(This is the second in our series about a certain kind of Internet Information provider that we call “Desired Monopolies.” Please see the first in the series, about Ariba, published on September 30.)
Zillow: Admit It, You Can't Help Looking At This Stock
As a company, you know you’re doing something right when customers and prospects in your primary market hate your guts, but sign up for your service in record numbers anyway.
Well, your average realtor (we interviewed several as part of our research for this report) doesn’t quite “hate” Zillow, but the realtor-Zillow relationship is complicated. Realtors generally admire Zillow’s web site and its ability to efficiently (and prettily) provide a wealth of real estate information. However, realtors loath Zillow’s price estimates, invariably describing them as wrong and bemoaning the friction they cause when prospective clients cite them, only to have the realtor "set them straight" with local knowledge Zillow never catches.
But the biggest thing realtors hate about Zillow is that ... they don’t own it. The National Association of Realtors licenses its realtor.com domain to Move, Inc. whose realtor.com web site was until just this summer more trafficked than Zillow. But Zillow.com, the 150th most visited site on the whole Web, with over 24 million unique visitors in September (up ~100% year-over-year) has blown by realtor.com. And it bothers realtors no end that while they originate real estate listings, they need to subscribe to Zillow directly to enjoy some of the premium services, like uploading listings directly to Zillow, or enhancing existing listings with extra photographs. Who’s in charge here?
The answer, of course, is us. We can’t resist Zillow’s free, voyeuristic window into our neighbors’ homes, what they paid for them, and what they’re worth now. Zillow’s official business model calls for signing up more subscribing real estate agents, facilitating more mortgage originations, and selling more of its highly targeted advertising. But a cynic doesn’t have to think hard about all the additional info that Zillow could route through its platform:
- How about crime statistics overlaid graphically on the classic Zillow aerial presentation? With specific notations for registered sex offenders? While distasteful to contemplate, what parent wouldn’t automatically consult Zillow in advance of searching for a home in a particular neighborhood to educate him/herself?
- How about health statistics, including the immunization rates at schools?
- Education levels? Ambient noise levels? Sewage treatment plants overlaid with arrows representing the predominant wind direction?
If Facebook charts our social graph, then Zillow clearly has the lead in charting our environmental graph. And as a Desired Monopoly, Zillow can be the trusted middleman, aggregating nice-to-have information into a must-have whole. But we’re getting ahead of ourselves: Zillow is compelling enough just as it is.
Name: Zillow Inc.
Market Cap: $703 million
Trailing 12-months Revenue: $44.9 million
Forward Price:Earnings Ratio (estimated): 50x
HQ: Seattle, Washington
Founded: December, 2004
Zillow is one of the largest real estate information marketplaces. The company provides vital information about homes, real estate listings and mortgages through its website and mobile applications. Additionally, homeowners, potential buyers and sellers are able to connect with real estate and mortgage service providers. Using proprietary automated valuation models, Zillow provides current home value estimates, known - awkwardly - as “Zestimates,” on over 100 million U.S. homes. Zillow also provides current rental price estimates, or “Rent Zestimates,” on homes and properties.
Zillow makes money through subscriptions, lead generation (principally for mortgages) and advertising on its web site. Individuals and businesses that use Zillow have updated information on more than 28 million homes and added more than 60 million home photos, creating exclusive home profiles.
Zillow’s Revenue Sources : Marketplace And Display (excerpted from Zillow’s IPO prospectus)
Marketplace Revenues (61% of total revs in Q211, vs. 36% in Q210)
Marketplace revenues consist of subscriptions sold to real estate agents under the Premier Agent program and cost-per-click ads related to the Zillow Mortgage Marketplace. These ads are sold to mortgage lenders. Zillow had 13,385 subscribers as of 6/30/11 (up 25% from the March quarter and 180% year-over-year). Subscription revenue was up 269% year-over-year in the June quarter.
The Premier Agent program allows local agents to establish an online and mobile presence on Zillow in the zip codes they serve. Contact information for each Premier Agent is presented alongside home profiles and home listings within an agent’s zip code, assisting consumers in evaluating and selecting the real estate agent best suited for them. Subscription pricing varies by zip code. Terms are generally six to 12 months.
In Zillow Mortgage Marketplace, participating qualified mortgage lenders make a prepayment to gain access to consumers interested in connecting with mortgage professionals. Consumers who request rates for mortgage loans in the Mortgage Marketplace are presented with personalized lender quotes from participating lenders. Zillow charges only when users click on their links for more information regarding a mortgage loan quote. Mortgage lenders can “re-up” with more funds as needed to continue to participate in the marketplace.
Display Revenues (39% of total revs in Q211, vs.64% in Q210)
Display revenues primarily consist of graphical web and mobile advertising sold on a cost-per-thousand basis to advertisers including real estate brokerages, home builders, mortgage lenders and home services providers. Advertisers include telecommunications, automotive, insurance and consumer products companies. Growth in display revenues depends on continuing growth in traffic to the website and mobile applications, migration of advertising spend online from traditional broadcast and print media and development of new advertising products.
Market Size And Zillow’s Opportunity
First, some market data:
- The National Association of Realtors has 1.2 million members, of which we estimate roughly half are active and associated with a real estate brokerage firm.
- According to the United States Bureau of Labor Statistics, there were 517,800 RE brokers and sales agents in 2008. That number was expected to grow only 1-2% annually, and may have shrunk since then.
Total Addressable Market Calculations
Let’s divide this generally into subscriptions and advertising.
The median real estate agent makes ~$40,000 annually. Assume $5,000/agent in work-related support expenses (ex-office space), including: local ad support, phone subsidy, Internet access, etc. So assume each agent could spend $1k-$2k/year on Zillow. (Our calculation is the current subscription rate is $1,500/year.) Now assume some sharing of subscriptions within brokerage offices, again reducing the total possible subscribers by half. Thus, the total addressable market is ~250,000 (working, compensated) real estate agents x $1,500/year = $375 million.
Second: Advertising And Marketing Services:
As the 150th most trafficked site on the Web, Zillow has much to offer in the way of targeted advertising. Using its own algorithms, for example, it can predict fairly reliably when a home in its database will shortly be put up for sale, thus allowing its advertisers (e.g. brokers, agents, re-modelers, movers) to rifle-shot ads straight to the person viewing that house’s information.
By some estimates, the total marketing spend in the United States on real estate-related products and services is between $10 billion and $20 billion.
With Zillow’s revenue run-rate at a mere $64m, there exists ample opportunity for Zillow take a much greater “share of wallet.” Not only because of the effectiveness of its advertising, but because being “on Zillow” will simply replace “being in the Yellow Pages.”
Recent Financial Performance
Zillow’s second quarter ended on June 30. The company went public on July 20 and on August 24 issued its second quarter financial release. Revenue of $15.8 million was up 116% year-over-year, and the company was profitable for the first time on both an operating and pro-forma net income basis. Subsequent metrics, like page views and unique visitors to its web site reflect continued triple-digit growth in the near term.
Concerns and Issues
No company or investment is perfect, and Zillow has several issues that concern us.
1. The Accelerated Lock-Up Agreement:
Buried deep in Zillow’s IPO prospectus is the following boilerplate (don’t worry, I offer a plain English translation immediately following):
“If, however, at any time beginning 90 days after the date of this prospectus, (i) we have filed with the SEC at least one quarterly report on Form 10-Q, (ii) the reported last sale price of our Class A common stock on The Nasdaq Global Market is at least 33% greater than the initial public offering price per share set forth on the cover page of this prospectus for 20 trading days out of any 30 trading day period ending after the 90th day following the date of this prospectus (which 30 trading day period may begin prior to such 90th day), and (iii) the reported last sale price of our Class A common stock on the last day of that 30 trading day period described in clause (ii) is at least 25% greater than the initial public offering price, then 25% of each holder’s capital stock that is subject to the 180-day restrictions described above as of immediately prior to the opening of The Nasdaq Global Market on the day following the end of the 30 trading day period, or the initial release date, will be automatically released from those restrictions on the initial release date provided that none of the underwriters have published research on us within 15 days prior to the day following the initial release date. If an underwriter has published research on us within 15 days prior to the day following the initial release date, the initial release date will be deferred until the expiration of the 15-day period beginning on, and including, the date such research is published.”
Plain English: On any day after October 18, if Zillow’s stock price has closed above $26.66 for 20 of the prior 30 trading days, then almost all of the non-IPO shares will begin unlocking, and insiders will be able to sell as much as 25% of their holdings. As of October 13, Zillow shares had closed above $26.66 for, coincidentally, 20 of the prior 30 trading days.
It’s worth mentioning that when Google went public seven years ago, they too had a similar, accelerated lock-up schedule. Yet that didn’t prevent the stock from climbing sharply from its $85 IPO price and more than tripling in its first year, without declining materially during that period.
Bottom line: With a float that represents only 19% of Zillow’s total shares outstanding, even modest selling by un-locked insiders is likely to hinder appreciation in Zillow’s stock price, by increasing the effective trading supply. If, however, sustained selling doesn’t seem to have any effect, this would be hugely positive for Zillow, representing as it does, “shadow demand” for Zillow shares.
2. Churn: Zillow hasn’t revealed its churn rates for its premier subscribers. It’s our experience with other subscription-based business models that suggested contract lengths are usually slightly greater than that implied by the churn rate. With contract lengths at a suggested 6-12 month period, we estimate that typical subscriber duration is 10-12 months. This is very short, and means that Zillow may “burn through” subscribers very quickly.
3. The Lawsuits: Zillow is being sued (separately) by Smarter Agent LLC, Corelogic and Lending Tree over various IP issues. In each case, Zillow has filed counterclaims. Zillow does not appear to have accrued against potential damages. Our gut feel: these are business process patents that will either be found invalid on re-examination, or the intellectual property will be cross-licensed.
Zillow is the largest independent real estate market site, as measured by homes in its database and unique visitors to its web site. However, they do not yet have a dominant position. Realtor.com, Trulia, Homes.com and a variety of other sites all have meaningful market share and listing information. Trulia.com for example, has about 90% of Zillow’s traffic and is growing faster, year-over-year.
One of the reasons we believe that Zillow is a Desired Monopoly, however, is that the site seems to reflect a Web 2.0 ethos: from the visual presentation to the emphasis on community via forums and agent reviews, Zillow.com simply feels more welcoming and less commercial.
As part of our analysis of Zillow, we built a Discounted Cash Flow (DCF) model for the company. We used the following parameters and values to arrive at our DCF value:
- Term: 5 years;
- Initial Cash Flow: $12.753 million (this represents the estimated annual free cash flow for the current fiscal year);
- Short Term Cash Flow Growth Rate: 25% (conservative considering that Zillow’s Free Cash Flow growth rate within the current year is in excess of 100%);
- Long Term Cash Flow Growth Rate: 6%;
- Discount Rate: 8.92% (derived using CAPM: Risk Free Rate = 3.20% from the 30–year Treasury Bond; 4.4% equity risk premium from Ibbotson; an estimated Beta of 1.3);
- Current Share Count: 24.106 million.
Using these inputs, our calculated DCF value per Zillow share is $42.30, about 60% higher than the current Zillow share price of around $26. But realistically, this estimate is mostly sensitive to the near-term cash flow growth, which, while conservatively estimated, is very uncertain.
By comparison, we estimate that Zillow’s 2012 pro forma net income per share will be $0.50, meaning the company has a forward P:E of 50. Not cheap, but given current triple-digit growth rates, not expensive either. Right now, it’s fair to describe Zillow’s valuation as, “a premium price for a premium opportunity.”
Beyond overcoming realtor antipathy, Zillow is also impressive for having demonstrated explosive growth during perhaps the worst real estate market in the past 70 years. From April of 2006 until this past July, the Case-Schiller 20-city home price index declined by 32%. By comparison, the S&P 500 declined only 7% over that same period.
Which makes it all the more amazing that a company whose sole product is real estate information could go from $0 in revenue in 2005 to an annualized rate of $64m today. You’re left to imagine how well they would have done in a real estate market that was at least flat. Or up.
We feel strongly that Zillow is not only emerging as a Desired Monopoly for real estate information, but also as a platform for understanding one’s physical environment. As a company, Zillow has an immense opportunity. As a stock, with the forthcoming unlocking of shares, and multiple competitors that are far from vanquished, we feel less certain about Zillow’s near-term prospects. But of course we can’t help watching ...
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.