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Summary

  • We forecast the number of Premier Agents at 56,908 and revenue at $67.95 million for Q1 2014.
  • There's an estimated annual churn rate of 37.8% for Premier Agents.
  • Curbside marketing swells users and premier agent subscriptions.
  • Insiders are dumping shares of Zillow.
  • It's a short-term trading opportunity for risk lovers with large perceived gaps in fundamental value.

Zillow (NASDAQ:Z) is an online real estate database that contains data on over 110 million U.S. homes, including homes for rent/sale and those not on the market. Their competitive advantage includes their comprehensive home data and valuation tools in the form of their Zestimate and Rent Zestimate values, providing guideline home values and rental rates. Zillow earns its revenue primarily through sale of ads to Real Estate Agents and banner-based ads. The residential real estate market in the U.S. is highly fragmented with 422,000 agents in 2012, of which approximately 59% are self-employed. Brokerage services make up 45% of industry revenue, with leasing coming in second at 35% and property management at 15%.

Zillow, through its Premier Agents program, allows agents to advertise at the zip and area levels, targeting both property sales and rentals. Furthermore, the Zillow Marketplace showcases agents for property management, buying, and renovation. The table we've created below demonstrates the growth in Premier Agents subscriptions in Zillow, and their growing importance as the main revenue contributor:

Quarter

Premier Agent Subscribers

Real Estate Marketplace Revenue

% of Total Revenue

Avg. Revenue Per PA

Dec-13

48,314

40,514

69.44%

$ 838.56

Sep-13

44,749

35,136

65.91%

$ 785.18

Jun-13

38,807

30,637

65.30%

$ 789.47

Mar-13

34,030

26,109

67.00%

$ 767.23

Dec-12

29,473

23,667

68.93%

$ 803.01

Sep-12

26,703

21,002

65.81%

$ 786.50

Jun-12

22,696

17,046

61.39%

$ 751.06

Mar-12

18,616

14,185

62.12%

$ 761.98

Seasonality

The average revenue per premier agent inferred from the real estate marketplace revenue seems to exhibit seasonality, with the final quarter of the year being the costliest for the advertising agents. Also, the share of real estate marketplace revenue in total revenue of Zillow is seasonally higher (nearing 70%) in the final quarter. Thus, Zillow's efforts at differential pricing based on demand for the location are translating to overall better numbers in the last quarter.

Penetration

The December 2013 Premier Agent count of 48,314 gives Zillow a penetration of 11.5% of all registered U.S. real estate agents, considering there is no churn among agents. Very crudely, this translates to an agent's pool of about 373k agents who can potentially subscribe to Zillow. However, as we will demonstrate later from our proprietary data, Zillow also experiences significant churn amongst its Premier Agent subscribers. We believe that bringing on an ex-Premier Agent back as a paying customer to Zillow is a stiff challenge -- hence the pool of unapproached agents is far lesser than 88.5%.

Our Methodology

We collect extensive data from the Zillow website to obtain a forecast for the number of Premier Agents for the quarter. As the first step, we use an exhaustive list of U.S. zip codes and a list of cities/neighborhoods that are prominently indexed on Zillow. Using this list of locations, we scrape through the Zillow website multiple times looking for Premier Agents being displayed in each of them. Finally, we tally the list of Unique Premier Agents to arrive at our forecast. Our historical data allows us to derive a retention rate of Premier Agents as well.

Adjustment Factors for Our Model Results

Our historical model results track the company reported quarterly numbers quite closely with a steady error rate of about 15%. We believe the errors arise due to the gradual onboarding and indexing of new Premier Agents with a lag, and also because of non-indexed premier agents who sign up with Zillow just for the listings and do not opt for any targeted geographical advertising. Hence, we inflate our tally of Unique Premier Agents, using a correction factor.

Furthermore, this quarter our scraping codes were run on the Zillow website during March 15 through March 20, 2014, and hence require extrapolation to represent quarterly numbers. Here we assume that the rate of onboarding of new Premier Agents on Zillow remains constant during the quarter.

Our Model Forecast

We have estimated the number of Premier Agents subscribed to Zillow as of March 31, 2014, to be 56,908. This represents a growth of 17.8% compared to previous quarters. A year ago, the growth rate for the first quarter was 15.5%.

Please click here to download the entire list of Premier Agents we compiled for this quarter. This increase in Premier Agents also ties in well with the frothy real estate conditions as shown by the Case-Shriller index and increasing volumes of transactions in the U.S. real estate sector.

Retention Ratio

Comparing our current list of Premier Agents to March 2013 and September 2013 shows us retention ratios of 62.26% and 74.85%, respectively. The two retention ratios indicate that a lot of agents did not rollover the subscription into 2014, though they mostly had a subscription both in March and September 2013.

In sum, our data indicates the success of Zillow in signing up new agents, but at the same time their weak retention of existing agents. This reveals that the current subscribers are continuously reevaluating their spending on Zillow, and do not hesitate to opt out when they do not achieve results.

Revenue Forecast

Using historical Premier Agents fraction of revenue of 67% (rolling average of the last four quarters) and an average subscription rate of $800 per Premier Agent, we forecast the revenue of Zillow for first quarter 2014 to be $67.95 million.

In terms of net profit, as the expanded sales require large advertising spends, we believe the firm will break even or make a marginal profit, as seen from historical margins. Hence we do not forecast an EPS.

Downside Risks

1. Short Squeeze: Zillow has moderate to high levels of institutional holdings (74%), but has a high amount of short interest at 5.76 days to cover in March 2014. We believe the short squeeze is preventing the price from reflecting all the information, and proving a detriment for efficient pricing of the stock and making it highly volatile. However, the sustained high valuation of Zillow has allowed the company to go an acquisition spree and consolidate its position in the Industry.

2. Softening of Commission Money: Renters/buyers feel that current commissions for agents are high with respect to their services. Although negotiable, a buy/sell typically pays 6% to both the buyer's and seller's agent. Internationally, the numbers are often half the levels as in the U.S. Going forward, any such softening of commissions can adversely affect the marketing dollars spent by agents, and directly impact Zillow.

3. Adverse Mortgage Rate Changes: Any increase in the mortgage rates following the fed tapering can place further pressure on advertising by real estate agents and could provide further downward pressure on Zillow.

4. Insiders Dumping Shares: Zillow insiders are not reluctant to let the market know of their view of firm value. In 2013, insiders sold shares worth $304 million and to date in 2014 have sold $29 million. There has not been a single purchase activity by a Zillow insider in the last 30 months.

Conclusion

While on the execution front Zillow has brought on a lot of Premier Agents in this quarter, the headwinds in the industry, perception of high commissions, and a volatile stock make Zillow appropriate for risk-lovers, purely for the short term. Combining the number of agents on Zillow and their typical annual churn ratio of 40% tells us that Zillow has reached far more than the 10% of all U.S. real estate agents it seems to have as current subscribers. One can speculate in Zillow purely in the short term for gains around the earnings announcement, while remaining cautious of the steep downside.

Source: Zillow: Playing Roulette In Online Real Estate