In a world of high-multiple internet stocks, Zillow (Z) might just win the rather repugnant award for 'most overvalued'. Zillow describes itself as a "real estate marketplace...[that] provides vital information about homes, real estate listings and mortgages...enabling homeowners, buyers, sellers and renters to connect with real estate and mortgage professionals." A cursory look at the company's valuation shows a trailing twelve month (TTM) price-to-earnings ratio of 850. That's assuming non-GAAP 2011 earnings per share of 4 cents as reported by the company.
As Zillow is supposedly a high growth name, it makes sense to evaluate it on forward earnings as well. Unfortunately, that measure is only slightly less crazy than the TTM P/E: Zillow's forward price-to-earnings ratio is a lofty 121 based on analysts' consensus estimates of 28 cents per share for 2012. While I maintain that no amount of growth is sufficient to support such a high multiple, it is worth noting that an examination of the company's most recent 10-K and 10-Q reports shows growth declining in some rather important areas.
Growth in the company's 'premier agent subscriber program' (i.e. Zillow's service that allows local real estate agents to post their contact information and listings on the site) has slowed dramatically. From December 31, 2009 to December 31, 2010 premier agent subscriber growth was 193%. From December 31, 2010 to December 31, 2011, that rate of growth fell to 97%. According to the company's 10-Q, premier agent subscriber growth from March 31, 2011 to March 31, 2012 was just 74%. This is a very disturbing trend given that premier agent subscriber revenue accounts for most of the company's 'marketplace revenue', which, in turn, accounted for nearly two thirds (64%) of the company's total revenue in 2011. The other 36% of total revenue in 2011 came from 'display advertising'. It is important to note that display ads accounted for 57% of total revenue in 2010, meaning that the company is increasingly relying on 'marketplace revenue', a category which could begin to suffer from the falling growth rate of its main cash generator: premier agent subscriptions.
Another 'key growth driver' for Zillow is unique users. The company counts a unique user "the first time an individual accesses one of [its] websites...during a calendar month". Unique users are important for two reasons. First, the more users the site has, the more valuable it is to real estate agents who are potential 'premier agent subscribers' and second, the company's display revenue depends upon the number of impressions generated. While the average number of monthly unique users grew 86% year over year during the fourth quarter of 2011 compared to year over year growth of just 66% in the fourth quarter of 2010, a bit further down in the company's 10-K is a quarter by quarter breakdown which shows that, during the fourth quarter of 2011, monthly unique users declined from the previous quarter for the first time in at least two years. If the growth rate of average monthly unique users continues to decline, so too will display revenue.
Given all of this, it seems doubtful that shares of Zillow can maintain their current valuations. Stocks whose valuations depend on unsustainable growth fall hard and fast when that growth shows signs of dissipating. It is also worth noting that on a GAAP basis, Zillow made no money last year:
For purposes of calculating earnings per share under GAAP, all income for the full year 2011 must first be ascribed to preferred shareholders; therefore, there is no income attributable to common shareholders, and 2011 GAAP basic and diluted earnings per share is zero dollars.
Investors are reminded that paying any amount of money for shares of a company that is not profitable makes very little sense.
Some analysts will undoubtedly argue that Zillow is also a play on a recovery in the housing market which, many note, has likely finally found a bottom. Be advised: A bottom is not a recovery. With the economic recovery still in question and the reputation of high multiple internet stocks damaged by Facebook's (FB) shaky IPO, Zillow is about as risky a bet as any.
Disclosure: Short Zillow or long Zillow puts.