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The Q1 2013 earnings report for Zillow (NASDAQ:Z) had a good amount of highlights and some low lights to be concerned with. In this article we will recap the earnings report and point out some reasons that can explain the 4.88% stock price decline in after-hours trading.

*Highlights and Low lights Bullet points taken from earnings report

Highlights

  1. Record Revenue of $39.0 million, up 71% over first-quarter 2012.
  2. Record Marketplace Revenue of $31.0 million, up 87% over first-quarter 2012.
  3. Record quarterly and all-time traffic, topping a record 52 million monthly unique users on mobile and Web in April 2013 (up 63% year-over-year), following a record 50 million monthly unique users in March 2013 (up 55% year-over-year).
  4. Premier Agent count grew 83% year-over-year, adding a record 4,557 quarterly subscribers for a total of 34,030.
  5. Raised full-year revenue outlook range to $178.0 - $182.0 million.

Low lights

  1. Total operating expenses were $42.8 million in the first quarter as compared to $21.1 million in the same quarter last year
  2. For the first quarter, cost of revenues was $4.1 million or 11% of revenues as compared to $3.4 million or 15% of revenue in the same period last year
  3. sales and marketing expenses, which include Premier Agent sales team, marketing team and advertising activity, were $19.8 million or 51% of revenue as compared to $8.3 million or 36% of revenue in the same period last year
  4. Technology and development costs were $10.6 million or 27% of revenue compared to $5 million or 22% of revenue last year
  5. On a GAAP basis, net loss for the quarter was $3.7 million, representing a non-GAAP loss per share of $0.11 for basic shares of $34 million

Areas of Concern

  1. Increasing advertising spend from 10 Million to 15 Million
  2. Average monthly subscription rate down to $259, a 3% decline from Q1 2012
  3. Increased spending across the board to gain brand awareness

Given the above data from the earnings transcript, there are some areas of concern that most likely worried investors. First it seems like Zillow is unsure of what the real marketing spend by realtors is. In the 2011 Zillow 10-K, management stated that the marketing spend by real estate agents was roughly 4.5 Billion, by saying that at 90 Million they were a little under 2% of market share. According to today's earnings transcript, Zillow's CEO Spencer Rascoff said that real estate agents make about 60 Billion on the high end in commission and spend 10-15% (he meant 17%) of it on marketing. This contradicts the 2011 real estate agent survey that was put out by ActiveRain.com, the largest professional network in the real estate industry. The following chart points out the disconnect between what real estate agents say they spend on marketing and what Zillow believes the market is:

(click to enlarge)Realtor salaries and average spend pulled from the Activerain.com survey

You can see the 6 to 10 Billion dollar estimate by Zillow is 1.5 to 5.5 Billion higher than what the Activerain.com survey predicts. This is somewhat concerning because a company that is trying to go after a market and decide how much resources to put into it, needs to know what the realistic market is.

Another possible factor of the after-hour share decline might be due to slower year-over-year revenue growth. Although the full-year guidance was raised to 178-182 Million this year, a 54% increase over 2012, taking a look at this chart the year-over-year increases have been declining:

(click to enlarge)2014 and 2015 estimates shown for the upcoming price evaluation

Why I believe the stock dropped in after-hours trading was the fact that even given a "growth stock" label, due to the fact that it is growing the agent subscriptions at 83%, the stock price seems inflated. Taking a look at the following chart, even giving a 100 P/E to this stock, which is twice as much as the yearly revenue growth and above the agent subscription growth, the largest price that Zillow could be worth in 2015 should be $40 per share.

(click to enlarge)

The last area of concern for investors was likely to be the doubling in advertisement and an increase in costs across the board. Zillow management explained that it can have great margins today if the company did not make this investment for the future, but this will be the strategy for now. Although there may be a correlation between revenue growth and an increase in advertisement, this might be troubling to some investors because this correlation usually takes some time to confirm.

To conclude the first-quarter recap, Zillow posted some great growth figures, but there is still cause for concern. Going forward it will try to prove the stock valuation to investors with continued high subscription rate increases, making new ventures like the Dig program profitable, forming new partnerships similar to the partnerships with AOL and Yahoo, and expanding internationally. But some investors might worry that it is growing spending too fast to try to propel its subscription growth even higher. Another cause for concern, which was only briefly mentioned on the call, is the growing competition from Trulia (NYSE:TRLA) (which was upgraded based on its Q1 results ), ZipRealty (NASDAQ:ZIPR), Redfin (going public soon), Realogy (NYSE:RLGY) and the dozens of others in this market's landscape. So time will tell if it is successful in adding to one of its key metrics, earnings per share, but with the current growth rates and small margins I believe the stock is overvalued at $60 a share.

Source: Zillow Q1 2013 Recap And Why Shares Fell In After-Hours Trading

Additional disclosure: All views are my own speculations and are not meant to influence the stock price.