Merger Monday kicks off with a big deal which is the acquisition of Trulia (TRLA) by Zillow (NASDAQ:Z) in a big $3.5 billion all-stock transaction.
The deal creates a market leader in online real-estate offerings. While I like the long-term prospects of the combination, I have serious doubts about the +$10 billion valuation at the moment given the combined revenue base of just $400 million.
While the tie-up could very well create a leading player in its field over the coming years, I don't think that the current risk-reward is very appealing.
Highlights Of The Deal
Zillow announced that the highly anticipated deal to acquire Trulia has been agreed upon. This came after reports about a potential deal broke out on Thursday afternoon.
Under terms of the definitive agreement, Zillow will acquire Trulia in an all-stock transaction, valuing the business at $3.5 billion.
The deal, which has been approved by the board of directors of both companies, is expected to close in 2015.
Operational Implications And Strategic Rationale
After the acquisition, Zillow will maintain its own brand as well as Trulia, both being separate consumer brands which offer information to buyers, sellers, homeowners and renters.
The companies will continue to offer advertising and software solutions to real estate professionals, as the combined increase in market power might give the combination more pricing pressure.
The companies stress that while both companies have grown quickly in recent times, real estate is still very much underrepresented online. Zillow states that the pro-forma revenues of the combination are less than 4% of the annual $12 billion which real estate professionals spend on their annual marketing efforts.
Yet both companies have a huge reach, with Zillow having 83 million unique users on mobile and web in June, while Trulia's online properties were visited by some 54 million unique visitors that month.
The combination aims to boost the pace of innovation, and provide greater access to free real estimate market data. Of course, industry professionals can further benefit from broader distribution and a greater value of the online offerings. This can boost the effectiveness of the advertising solutions on the websites by real estate professionals.
Zillow's CEO Rascoff stresses that both companies will continue to operate with stand-alone front end operations. Zillow will mainly focus on general market data as well as transaction-related information, while Trulia will focus more on buyers, renters and sellers. The distinctive focus is also evident in the differentiated customer base, with half of Trulia's website visitors not visiting the website of Zillow and about two-thirds of the visitors of Zillow not visiting Trulia's website.
While the companies will continue to operate as stand-alone businesses, the back-end operations will of course be combined resulting in an estimated $100 million in cost savings by 2016.
The Financial Terms
Under terms of the deal, investors in Trulia stand to receive 0.444 shares in Zillow for every share they currently own. Based on Zillow's closing price of $158.86 per share on Friday, the deal values Trulia at $70.53 per share.
There appears to be some skepticism regarding the potential closing of the deal. Shares of Zillow initially fell to $150 following the news, but even when trading at $162.50 during the afternoon, shares of Trulia trade just shy of $67. This is still quite a bit below the implicit offer price of $72 per share based on the agreed terms.
In total, Trulia's shareholders will hold about a 33% stake in the new business. The deal is of course subject to anti-trust provisions, a reason why shares might still trade at a discount compared to the offer price. Zillow's co-founders, as well as Trulia's shareholders, who hold over 7% of the outstanding share base, have agreed in favor of the deal.
Pro Forma Implications
Zillow has posted trailing sales of $224.8 million for the past twelve months, posting annual sales growth of 70% over the past quarter. The company did post some $15 million in losses over this time period which was not really a big issue given that it held a net cash position of little over $300 million.
Trulia has posted sales of $174.2 million over the past twelve months and its sales growth of 127% has been even more impressive, although it was aided by acquisitions. Its net loss of nearly $31 million was a bit steep as well. Trulia did hold about $220 million in cash and equivalents ahead of the deal, while operating with a roughly flat net cash position.
Combined both firms report sales of about $400 million, while they are losing close to $50 million per annum currently.
Given the $3.5 billion reported deal tag, Zillow anticipates about 49.6 million shares outstanding by Trulia. This means that Trulia's shareholders combined will own about 22 million shares in Zillow.
This means that the total outstanding share base in Zillow would be about 66 million shares at the moment. With shares trading at $162.50 per share, the new combination is valued at $10.7 billion, or about 26-27 times trailing annual revenues!
The Deal Makes Sense, But What About The Price Tag?
The tie-up between Trulia and Zillow makes perfect sense, as both companies were in some sort of a marketing war in recent times, boosting their marketing costs in order to gain professional customers in the real estate industry.
As such the consolidation does not only allow for lower marketing costs, but also allows for the sharing of costs at the back end. The $100 million cost savings, anticipated for 2016 are huge. In comparison, Trulia has posted sales of only $175 million on a trailing basis. The anticipated cost savings of a deal are enough to allow the combination to report a profit, but by far not enough to justify a +$10 billion valuation.
While the combination only generates pro-forma revenues of about $400 million at the moment, the current run-rate based upon the latest quarter is approaching $500 million per annum. Given the huge growth trajectory, a billion in trailing sales at some point next year cannot be ruled out. As such investors are very upbeat, believing that both companies are still in the start-up phase of the online real estate market. Today's tie-up increases the chance for domination of this market going forward.
This is the sole reason why the valuation of over $10 billion could make any sense. Note that at the moment, hopes and risks have increased after shares of both companies have nearly doubled so far this year.
While I have been a previous shareholder in Trulia, the current momentum is too much for me to provide any appealing risk-reward opportunity at the moment. As such I remain on the sidelines, keeping a close eye on the developments. I won't jump the bandwagon for now.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.