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Shares of Zillow (Z) are seeing a modest correction after the US real estate and home-related marketplace announced the acquisition of StreetEasy.

After a great run-up so far this year, amidst optimism in the US housing market, the current momentum might have been too strong. This could leave shares vulnerable for a short - term correction.

That being said, the long - term prospects for a market leader like Zillow remains good. The absolute valuation is still very moderate compared to the large market opportunity if the company manages to monetize its traffic and information effectively.

The Deal

Zillow announced that it has entered into a definitive agreement to acquire StreetEasy, the leading real estate website in New York City in a deal valuing the company at $50 million.

StreetEasy's websites attract 1.2 million unique users on a monthly basis. Having access to Zillow's resources gives the company the possibility to invest in product development and grow the audience further. In comparison, Zillow's websites attract 61 million unique users on a monthly basis.

StreetEasy was founded in 2006 and employs 34 workers. The website provides for-sale and for-rent listings having partnerships with the largest local real estate brokerages.

CEO Spencer Rascoff commented on the rationale behind the deal, "StreetEasy is an excellent strategic fit with Zillow, as we share a common goal: To help consumers become smarter about real estate by communicating comprehensive, unbiased information about apartments and homes."

The deal is subject to normal closing conditions and is expected to close in a few weeks' time.

Signaling A High Valuation

While Zillow has sufficient financial resources to finance the deal and its operating losses, the company has announced an issue of 2.5 million shares of common stock, thereby raising a little over $200 million in cash.

Another 2.52 million shares will be offered by selling shareholders.

Valuation

Zillow ended its second quarter with $169.7 million in cash, equivalents and short - term investments. The company operates without the assumption of debt, for a favorable net cash position.

Revenues for the first six months of the year came in at $85.9 million, up 70% on the year before. The company reported a $14.0 million loss compared to a modest profit of $3.1 million the year before.

Full year revenues are seen between $186 and $188 million, while Zillow expects to generate EBITDA of $20 million.

Factoring in losses of about 6% in Monday's trading session, with shares exchanging hands at $85 per share, the market values Zillow at $3.0 billion. This values operating assets of the firm around $2.9 billion, or roughly 16 times annual revenues.

Zillow does not pay a dividend at the moment.

Some Historical Perspective

Zillow went public in July of 2011. Shares traded within a $25-$45 trading range till January of this year. Shares broke out and reached all - time highs of $97 in recent weeks on the back of the housing recovery and Obama's appearance at Zillow's website to answer questions from Zillow's users.

Zillow has rapidly increased its operations in recent years. Annual revenues rose from merely $17.5 million in 2009 to an expected $187 million in 2013. While the company has turned losses into modest profits in recent years, Zillow is on track to report a large loss this year.

Investment Thesis

The reported $50 million price tag for StreetEasy is a lot in absolute terms for a company with merely 34 employees, operating a website with 1.2 million unique visitors per month.

Yet the relative price tag is equivalent to Zillow's own valuation, or occurs at a slight discount to its own valuation. Zillow paid $42 per unique visitor per month for StreetEasy, which compares to its own valuation of around $51 per unique visitor for Zillow itself.

New York is a crucial local market to conquer for Zillow and the gained techniques and insights could be used nationwide as the city is one of the toughest real estate markets.

The announced equity issue of more than $200 million implies Zillow might make more acquisitions to fortify its market leading position. At current levels, Zillow thinks its stock offers a great currency of exchange at elevated levels, after nearly tripling year to date.

Zillow has seen competition from Trulia (TRLA) which bolstered its market position after acquiring Market Leader (LEDR) back in May of this year. Still, both companies have been winners, both having seen astonishing returns this year. The continued housing recovery and need for reliable and timely information has boosted interest in both Zillow's and Trulia's shares.

While both firms are very expensive on revenue multiples, not to mention price-earnings multiples, the absolute valuations remain rather modest. Zillow is now valued around $3 billion while Trulia is valued at $1.4 billion. These are still relative amounts for market leaders in the information provision for consumers on the housing markets.

While both companies still have to generate meaningful earnings going forward, they have time to figure out their definitive business model. Shorting any of these names on current valuation multiples doesn't make sense, as sometimes you need a bit of imagination.

That's not to say that shares in both firms are an absolute buy. I think the recent strong momentum leaves the shares in both Zillow and Trulia vulnerable to a short term correction. Yet the long - term prospects remain good when these companies find the balance between subscription offerings, advertising solutions and a high quality database full of information.

As such I remain cautious in the short term, but could have a renewed look after a possible correction in the coming weeks. At a discount I might be willing to pick up a stake in these highly promising long - term businesses.

Source: Zillow - Beware Of Short-Term Correction As Momentum Is Too Strong