- Zillow's stock has bucked trend of weak housing data for now, possibly due to a short squeeze.
- Comparable companies trade at discounts by a variety of metrics.
- Management has difficulty controlling costs; equity compensation is aggressive.
- Insiders have been heavy sellers of the Company's stock.
Zillow, Inc. (NASDAQ:Z) operates real estate and home-related information marketplaces through a variety of mobile applications and its desktop website Zillow.com. Management markets the firm as a one-stop-shop for buying, selling, renting, borrowing, and remodeling. The firm is a leader in the real estate marketplace space and dwarfs in competitors Trulia, Inc. (TRLA) and Move, Inc. (NASDAQ:MOVE). MOVE runs the website realtor.com.
The main source of Zillow's revenue and revenue growth is its Zillow Marketplace segment. The firm makes money in three distinct ways in this segment:
- Real estate agent subscriptions that are based on the number of impressions delivered in purchased zip codes
- Advertising sold on a CPC (cost-per-click) basis to mortgage lenders and on a CPM (cost-per-impression) basis, i.e. display revenue
- Subscriptions with rental professionals and brand advertisers
Real estate agent subscriptions are the main revenue driver in Zillow's business and consistency could come under pressure during a prolonged downturn in the housing recovery. Long periods with low growth in housing prices could incentivize RE agents to focus on other sources of income besides the market and in turn drop their subscriptions. Zillow does not report a churn rate for its real estate agent subscriptions; it must be weak, otherwise the firm would report the metric.
Recent Housing Weakness
From September 2013 through March 2014, the Case-Shiller 20-city index has hardly budged. Trulia and Move have been hurt by weaker housing data alongside a sell-off in momentum stocks, both stocks are down 25% from their 52-week highs. Zillow, on the other hand, has been resilient and made new 52-week highs early last week. Housing weakness has failed to put a dent in Zillow's revenue growth rate, but there is no guarantee that real estate agents will continue to ignore the slowing rate of growth in housing price increases.
Comparable Companies' Analysis
Neither Z, TRLA, nor MOVE turned a profit over the last twelve months. TRLA and MOVE trade at significant discounts to Z based on Price/Sales (P/S) and Price/Tangible Book Value (P/TBV), as we can see from this chart:
|Price/Sales||Price/TBV||Q/Q Revenue Growth||Forward P/E|
Source: 10-Q Filings, Yahoo Finance
MOVE sticks out from the other two for its lack of revenue growth but more attractive prospects for the near future, so it is probably the least risky of the three prospects. Because MOVE isn't growing, it is harder to compare to Z and TRLA.
TRLA trades at better multiples of P/S, P/TBV, and Q/Q revenue growth but has more rapidly rising expenses than Z. TRLA's expenses rose 166%, greater than revenue growth, while Z's expense growth was in line with revenue growth at 70.0%.
I think that the first three metrics overshadow TRLA's expense growth and make it the strongest candidate from a comparable companies' standpoint. TRLA has more sales that are growing at a faster rate than Z and has more tangible assets as a percentage of the firm's value.
Zillow was able to constrain its expense growth to its revenue growth rate, which is a positive, but dollar compensation expenses were artificially restricted by large issuances of employee stock options. The Company's share count rose approximately 16% from the March quarter last year. Zillow cannot continue to issue this much equity in the future and will have to resort to dollar compensation at some point, adding to compensation expenses.
Zillow has also rapidly increased its Sales and Marketing spend, up 76.3% from the March quarter last year, outrunning revenue growth. This level of Sales and Marketing expense growth is not encouraging. Aggressive advertising aimed at real estate agent subscriptions could be a symptom of a high churn rate and is unsustainable in the long run. Cost control appears to be a big problem at Zillow due to rapid equity issuance and high advertising costs.
The large majority of Zillow insiders own vested options, meaning they cannot exercise them until a predetermined time. According to the Company's 10-Q filing, they are "typically granted with seven-year terms and typically vest 25% after 12 months and ratably thereafter over the next 36 months."
Over the last six months, there have been forty-eight insider sales and zero insider buys. It follows that management believes that the shares are overvalued and will continue to exercise options and sell shares as their options vest.
Zillow, Inc. is an overvalued stock. Recent housing weakness, better priced comparable companies, weak cost control, and insider selling all point to a company with many more reasons to fall than continue to increase.
If the current short squeeze runs out of gas, Zillow is an excellent short candidate. Shorting overextensions using small position sizing is an attractive option at the moment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.