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Zillow (NASDAQ:Z) provides information about homes, real estate listings and mortgages, through its Website and mobile applications. It enables homeowners, buyers, sellers and renters to connect with real estate and mortgage professionals. The beauty of Zillow's business model is that as more buyers and sellers utilize the website, the easier it is for real estate and mortgage professionals to create relationships and therefore the higher the odds of selling a listing.

The company makes money in a number of ways such as subscription fees from agents who wish to generate leads, commissions through brokering prospective clients with lending institutions and through traffic on its site by selling display ads and listings on its home page and side bar.

Zillow has shown promising growth within the past five years. In Q32012, its revenues reached 102.4 million, an 83.7% increase from the corresponding period in 2011. Its operating profit margin increased to 6%, while its net income margin increased to 3% on a TTM basis. Zillow's monthly unique active visitors climbed to 36.1 million in Q3, up from 24.2 million the prior year. Real estate agents subscriptions also increased, with 80% more signing up for Zillow's Premier Agent service, a subscription model accounting for 74% of the company's revenue. Ad revenue increased up to 15%.

Following Q3, the stock took a nosedive because of fears about the loss of one of its largest advertisers, Foreclosure.com. Since the downturn however, investors have realized the mispricing of Zillow and the stock has come back significantly. We believe Zillow has great potential growth going into earnings. Analyst expectations have also come down since Q3, which may make it easier to meet or beat in 2013.

We see Zillow's launch of Zillow Digs as a growth catalyst going forward. Zillow in February launched Zillow Digs, an online platform geared toward remodeling homes. This service is similar to Pinterest in that users can post, share and organize pictures of homes, materials and remodeling products. Zillow has curated thousands of pictures to help give users remodeling ideas as well as help users with costs. Zillow CEO, Spencer Rascoff, has noted that

Over the long term, it will become a revenue stream, either through local lead generation, advertising, or there's also an E-commerce aspect here.

According to Rascoff, some 75% of homebuyers go on to remodel their homes. We feel this move by Zillow creates new growth markets. It is a disruptive innovation by the company and although it may take a few quarters to monetize the product, it will eventually bring new growth to the company.

Zillow contiunes to offer a valuable service to homebuyers, sellers, real estate agents and mortgage proffesionals. As the real estate market begins to improve1, and as monetization of its product lines such as Zillow Digs begin to increase, we see strong growth for the company going into the future.

Growth Rates

Company

Industry

Sector

Sales (MRQ) vs Qtr. 1 Yr. Ago

67.47

79.53

26.31

Sales (TTM) vs TTM 1 Yr. Ago

83.73

7.14

16.07

Sales - 5 Yr. Growth Rate

72.79

0.01

11.54

EPS (MRQ) vs Qtr. 1 Yr. Ago

441.93

110.29

95.36

EPS vs TTM 1 Yr. Ago

581.27

--

--

EPS - 5 Yr. Growth Rate

--

-2.56

4.72

Let's dive in to Zillow's profitability ratios:

PROFITABILITY RATIOS

Company

Industry

Sector

Gross Margin

87.11

25.14

15.13

Gross Margin - 5 Yr. Avg.

79.12

24.28

12.98

EBITD Margin

16.22

--

--

EBITD - 5 Yr. Avg

-16.99

11.16

1.87

Operating Margin

6.04

8.82

19.32

Operating Margin - 5 Yr. Avg.

-47.45

9.54

11.3

Pre-Tax Margin

6.16

9.53

22.78

Pre-Tax Margin - 5 Yr. Avg.

-45.58

9.42

1,114.56

Net Profit Margin

6.16

4.79

16.9

Net Profit Margin - 5 Yr. Avg.

-45.58

5.03

1,104.03

Effective Tax Rate

0

37.47

24.21

Effective Tax Rate - 5 Yr. Avg.

--

46.03

25.31

As you can see above, gross margins for Zillow were very strong compared with its industry and five-year average. Operating margins were a little lower than the industry average, but significantly better than its five-year average. The same can be said of its net profit margins of 6.16%. This is a significant improvement compared with its five-year average.

Financial Strength

Company

Industry

Sector

Current Ratio (MRQ)

12.5

1.75

0.47

The current ratio represents Zillow's assets to liabilty ratio. Zillow's 12.5 ratio is very strong compared with both the industry and sector. Within its industry Zillow is probably best compared with Trulia (NYSE:TRLA). Trulia is another real estate website that utilizes a similar business model to Zillow. The company helps both buyers and sellers in finding and listing homes, while also providing real estate information. It is also a tool for real estate professionals to market their listings, view real estate data and promote their services.

Trulia has also shown strong sales growth in the most recent quarter. In Q32012, its revenues reached 59.3 million, a 79.7% increase from the corresponding period in 2011. However its operating profit margin stood at -16.9% and its net income at -19.2% on a TTM basis.

Let us now look at some valuation ratios. We will use Trulia as our relative company.

Valuation Ratios

Z

TRLA

Market Cap

1.20B

681.29M

Enterprise Value

972.04M

589.67M

Trailing P/E ttm

206.44

N/A

Forward P/E

73.31

146.59

PEG Ratio (5 yr expected)

2.7

-0.76

Price/Sales

11.99

11.49

Price/Book

4.44

7.88

Enterprise Value/Revenue ttm

9.49

9.95

Enterprise Value/EBITDA

81.36

-87.29

Trulia had negative earnings in the most recent quarter so we could not calculate a Trailing P/E. However from a forward P/E perspective analysts are expecting Zillow to grow earnings and is significantly undervalued compared with Trulia. From a Price/Sales and EV/Revenue perspective both companies are relatively valued at the same price. We view these ratios as an advantage to Zillow. Although both Trulia and Zillow are valued similarly, Zillow's operating margins are much higher at 6% vs Trulia's operating margins of -16.9% TTM.

Looking forward, Zillow's outlook for revenue for the fourth quarter of 2012 is expected to be in the range of $30.0 to $31.0 million. This represents 53% year-over-year growth over fourth-quarter 2011 revenue of $19.9 million. For the full year of 2012, revenue is expected to be $113.0 million. This represents 71% year-over-year growth over full year of 2011 revenue of $66.1 million.

Using Zillow's forwarding-looking guidance for the next quarter and full year of 2012. We have estimated the following variables:

10-year CAGR: Sales growth will grow steadily from 70%-80% averaging 75%.

Capital expenses will grow at the same rate to sales.

10-year operating margin: 6% steadily increasing to the industry average of 8%

WACC: 12%-9% steadily decreasing

Base12345678910Terminal Year
Revenue Growth Rate 70.00%70.00%75.00%75.00%75.00%75.00%80.00%80.00%80.00%80.00%2%
Revenues$66$112$191$334$585$1,023$1,790$3,223$5,801$10,441$18,794$19,170
Operating Margin4.79%6.08%6.85%7.31%7.58%7.75%7.85%7.91%7.95%7.97%7.98%8.00%
EBIT$3$7$13$24$44$79$141$255$461$832$1,500$1,534
Taxes$1$2$5$9$16$28$49$89$161$291$525$537
EBIT(1-t)$2$4$8$16$29$52$91$166$300$541$975$997
+ Depreciation$9$15$26$46$82$148$267$480$490$499$509$520
- Capital Expenditures$20$33$56$99$173$302$529$952$1,714$3,086$5,554$730
- Chg WC($2)($1)($2)($4)($7)($12)($22)($41)($73)($131)($236)($11)
FCFF($7)($13)($20)($33)($55)($90)($149)($266)($852)($1,914)($3,833)$797
NOL $0$0$0$0$0$0$0$0$0$0$0
Terminal Value $10,963
Cost of Capital Calculations
Tax Rate35.00%35.00%35.00%35.00%35.00%35.00%35.00%35.00%35.00%35.00%35.00%35.00%
Debt Ratio0.00%0.00%0.00%0.00%0.00%0.00%1.39%1.74%2.32%3.49%6.97%6.97%
Beta1.571.571.571.571.571.571.471.381.291.191.11.1
Cost of Equity12.23%12.23%12.23%12.23%12.23%12.23%11.68%11.13%10.58%10.03%9.48%9.48%
Cost of Debt12.00%12.00%12.00%12.00%12.00%12.00%11.60%11.50%11.33%11.00%10.00%10.00%
After-tax cost of debt7.80%7.80%7.80%7.80%7.80%7.80%7.54%7.48%7.37%7.15%6.50%6.50%
Cost of Capital12.23%12.23%12.23%12.23%12.23%12.23%11.63%11.07%10.51%9.93%9.27%9.27%
Computed Variables (These are measures of how efficiently your firm is investing over time)
Total Capital Invested$119.68$137$165$214$297$439$679$1,111$2,263$4,717$9,526$9,725
Reinvestment Rate458.95%382.00%330.28%308.41%289.22%275.03%224.02%211.27%190.02%147.51%20.00%20.00%
Increase in Revenue/Increase in Capital 2.732.82.933.013.093.193.322.241.891.741.89
Return on Capital 3.71%6.22%9.64%13.49%17.36%20.82%24.39%26.96%23.90%20.67%10.00%
Present Value Calculations
Cumulative WACC 1.1223481.2596650331.4137825311.5867559961.7808924181.9879473282.2080116562.4400381562.6823852542.931153809
Present Value of FCFF ($11)($16)($23)($34)($51)($75)($120)($349)($714)($1,308)
Present Value of Terminal Value $3,740
The Valuation
PV of FCFF during high growth phase = ($2,701)
PV of Terminal Value = $3,740
Value of Operating Assets of the firm = $1,039
Value of Cash & Non-operating assets= $153.71
Value of Firm = $1,193
- Value of Outstanding Debt = $0
Value of Equity = $1,193
- Value of Equity Options = $0
Value of Equity in Common Stock = $1,193 Treasury Stock Approach
Value of Equity per share = $42.43 $53.25
Summary Output
Revenues$112$191$334$585$1,023$1,790$3,223$5,801$10,441$18,794$19,170
EBIT$7$13$24$44$79$141$255$461$832$1,500$1,534
EBIT(1-t)$4$8$16$29$52$91$166$300$541$975$997
- Reinvestment$17$28$49$83$142$241$432$1,152$2,455$4,808$199
FCFF($13)($20)($33)($55)($90)($149)($266)($852)($1,914)($3,833)$797

Estimating these variables we come to an equity valuation of $42. This is about inline to above current analyst price targets. The mean analyst price target for Zillow is $38.

Source: A Simple Valuation Of Zillow