A functions. The company estimated the reduction at $35.4 million in annualized compensation ($8.85 on a quarterly basis).
During the earnings call, the management promised to come back with a comprehensive cost review plan, which should provide investors with visibility into the expense levels going forward. Let’s wait for this plan, but for now, there is a clear disconnect between the expected gross profit levels and the operating expenses (even after the announced layoffs, and even if we exclude stock-based compensation).
Net Loss and Adjusted Net Loss
The company reported a Net Loss of $72.4 million in Q1 2022, an increase from a Net Loss of $27.1 million in Q1 2021. The company also reports an Adjusted Net Loss (GAAP Net Loss adjusted for stock-based compensation, one-time expenses, and amortization of intangible assets). Thus, the company reported an Adjusted Net Loss of $45.1 million, which is an increase from an Adjusted Net Loss of $18.7 million in Q1 2021.
One can think of the Adjusted Net Loss as a proxy for the cash burn. At the end of Q1 2022, Blend had cash, cash equivalents, and marketable securities of $499.4 million, and outstanding debt of $225.0 million. Thus, the company has a sizeable cash buffer to operate through the market downturn.
Nevertheless, I would expect the management to come back with additional measures to lower the cash burn going forward. As I argued above, the announced layoffs don’t help much with this, especially given the decreasing gross profit and limited growth opportunities in the short term. Unfortunately, the only way for Blend to lower the cash burn is to lay off more people.
Things to Watch in 2022
Client growth. As I argue above, given the market conditions, it is unreasonable to expect revenue growth in the short term. However, the company can use the downturn to grow its market share, as well as diversify its income with Consumer Banking products. Mortgage lending is a cyclical business, so if the company comes out of this cycle with a higher market share, this will be a win for shareholders in the longer term.
Gross profit margins. Gross profit margins for both segments, Blend Platform and Title365, have been decreasing for the last few quarters, which is a concerning trend. Apparently, the growth of Consumer Banking is eating into Blend Platform's gross margins, so I guess we are yet to see what is the sustainable gross margin level for the company.
Operating expenses. The company’s management promised to come back to investors with a comprehensive cost review plan. At this point, there is no clear path for the company to reach break-even (at least on the adjusted basis), and the announced reductions will have a marginal impact. The company has a sufficient cash buffer, but I don’t expect management to continue exhausting it at the current rate.
In summary, the company keeps growing its customer base and market share, which is great. However, the mortgage market is in a downturn and things might get even worse, which is not so great. I believe the company has a sufficient cash buffer to navigate this period, so, assuming the management doesn’t make costly mistakes, Blend can come out a much stronger company from this downturn.
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Source of the data used above: Investor Relations
Disclosure & Disclaimer: despite rocky performance in 2021 and early 2022, I have open positions in most of the companies covered in this newsletter, as I am extremely bullish on the transformation in the financial services industry. However, none of the above is financial advice, and you should do your research.