ZILLOW INC Z S
November 01, 2012 - 8:49pm EST by
birdie11
2012 2013
Price: 37.22 EPS $0.30 $0.71
Shares Out. (in M): 38 P/E 123.7x 52.7x
Market Cap (in $M): 1,411 P/FCF 75.0x 39.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 1,195 TEV/EBIT 364.0x 67.0x
Borrow Cost: NA

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  • Real Estate
  • Internet
  • Competitive Threats

Description

I believe that even under the most aggressive of scenarios, there is a significant and unwarranted premium being paid for Zillow today in light of the current competitive and market environment.
 
Table of contents
  1. Business Background
  2. The Bull Case
  3. The Bear Case
  4. Valuation
  5. Conclusion
  
Business background
 

Business description

Zillow operates what they call the “largest living database” of homes - an online residential real estate marketplace which has pricing, pictures and other detail for approximately 100 million homes in the United States. The company provides information on properties and mortgages that can help drive transactions by connecting buyers, sellers, renters, landlords, and service providers like brokers and mortgage specialists. The company also provides home value and rental pricing estimates to assist in valuing homes that currently aren’t on the market.

Zillow's business model targets both consumers and real estate agents, but focuses on agents

Zillow intends to gain revenue from virtually every player in the residential real estate ecosystem, either directly or indirectly. The ecosystem consists of homes, agents, consumers, ancillary service providers (e.g., lenders/legal/rental/other services), and advertisers. Zillow revenue comes from:

  • Agents - Listing fees, subscriptions and advertising
  • Ancillary service providers - Referral fees, advertising
  • Advertisers - Advertising

Zillow’s key revenue producing products/services  

Agents and/or brokerages can pay to have their listings appear higher up in the search results, so called "Featured Listings." Featured listings also allow the agents and/or brokerage to post a profile picture of the agents, list the agents contact details, and provide a “contact agent” button. Agents that pay for "Premier Agent" status will have their photos and contact link place at the bottom of the search results.

Company history

Zillow was founded in 2005 by Rich Barton and Lloyd Frink, former Microsoft executives and founders of Microsoft spin-off Expedia. Zillow’s IPO was completed in July 2011 at $20 per share. Several large Venture Capital firms have been involved in the past and continue to be involved today:

  • Benchmark Capital
    • Richard Barton, Zillow Board Chairman
    • William Gurley, Zillow Board member
    • Eric Blachford, Zillow Board Member
  • Technology Crossover Ventures (TCV)
    • Jay Hoag, Zillow Board Member
  • PAR Capital Management

Management has recently evolved the Zillow business model from a disintermediation tool (consumer focused) to a agent-empowerment tool

Current capitalization and valuation
Source: CCM analysis, Capital IQ

 

Current Capitalization

As of 10/30/2012

  

 

Share Price

 $37.22

FD Shares Out (1)

     37.9

  

 

Market Cap ($ Mil)

   1,410.6

Cash (1) 

      216

Debt 

        -  

Enterprise Value (EV)

   1,194.6

  

 

Price / Tang. Book Ratio

20.8x

 

Consensus Estimates and Implied Valuation (3)

As of 10/30/2012

 

 

 

 

 

($ Mil)

LTM 6/2012

2012 (Est.)

2013 (Est.)

2014 (Est.)

Revenue

89.5

115.4

171.3

239.6

Rev Growth

 

74.7%

48.4%

39.9%

 

 

 

 

 

adj. EBITDA (2)

6.9

15.5

27.5

53.1

EBITDA Margin

8%

13.4%

16.1%

22.2%

 

 

 

 

 

adj. EPS

0.08

0.30

0.71

1.38

 

 

 

 

 

EV / Revenue

13.3x

10.4x

7.0x

5.0x

EV / EBITDA

NM

77.2x

43.5x

22.5x

P/ E

NM

123.7x

52.7x

27.0x

(1) - CCM estimate – pro-forma share count and cash balance based on Zillow’s 9/5/2012 follow-on offering.
(2) - CCM estimate – reflects adjustments for tech development expenses that are capitalized on Zillow’s filed financial statements
(3) - Estimates reflect sell-side consensus as provided by Capital IQ and is subject to future revision


 

The Bull Case
 
Paradigm shift in home buying/selling: Online is how people will find homes in the future
Source: Kelly Blue Book,  J.D. Power New Autoshopper.com Study, 200-2008, J.D. Power WSPT 2009-2010
 
The internet has reduced inefficiency through disintermediation in a range of industries from insurance to air-travel. Is the auto industry an analogy for where real estate is headed? Auto and real estate are a good comparison given that Americans hold onto their new vehicles for 6 years (as of 2012). Auto-related internet usage among new-vehicle buyers has increase from 54% in 2000 to over 79% in 2012.

Sizing the market
Source: Move.com  second quarter 2012 investor presentation

In total, $128B is generated from all of the various activities that touch residential real estate in the form of commissions, fees and services.

Addressable market is huge
Source: Borrell Associates 2012 Real Estate Outlook, Trulia IPO roadshow presentation

Of the $128B in revenues, the industry (agents, brokerages, leasing agents, developers, mortgage servicers, etc…) spends $24B on marketing and advertising each year (19% of revenues):
 

2012 Projected Ad Spend by Medium

Medium

Spend ($B)

Spend (%)

Online

$13.1B

55%

Print

$4.6B

19%

TV

$3.0B

13%

Radio

$0.5B

2%

Direct Mail

$1.7B

7%

Other

$0.9B

4%

 

2012 Projected Ad Spend by Source/Activity

Medium

Spend ($B)

Spend (%)

Agents, Brokerages, Developers

$12.7B

53%

Mortgage

$9.1B

38%

Rentals

$2.2B

9%

 

Room to expand into the agent/brokerage ad-spend
Source: CCM Analysis, Move.com second quarter 2012 investor presentation, Borrell Associates 2012 Real Estate Outlook

It is widely believed that $5B of the $24B in total advertising dollars is spent directly by transactional (non-rental) agents & brokerages. Approximately $1 trillion of residential real estate transacted every year. Agents commissions are around 5%, or $50 billion. 10% marketing spend = $5 billion. Of the $5 billion of advertising & marketing spend, online is estimated to be $1B and growing at ~20% per annum. Agents and brokerages leverage many tools to create impressions and ultimately generate business. Offline includes signage, print, television, literature/pamphlets. Online includes owned websites, listings on Zillow and other syndication sites, display and banner ads, search results optimization

Platform traffic growing rapidly
Source: Zillow  2011 10-K, Zillow quarterly earning press releases 

Zillow Monthly Unique Visitors

Month

Uniques (Thousands)

2010 – March

9,301

2010 – June

10,677

2010 – September

12,061

2010 – December

12,666

2011 – March

17,306

2011 – June

20,758

2011 – September

24,352

2011 – December

23,507

2012 - March

31,797

2012 – June

34,600

2012 – Jul

37,000

 
Platform traffic growing rapidly as mobile is just coming into play
Source: Move Q2 2012 conference call and press release, Trulia IPO roadshow presentation
 
Users are now using mobile - phone, tablet - at an increasing rate
  • “According to a 2012 survey by The Real Estate Book, a real estate website, 52% of respondents reported using a mobile device to look for homes, with 85% of non-users stating that they would consider using a mobile device for their next search.”
    • (Trulia IPO Prospectus, 19 September 2012, p2)
  • “Over 50% of our home views now occur by consumers on a mobile device.”
    • (Zillow Prospectus, 7 September 2012, p S-4)
  • Up from ~ 1/3 of usage
    • (Zillow Presentation, March 2012)

Mobile growth rates are 100%+

  • MOVE Q2:12
    • +200% homes-for-sale viewed
    • +300% photos viewed
    • +120% mobile connections
  • Trulia
    • +141% mobile visitors (Q212)

Upselling and continuing revenue

The company is trying to find products and services to sell to customers throughout the ownership cycle, not just when a transaction is imminent
  • Rentals - Listing Fees, Renter Pre-Qualification
  • Finance / Legal - Mortgage Origination, Refinancing, PMI, Closing
  • Other Services - Moving, Renovation, Cleaning, Landscaping, etc…
Zillow believes it is unique
 
Zillow puts a lot of faith in its new branding and CRM-type services for brokerages with comprehensive tools for the real estate brokerage business and rental tools, mortgage tools, etc. Powerful data for consumers, particularly Zestimates (estimated home value), which may become invaluable to home buyers and sellers

Big growth expectations
Source: Company IR presentation (March 2012), Capital IQ, CCM analysis 

The company believes it can execute quickly to roll-up traffic and develop significant paying agent and brokerage relationships, growing revenues and significantly expanding profitability in the process. I believe that Wall Street tends to agree with the plan, forecasting aggressive growth. Based on target model, Zillow will likely need to do $250m in annual revenue to meet long-term EBITDA margin of 35%
 

Zillow’s Target Model

Percentages of Revenues

2010

2011

 

Target model

Revenue

100%

100%

 

100%

Cost of Revenue

16%

16%

 

14-16%

Sales and Marketing

49%

39%

 

30-34%

Technology and Development

35%

21%

 

13-15%

General and Administrative

22%

22%

 

9-11%

EBITDA Margin

0%

18%

 

30-35%

 
 

The Bear Case

There are fewer agents to sell to than management thinks
Source: CCM analysis; The Economist, 5 May 2012 ; NAR; Move.com

Some sources indicate that there are 1.8M real estate agents in the US. However, data from The Economist suggests the number of active agents is much less. There were 4.8M annual transactions in the US in 2011. According to The Economist, the average active agent has 7 transaction per year. These numbers imply the number of active agents in the US is about 700 thousand, less than half of the 1.8 million Zillow claims.

There are very few agents who have not been pitched to by Zillow already
Source: Company estimates

I believe that virtually all of the addressable market has been solicited by Zillow and others with these services and most have chosen not to pursue a premium membership.

  • I believe most agents do not see enough benefit from a paid account to switch from their free accounts
    • Free Account includes:
      • Ability to post listings with 5-10 pictures
      • Listings end up in search results organically
    • Paid Account Includes (For up to $2,400 per year)
      • Listings with unlimited pictures and edit ability
      • Featured placement of listings, contact information
  • Zillow has 409 thousand agents signed up to free accounts (95%) and 23 thousand agents signed up for paid accounts (5%)
    • Zillow's 5% conversion to paid accounts is consistent with the 4-6% conversion range for other "freemium" models
      • Pandora
      • Spotify
      • LinkedIn

There are fewer dollars to capture from brokerages/agents than management wants to think
Source: Borrell Associates 2012 Real Estate Outlook; Citi Investment Research; The Economist “American Property” 5 May 2012.

Total add spend is shrinking.
  • Total real estate ad spend is expected to decrease from $28.3B in 2011 to $23.7B in 2012, a decline of 15% y/y and 20% decline since $29.5B spent in 2010. Furthermore, survey results indicate brokerages/agents are going to keep ad spend flat. 65% of respondents to a CIty Investment Research survey this year indicated they would keep spending the same when asked if they planned to increase or decrease overall ad spend in the next year.

As a result, there will be less marketing dollars for online

  • Even though online ad spend as a share of total ad spend will grow, the total $ value of ad spend will be declining
  • I believe $5B current overall ad spend could shrink to $3B

Pressure on commissions will reduce ad spend further

  • I believe that disruptive pricing models and the spread of information will lead to a reduction in the average 5-6% commission for real estate transactions over time. 2-3% realtor commissions in the UK indicate where US commissions could end up
  • Downward pressure on commissions is in the news
    • “Lately that figure [6%] is under attack by buyers and sellers looking to save money in a tough economy, and by an array of alternative real estate business models that offer an à la carte menu of services to clients willing to do some of the work themselves.”  New York Times, January 2011
    • “What happened to travel agents, stock brokers and book sellers – the encroachment of the Internet – is beginning to affect real estate agents. And the sacred six percent is under assault from online discounters.” CBS News, February 2009
  • I believe a decline in commission percentages will primarily effect buyer’s agents
    • Buyer’s agents’ value-add decreases as information availability increases while seller’s agent still generally has to do the same amount of work
How much value is there in being Featured/Premier?
 
As brokerages and agents sign up for premium service, the value of “featured” or “premier” designations decline significantly, and in smaller markets with smaller home inventory the value is not as clear. Looking in large and small real estate markets, the lack of value is already apparent according to actual queries from Zillow:
  • 45% of listings were "featured" in an real urban search. Is having a featured listing valuable to an agent if nearly half of all listings are "featured?"
    • 49 featured listings out of 109 results in Gold Coast/River North/River West, 2+ bedroom, $295K - 400K
  • 5 of 15 listings in a suburban search were "featured." Does it pay to be "featured" when 15 homes are for sale? Consumers will likely look at all 15 properties anyway
    • Upper Arlington, OH, 3+ bed, $245K - 300K

The ROI to agents is an illusion
Source: Industry interviews, Trulia, NAR, US Census

The sales pitches of the syndicatation sites imply an ROI to their clients of nearly 1000%. My analysis suggests that the ROI is much lower. There are two key driver of the lower ROI:
  1. As Zillow and the other syndication sites sign up as many agents as possible to their premium services, the conversion rate per agent will decline significantly.
  2. Most of the leads syndication sites say they “bring” to the premium agent would have ended up in the agent’s hands through some other traditional means. Thus the syndication sites should only get credit for incremental leads in calculating ROI to the agent. To account for this discount, in the model below I have reduced the 120 leads per agent per year pitched by Zillow to a more realistic 20 leads per agent per year.

 

Agent/Brokerage ROI from using Zillow 

 

 

Company Pitch

 

Reality

 

 

 

 

 

Leads per agent, per year

 

120

 

20

Conversion rate

 

2%

 

2%

Expected Home Sales (Conversions)

 

2.4

 

0.4

Average home price ($000)

 

350

 

350

Net commission rate

 

2%

 

2%

Total Generated Commissions

 

16,800

 

2,800

 

 

 

 

 

Monthly payment for service

 

$138

 

$138

Annual Payment for service

 

$1,656

 

$1,656

 

 

 

 

 

Implied ROI

 

914%

 

69%

 

 

Fantasy

 

Reality

 
Zillow's technology doesn't provide much value to customer or agents
Source: Zillow website and blog

Zillow’s Zestimate was attractive in the beginning, gaining Zillow share with page views and uniques, but is now a drag on performance. Speaking with agents and brokerages has led me to belive that Zestimates are not useful, and are potentially harmful. Agents stated that Zestimates are too impercise and people have realized it. Agents dislike Zestimates because they give consumbers false expectations of value, making the agents' job more difficult. Furthermore, Zillow claims it has the “largest living database” of homes, but this should be easy for competitors to replicate over time without a lot of capital commitment because much of Zillow's data is publicly accessible or comes from ListHub. Zestimates have a wide margin for error, leading to levered impact on sellers' return. More than 20% of Zestimates are more than 20% incorrect:

Zestimate accuracy in selected geographic markets

 

 

 

Accuracy Range

 Geography

 

Rating

Within 5%

Within 10%

Within 20%

Median Error

 

 

 

 

 

 

 

National

 

***

32.4%

56.7%

78.8%

8.4%

 

 

 

 

 

 

 

Select Markets

 

 

 

 

 

 

New York

 

****

35.7%

59.7%

80.1%

7.6%

San Francisco

 

***

31.2%

57.8%

83.1%

8.4%

Chicago

 

**

30.7%

53.9%

75.7%

9.0%

Dallas-Fort Worth

 

**

26.2%

50.1%

75.7%

10.0%

 

Inaccurate Zestimates can be especially damaging for homeowners in a weak real estate market

A 10% difference in realized sales price results in a nearly 40% drop in equity value to owner when LTV is 70%. For example, an owner with a $140K mortgage who believes they can sell their a home for $200K would see a 38% decrease in equity value if they sell at a Zestimate which is 10% below $200K (assuming a 5% agent commission).   

Zillow has been keeping inaccurate data on its site
Source: WAV Group “The Accuracy of Real Estate Websites”, October 2012 

A recent study from Windermere and Redfin indicates that over one-third of Zillow’s inventory of for-sale homes are actually not for sale per MLS data (sale closed or house was taken off the market). Zillow is incentivized to keep old or pulled listings on the site because it continues to attract web traffic, despite the fact that it upsets both agents and consumers.

 

Percent of Homes Shown as “For Sale” That Are Not For Sale

Listing Source

Percent

Zillow

36%

Trulia

37%

Windermere

1.7%

Redfin

0.1%

Long & Foster

0.0%

MLS

0.0%
 
ListHub and the National Associations of Realtors (NAR) are potential short-term choke points
Source: Industry interviews; Zillow 2011 10-K; Inman News; Company websites
 
Zillow's data sources have significant risk. The NAR (through the MLS) provides a substantial amount of data used in Zestimates and other proprietary Zillow products, and industry experts believe that the NAR may have claim to the revenue gained from those end products that are dependent on MLS data. Additionally, Zillow gets a large portion of its listing data from ListHub, a listing aggregation, distribution, and reporting service that’s wholly owned by competitor Move (MOVE).
 
There is a great deal of competition between the syndication sites
 
Barriers to entry are not high:
  • Mostly identical data sources
  • Inexpensive data
  • Analytics easily replicable
  • Large number of uniques can be acquired through marketing spend    

A hot space has invited too many players:

  • Realtor.com - Entered 1996
  • HouseValues.com - Entered 1999 (Now LEDR)
  • Zillow.com - Entered 2005
  • Trulia - Entered 2006
  • Move.com - Entered 2006

It is difficult to differentiate on websites - they all look similar:

  • I invite the reader to go to Zillow.com, Trulia.com, Realtor.com and Homes.com. Finding key points of differentiate is difficult.

It is also difficult to differentiate on features:

 

Zillow and competitors features comparison

 

 

Zillow

Trulia

Move / Realtor.com

Homes.com

 

 

 

 

 

 

Founded

 

Feb-06

Jun-05

May-06

 

 

 

 

 

 

 

User Features

 

 

 

 

 

Maps

 

X

X

X

X

MLS data

 

X

X

X

X

Value estimates

 

X

X

 

X

Location information

 

X

XX

X

X

Update frequency

 

X

X

XX

 

 

 

 

 

 

 

Features for Brokers

 

 

 

 

 

Enhanced Listings

 

X

X

X

X

Product

 

Premier Agent

Trulia Pro

Showcase

 

Productivity Tools

 

X

 

X

X

Product

 

Agent Business Hub

 

Top Producer

Homes Connect

 

 

 

 

 

 

Other products

 

 

 

 

 

Mobile

 

X

X

X

 

Mobile launch

 

2009

2008

2009

 

Rental

 

X

X

X

X

Links to other services

 

X

X

X

X

 

 

 

 

 

 

Partners

 

 

 

 

 

 

 

Yahoo Real Estate

 

NAR

 

 

 

 

 

ListHub

 

           

Rental

 

RentJuice

 

 

ForRent.com

 

Meanwhile, competitors are growing in terms of quantity and quality:
  • Realtor.com (MOVE) is undergoing a turnaround. It is launching its new website, has long-standing backing by NAR, and possesses the highest-quality listing data (accuracy, refresh rate). Additionally, it is coming out with innovative products (agent-branded app, new Top Producer CRM) and has a new CFO.
  • Trulia (TRLA) recently a raised $102 million in an IPO and has more user-generate content, features, and better consumer reviews.
  • New entrants are appearing rapidly including Homes.com and a new HouseValues.com website.

Recent traffic data shows that Zillow may be losing some uniques to the competition
Source: Compete.com

 

Website traffic growth as measured by uniques

 

Aug 2012 Uniques (mil)

y/y Growth

Growth from July 2012

Zillow*

21.5

9.2%

-10.9%

Trulia

10.7

32.2%

1.1%

Realtor.com

9.2

-1.0%

-1.2%

 

 

 

 

* Includes Yahoo! Real Estate

Note: Mobile traffic is not included in uniques data above

 

Management's focus on uniques overstates the number of people looking to buy a home
Source: Trulia IPO Prospectus, Zillow press releases, NAR, Industry interviews

Trulia claims that 55% of its 23 million monthly uniques do not visit Zillow, or roughly 13 million unique visitors. Therefore,  Zillow and Trulia together  have 50 million monthly uniques (just 2 players in the space). Industry participants agree that there are likely 2 people looking to do a transaction for each annual closed transaction, so roughly 9.6 Million people are looking to transact (4.8 Million annual transactions x 2). Even if you assume every person looking to transact was looking online, Zillow and Trulia together have over 5 uniques for each person looking to transact, and nearly 11 uniques for every single transaction in the entire industry. Furthermore, many uniques are coming from people who are casually browsing real estate with no plans to buy or sell a home in the next several years.
 
Zillow occupies the low value end of the lead generation spectrum
 
Buyers tend to use different syndication sites depending on where they are in the buying process. For an agent, the highest value leads are those customers looking to buy in the next 1-2 months. It is my belief that buyers are likely to use Zillow at the start of their home search, but switch to Realtor.com or a brokerages' proprietary site once they get closer to purchasing.
 
Wall Street's traffic growth expectations will be difficult ot meet
Source: Company reports; NAR; Industry interviews
 
Market consensus implies that Zillow and Trulia will double in size in 2-3 years and Move (Realtor.com) will grow roughly 50%. In terms of traffic, under these expectations there will be a lot of “garbage” uniques created, or this imagination of the market simply will not materialize.
 
There is a growing negative perception of Zillow among agents

Zillow's policies keep traffic on-site at the expense of value to agents and brokerages
  • Zillow has shaped its listing policy to keep traffic on its site, a big relative difference from competition. Trulia allows agents to provide links to their own site’s listing off of the search results page (SRP), while Zillow does not. Trulia also allows several opportunities to point to agent sites from the property listing page, whereas Zillow offers few.
  • Not allowing the agent to promote his/her own page blocks the consumer from accessing better and more complete information about the property they’re interested in.
Brokerages and agents are doubting the value of traffic as measured by uniques
Source: MSN Money, February 2012
  • From an article in MSN Money earlier this year: “San Diego Realtor Jim Abbott studied three years of his agency's sales data and compared listings that the company didn't share with national sites to those it did. "Time after time, the listings that I did syndication compared with the listings that I didn't had no better outcomes," he says. "In fact, the ones I didn't syndicate often sold faster and closer to the asking price.”

Zillow has done little to mitigate an adversarial relationships with brokerages

  • Several realty firms and trade groups have argued publicly against using the site, pulling listings and canceling contracts due to poor quality leads and Google search manipulation (taking organic search results from brokerage-owned websites, and poor/inaccurate information)
  • “Before [Zillow] had one agent getting the lead, and now they have three agents getting the lead…Zillow went from being A+ to D- on their lead quality.” (James Sanson, Agent, Sonoran Properties, Blog post, 6/15/2012)
  • "Neither you the home seller, nor the potential buyer, is served well by  [Trulia and Zillow].” (David Cooper, CEO, Prudential KC RealtyApril 2012)

Real-estate professionals are banding together to create a non-profit listing site
Source: AG Beat, NAREP website

  • National Association of Real Estate Professionals (NAREP) founded October 10, 2012 is a non-profit trade organization designed to create an independent listing database accessible by consumers and with no advertising or “premium” options
  • Claims Zillow and other listing syndication sites have diminished credibility and positioning of real estate professionals
  • NAREP plans to sign up agent/brokerage members with intent to have all participants shut off all listings to Zillow and other sites once meaningful listing volume is met
  • "We'll cut off the supply of MLS listings to the syndication sites" (NAREP website)

The Zillow story has been seen before, with less than stellar results
Source: Capital IQ; Kelly Blue Book,  J.D. Power New Autoshopper.com Study, 200-2008, J.D. Power WSPT 2009-2010

Zillow's story eerily similar to HouseValues.com 
  • HouseValues.com IPO'd in 2004 at $500M valuation and was expected to revolutionize lead-gen for agents
  • Began acquiring companies to keep up growth pace, but lack of significant market growth led to destruction of value
  • Share price declined 81% from $15 2004 IPO price to $2.75 on August 28th 2008, even before the subsequent financial markets meltdown

Analogy with auto websites is not necessarily a positive for Zillow

  • Early champions of auto industry ad spend such as Autobytel have not benefited from the steady growth in auto-related internet usage among new-vehicle buyers
  • While auto-related internet usage has increased from 54% to 79% from 200 to 2012, the share price of Autobytel, an early champion of auto industry ad spend, has decreased from over $200 to less than $5.
  • Early auto-lead companies suffered from the same problems currently effect Zillow: exaggerated ROI and poor lead quality.

Insider selling raises red flags
Source: Capital IQ, SEC Form 4 filings, Zillow 2Q11 earnings call

Rich Barton (Exec Chairman & founder) and Lloyd Frink (Vice Chairman, President & founder) have sold $42.2M and $47.0M of equity, respectively, since February 1, 2012. Barton and Frink are even selling their super-voting Class B shares.
 
 
 
Expensive Valuation
 
Relative to MOVE and TRLA, Z looks expensive
Source: Capital IQ
 
Clearly the market has pretty heavy money behind Zillow and expectations for delivery are high:
 

Financial metrics

As of 10/30/2012

 

Z

TRLA

MOVE

Market Cap (Millions)

$1,410.6

$579.3

$331.8

2013 Sales (Millions)

$171.3

$94.3

$216.8

2013 EV/Sales

7.0x

5.1x

1.3x

2013 EV/EBITDA

43.5x

180.8x

8.3x

 

 

 

 

Note: Zillow & Trulia EBITDA margins were adjusted 7% to reflect capitalized software costs. Pro-forma share count and cash balance used to calculatate Z's Market Cap and 2013 EV/Sales is based on ZIllow's 9/5/2012 follow-on offering 

 
 
Zillow looks expensive relative to comparable firms in niche pole positions
Source: Capital IQ; National Association of Home Builders; HousingEconomics.com
 
Zillow has a large and unwarranted premium when compared to several companies that have dominant positions within their slice of the 3rd party-lead generation/ internet marketing business model
  • BankRate – Personal Finance (home mortgage, credit cards, bank accounts)
  • Autobytel – New / OEM Car Sales
  • Quinstreet – Online education 

Market Leader Comparison

As of 10/30/2012

   

Stock Price

MV

EV

Market

Market Share

BankRate

 

$10.7

$1,077.1

$1,192.9

Personal   Finance

60%

Groupon

 

$4.46

$2,372.7

$1,185.9

Daily   Deals

55%

Autobytel

 

$3.96

$38.2

$30.8

New/OEM   Auto

40%

Quinstreet

 

$6.86

$321.5

$323.8

   

Comp Average

   

$952.4

$383.4

 

52%

             

Zillow

 

$37.22

$1,410.6

$1,194.6

Residential   RE

40%

 

2013 Financials and Valuation

As of 10/30/2012

   

Sales

EBITDA

EBITDA Margin

EPS

EV/S

EV/
  EBITDA

P/E

BankRate

 

$514.9

$144.3

28%

$0.30

2.3

8.3

35.9

Groupon

 

$1.353.3

$375.4

13.5%

$0.35

0.4

3.2

12.6

Autobytel

 

$66.4

$5.1

7.1%

$0.32

0.4

6.0

12.3

Quinstreet

 

$352.9

$74.7

18.8%

$0.31

0.9

4.3

22.4

Comp   Average

 

$571.9

$149.9

18.7%

$0.32

1.0

5.4

20.8

                 

Zillow

 

$171.3

$27.5

16.1%

$0.71

7.0

43.5

52.7

                 

Comp   Average - Multiple Discount to Z(1)

         

85.7%

87.6%

60.5%

Comp   Average - Fundamental Multiple of Z (2)

 

3.3

5.5

         
(1) Calculated mulitple discount between comp average and Zillow, expressed as percentage of Zillow valuation multiple
(2) Calculated relative size measure, expressed as multiple of Zillow's sales and EBITDA characteristics, respectively
 
There are specific phenomena related to residential real estate and the brokerage model that will make things difficult for Zillow relative to the above companies:
  • Connection to user (consumer) is seldom as home purchase/sell transactions occur once every 12-15+ years 
  • No opportunity to increase transaction volumes
  • Agent population is difficult to work with, yet has inherent information advantage (local knowledge)

Sales & marketing could be a large long-term drag on Zillow
Sources: Company filings, Capital IQ

Switching costs are a significant business model issue
  • Switching costs in the industry are low and agent turnover is high. Contracts with agents/brokerages range from 6 months to 2 years with very easy out clauses. As a result, the company has had to put significant dollars behind sales and marketing and will be forced to continue increasing its sales and marketing commitment to maintain share.
  • In 2Q12, y/y increase in sales & marketing (GAAP) was 115.9%, while y/y increases in uniques and premium subscribers were 69.6% and 65.9%, respectively. Zillow may have to continue increasing marketing expense at a rate higher than unique & subscriber growth. 
Zillow is better compared to companies with high sales & marketing costs
  •  The issues specific to Zillow’s niche (low switching costs, dealing with agent population, etc…) force the company to invest heavily in sales and marketing in order to maintain market share. Heavy inside-sales element means high-turnover sales positions with little ability for leverage with scale or experience.
  • Other companies facing such issues have similar sales & marketing expenses as Zillow (44% trailing 10 qaurters average, Non-GAAP, as % of sales): Expedia (41%), Constant Contact (43%), Groupon (67%).  
  • Nevertheless, Zillow has a dramatically higher 2013 EV/EBITDA (49.7x) as compared to Expedia (7.9x), Constant Contact (9.4x), Groupon (3.4x)
Open questions around accounting and transparency
 
Zillow and Trulia capitalize expenses related to software R&D, making adjusted EBITDA margins (a focal profit measure) look better than MOVE. Long-term FCF margins are expected to be relatively similar between firms
 
Meanwhile, despite the fact that 75% of Zillow revenues come from subscription-based products, the company continues to avoid talking about significant subscriber population attributes, specifically churn and average subscription price. Zillow recently received a comment letter from the SEC related to lack of adequate disclosure around subscriber metrics, which sent the stock down ~10% upon public availability of the document:
 
“…it is unclear why that would preclude you from discussing, at a minimum, the percentage increase in the average price paid for Premier Agent subscriptions” ... "it is unclear how useful information regarding the number of subscribers to your Premier Agent program is without also disclosing the related revenues.  Please explain. “ ... “it would seem that a separate discussion of these revenues streams would be meaningful to investors” (SEC Comment Letter, SEC File # File No. 001-35237, 8/30/12)

Valuation of the industry
Sources: Company filings, Capital IQ 

Zillow’s valuation ($1.7B) is 34% of the total current budget agents and brokerages spend on advertising ($5B) and 170% of the total online brokerage/agent spend ($1B). Zillow and Trulia combined are doing $140M in revenue and they are valued at $2.5B. Market acting as if both will win the whole pie
 
 

Conclusion

Short-term bear case

  • Issues with growing traffic and revenue
  • Industry doubting value of service offering, claims of ROI, and Zillow’s overall intentions for the market
  • Competition is heating up
  • Insider selling raises red flags
  • Unrealistic implied industry valuation
Long-term bear case
  • Overestimated Market Opportunity - Fewer agents to sell to than management states. Fewer dollars to capture from agents than management claims. Syndication companies and investment community using incongruent data, fuzzy math that erroneously inflates market size
  • Questions about the Business Model - Lead generation model not scalable (heavy sales and marketing spend). Zillow’s technology doesn’t provide superior value (Zestimates are inaccurate)
  • Competition is fierce, increasing - Several competitors in the space, many trusted more by agents than Zillow. MLS and other industry resources provide free alternatives to paid syndication sites.

Risks

The big-picture risk is a resurgence in the housing market which could drive up both the number of transactions and the dollar-value of agent's commissions (as housing prices increase). On a more micro-level, Zillow could either come out with new products (e.g., additional mortgage products), or develop a new revenue model (e.g., impressions-based pricing). The risk from mortgage products may be more important in the short run as interest rates are at all-time lows. In the short-term, Zillow may be able to push through pricing increases to agents and brokerages, though I believe the negative reaction from the agents and brokers will put a limit to the size of those increases. There is also an outside chance that better corporate cost control could lead to an earlier path to profitability targets.

 

The author of this report is short Z, and may buy or sell the securities of Z without disclosure. This report was prepared for the Value Investors Club for use only by investment professionals. The information presented in this report should not be considered a recommendation to purchase or sell any particular security, and all statements and expressions are the sole opinion of the author and are subject to change without notice.  Although the author believes that the expectations expressed in this report are accurate and reasonable, actual results could differ materially from those projected, and are subject to inherent risks and uncertainties.  Neither author nor its affiliates guarantees the accuracy or completeness of the information.  Securities trading involves a high degree of risk, and should only be undertaken by accredited investors.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

In addition to the short- and long-term bear arguments above, Zillow is entering a period of tougher comps. Growth projections are high and are set to disappoint in the next several quarters. There will be more Wall Street questions in Q3 following the SEC inquiry.  Data from Compete.com indicates uniques is down sequentially from July to August. On top of all of that, there is anecdotal evidence of brokerages getting fewer leads from Zillow over the last couple of months.
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