What Is Keeping Zillow Sky-High?

Aug.14.14 | About: Zillow Group, (Z)


Ability to consolidate and dominate a large online market kept Zillow's stock at highs.

The purchase of Trulia introduces extra risks.

Zillow might have seen the highs for now.

Earlier in the year, when all of the social media and high-flying stocks crashed, one notable stock soared to new all-time highs. The move by online real estate leader Zillow (NASDAQ:Z) was made despite valuation multiples most consider extremely expensive.

Unlike most of the social media brethren, Zillow posted a Q114 earnings beat that was actually in the black. At the time, analysts expected the company to generate a solid profit for the year, evidently making all the difference to investors willing to push the stock trading in the $80s when social media stocks collapsed up to $140 by July.

The real estate sector is in the peak summer selling season, so it probably helps push the stock higher with monthly metrics soaring as the move to the Internet transpires. Of course, the merger with Trulia Inc. (TRLA) helped create the final spike to $160, but Move, Inc. (NASDAQ:MOVE) expects to have a say in that ultimate leadership position in real estate. The current metrics continue to suggest Zillow was pulling away without a deal for Trulia so does the consolidation justify the sky-high price?

Consolidating The Industry
Probably because of the housing crisis, the online real estate market is far from fully developed. The industry that calls for easy access for consumers to real estate listings and other ancillary services related to a home is far behind the travel industry, stock trading, and other sectors that migrated to the Internet in full force a long time ago. Now the real estate industry is rapidly moving online, and especially to mobile.

Prior to the Trulia deal, Zillow appeared poised to be the one that consolidated the industry anyway. The revenue estimates for 2014 only place Zillow a fraction ahead of both Trulia and Move, at around $320 million to just over $250 million for the laggards. The real difference is the trajectory of the growth rates that has Zillow growing the fastest in 2015 and further pulling ahead.

Maybe the most important metric, Zillow saw record traffic in Q2 at 81.1 million monthly unique users, or MUUs, followed by 89.0 million in July. The surging traffic is leading premier agent subscribers to spend more. For Q2, these agents spent $54 more this year than in the same quarter of 2013. The number reached $320 this quarter.

Trulia saw a record as well in Q214, but the company remains far behind Zillow at only 51.6 million MUU. The user base grew by 48% from last year's levels, trailing the 49% of the larger Zillow. For July, the MUUs jumped to 57.0 million. The news, though, turns bad when looking at Trulia's stand-alone traffic, which excludes the users from the Market Leader acquisition, with the audience growing substantially slower.

At the same time, Move continues to celebrate that realtor.com saw the greatest monthly traffic in its history during March, with only 33 million MUU. The site averaged 312 million MUUs during Q214. The site is quickly becoming a distant third with revenue only growing 7%, having long been surpassed by the two more aggressive and modern real estate marketplaces.

Growing The Marketplace

The intriguing potential in Zillow moves beyond attracting the advertising budgets of agents to the ability to sell add on services for consumers looking to buy a house. The mortgage revenue grew 45% to reach a record of $7.1 million in Q1, but it contracted to only $6.6 million in Q2. The marketplace processed 5.5 million loan requests and saw reviews of lenders reach over 75,000. The numbers were solid considering the weak mortgage market, but not eye-popping considering the company grew revenue by 68% as a whole. Peak selling season occurs during spring and summer seasons, so the growth in this category will be interesting to watch during the third quarter.

Bottom Line

Zillow avoided the carnage of social media and other high-flying stocks because of the growing realization that the company had the ability to consolidate the real estate market single-handedly. Not only was Zillow pulling away from the competition of Trulia and Move, but the company also generated a small profit to start the year.

Now with the deal to buy Trulia, the combined company is worth around $7.3 billion and trades at nearly 13x revenue estimates for this year. The stock was originally sky-high, based on the ability to consolidate the leading online real estate marketplace leading to a much higher valuation down the road as a stand-alone entity. Now it appears that some of the upside is capped and the company faces integration issues that could stall stock appreciation. In addition, the move to create an industry leader amongst the upstart players in the industry could cause a backlash by agents not wanting a new entrant in the business to control so much market share.

The previous tailwind keeping Zillow sky-high appears like a headwind now.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in Z over 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.