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Summary

  • Shorting Technology Companies On High Valuations Is Dangerous Because Of M&A Potential, Such As What Happened With Zillow And Trulia.
  • The Upside Of Consolidation Appears Priced In At Current Levels With Zillow Offering Limited Upside.
  • Zillow Produced A Great Quarter With Strong Top Line Growth.
  • Current Valuation And Risk Of Deal Closing Leave Limited Upside.
  • The Question Remains Though What If Anything Will Cause Stock To Correct To Reasonable Valuation?

Situation: Zillow is humorously valued even compared to its high growth internet peer group. Zillow trades at 148 times forward earnings versus the 76 median forward earnings of its comparable companies. The competitive moats around Zillow are mostly its userbase and its IP does not seem to be a large barrier to entry. Our full powerpoint presentation is available here. The only element which has since changed in our argument is comparing Zillow to Trulia, as they now are planning a merger. We are still short Zillow, and it the largest short in our book. However, earnings do not seem to correct the stock like other stock. For instance our largest long Chegg went up 25% post earnings, earnings generally function as catalyst but with Zillow guidance is beatable and it does not correct.

What Does Zillow Do? Zillow (NASDAQ:Z) operates the leading real estate and home-related information marketplaces on mobile and the Web, with a complementary portfolio of brands and products that help people find vital information about homes and connect with local professionals. In addition to their living database of homes, accessible on Zillow.com, they also own and operate Zillow Mobile, their suite of home-related mobile applications; Zillow Mortgage Marketplace, where borrowers connect with lenders to find loans and get competitive mortgage rates; Zillow Digs, a home improvement marketplace where consumers can find visual inspiration and local cost estimates; Zillow Rentals, a marketplace and suite of tools for rental professionals; Postlets; Diverse Solutions; Agentfolio; Mortech; HotPads and StreetEasy.

Insider Selling: Insider selling has been enormous at this company, with the chief revenue officer even selling shares post public announcement of the merger. However, the market does not seem to care even as executives dump shares into the general public the stock price does not correct, thus it does not seem a viable catalyst for the short thesis to play out.

Catalysts:

-Insider Sales(Not working as catalyst)

-Market Downturn(This could work, as zillow is likely to sell-off harder then general market given its lofty valuation)

-Earnings(The problem is guidance is conservative and company has history of meeting metrics, so even with an insane valuation the stock does not seem to correct, although any miss will likely send shares crashing. Shorts also have to wait some time now for next earnings release)

-Increased competition via existing companies or venture-backed competitors(still possible but harder given the scale of these two companies with merger)

-Real estate, mortgage and rental professionals or other advertisers reduce or end their advertising spending on Zillow(This is one still possible catalyst as many companies have there own listing services, however Zillow just had strong top line growth so they have been able to continue to extract revenue)

Bull Case Offers Limited Upside:

Bull Case assuming high net income growth increasing to $210 million by 2018 and a 5% LT growth rate and lower discount rate of 9%(discount to peer group), we obtain a $130 price target. A discount to the current stock price, offering long investors no upside.

Key Risk Factors: The largest risk factor is that the short squeeze takes the stock to $170, completely ignoring any conventional valuation. Other risk factor is that ARPU and margins improve without any flaws and revenue growth continues at light speed and despite its lofty valuation the stock never corrects because the company continues to produce strong results. We view this scenario as unlikely given increased competition, in our view the unsustainable competitive advantage, and insiders selling shares with their detailed knowledge of companies growth potential. Even if this occurs we feel the upside(short's downside) is limited given where the stock is already trading.

Disclosure: The author is short Z. 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.

Source: Merger Provides No Upside For Zillow At Current Valuation