Zillow (Z) may be the most resilient social media stock in the entire industry. It is a company with the most loyal of investors, who won't sell regardless of its apparently overvalued price tag or the excessive negativity surrounding the company as of late. The stock has performed well and doubled from its IPO price in less than a year. But with its greatest strengths being its greatest weaknesses, investors must wonder if its run can continue.
On Tuesday, shares of Zillow fell by nearly 7% due to a negative outlook by well-known analyst/short-seller, Andrew Left, of Citron Research. The title of the research report sums up the topic of the piece, "Zillow: It's Not Just the Ridiculous Valuation - it's the Ridiculous Business Model." Normally, I am not too fond of Citron Research for its preference to write negative articles on stocks that are overbought, which are, therefore, stocks that can be easily manipulated. However, the report from Citron was among the most detailed analysis that I've seen for a social media stock, and I urge all to read the report by clicking here.
As a result of the companies that Citron typically covers, the mere mention of analysis from the firm usually leads to a large loss for a stock, minimum of 10%. Yet with Zillow, its loss was less than 7%! Also, keep in mind this 7% loss was also due to the fact that all social media/internet-based companies were trading lower on Tuesday due to strong selling in the market. So if the market had been trading higher, it's possible that Zillow's loss would've been even less. Then, when you incorporate the company's recent secondary public offering earlier this month, it is easy to suggest that shares of the company should be trading significantly lower for the month of September.
There are two key factors to consider when assessing the performance of Zillow in the month of September: its secondary offering of 3.18 million shares in the first week of the month and the bearish outlook from Citron Research on Tuesday. Despite these two stock-crushing events, the company has maintained its valuation! It began the month at $41.00, and on Tuesday it closed at $41.45. To better explain just how extraordinary this performance is, let's rewind and consider the market influence of Citron Research. We already know that anytime a company does a secondary offering, or any type of financing, it pushes shares lower. But Citron is, perhaps, more damaging than a secondary offering, and has a long history of bearish articles that push stocks lower. The firm's most recent articles have led to losses of more than 10% in shares of Nu Skin (NUS) and Vivus (VVUS), along with a loss of more than 20% in shares of Quesctor Pharmaceuticals (QCOR). However, in terms of valuation, none of these stocks were as expensive as Z in relation to fundamentals, thus making its loss of only 7% very surprising.
Considering the valuation of Zillow, its performance is remarkable. Its valuation suggests that this small company has found the cure to cancer or has the next iPhone, but in reality it's just a real estate information website. The bull's case for the future of this company is based on three key elements: fundamental growth, premier agent subscriber growth, and average monthly user growth. Over the last year Zillow has grown at a tremendous rate. In its last quarter the company announced revenue of $27.77 million or 75% growth year-over-year. It also announced 70% growth in premier agent subscribers with 22,696 and a 61% increase with 33.5 million average monthly users.
Now, here's where common sense must come into play for investors of a real estate company: If Zillow has 110 million U.S. homes on its database, 22,696 premier agent subscribers, and this combination amounts to revenue of under $90 million for the last 12 months, then what is the upside potential for this company and its stock? How long can it maintain this growth and what's the ceiling? Granted, real estate is a large industry, but with 22,696 agents, the company is already profiting from a large share of its addressable market. The company trades with a price/sales ratio of 14.53 and a forward P/E ratio of 58.38, so can the company really grow to a level in which fundamentals could come close to validating its stock metrics? Unfortunately, I don't think so. Zillow is a real estate information marketplace, and already has virtually all houses on its website that are for sale, and a large chunk of real estate agents who pay for Zillow's services. In addition it shares this space with competitor Trulia (TRLA), and no one knows for certain if agents will be willing to pay for Zillow services if real estate demand continues to rise.
The bottom line: There are too many questions, not enough answers, and a limited market for growth with the company's current business model. It will most likely never grow and materialize to be deserving of a $1.2 billion market cap. However, with that being said, there are companies with far worse fundamentals valued at over a billion in this new era of dotcom companies. Zillow does have a legitimate, profitable business model; I am not suggesting that it will experience the same fate as the dotcom era of the past. Eventually fundamentals and valuation begin to close the gap once the hype dies down. Ergo, despite the fact that Zillow investors are a loyal bunch, the stock does look to be near the top of its range, and could very well experience the "single digit fate" detailed in the Citron Research report… and at that point, shares of Zillow may be attractive.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.