A Strong Pick In The Real Estate Sector? Look At CoStar Group

| About: CoStar Group, (CSGP)

I think that CoStar (NASDAQ:CSGP) is one of the most interesting opportunities I am currently analyzing. The company has a unique business model that helps real estate brokers to get accurate data and key property analysis that no other company can provide. A combination of strong potential growth, a wide moat, and constructive technical action makes me interested in this company at current levels.

CoStar is a "must have" tool of information and analytic services for commercial real-estate brokers, developers, investors, and lenders as it's an innovative service provider that serves the industry with vital, up-to-date information on properties and tenants.

Todd Lukasik, analyst at Morningstar, explained in his report:

Participants in the commercial real estate industry rely on accurate and timely data to perform their jobs. Lenders and appraisers require comparable sales data for underwriting and valuations. Brokers, property managers and building owners require tenant information to track available space and tenant leasing needs. CoStar's nearly 1,000 researchers develop and update its database of information to support these functions.

By spreading the cost of its research staff and technology platform across a diverse client base, CoStar can price its service below the cost of collecting the data in-house. Its high customer retention rate (averaging 90% historically) coupled with annual rate increases (usually in line with inflation) have led to a solid recurring revenue base that should increase modestly over time.

In 2009, CoStar acquired two firms that expanded its offerings in terms of research and analysis. Its recent acquisition of LoopNet (the largest commercial real estate listing service online) and smaller acquisitions, are a great mix to CoStar offerings. I think CoStar can create cross-selling strategies and integrate those with the existing platform.

Steve McLinden wrote in the August 2011 issue of Shopping Centers Today:

If information is king, then the acquisition of LoopNet by rival CoStar Group may signal the establishment of a data and property-listing dynasty that could rule the retail real estate realm for decades to come.

When Andrew Florance launched CoStar in 1987, he never imagined the combination of two of the most powerful commercial real estate data and property-listing firms. Today, Florance said that "CoStar revolutionized how the industry researches commercial real estate and LoopNet revolutionized the way the industry markets commercial real estate."

On June 29, LoopNet announced that it surpassed 5 million registered members. Its website traffic engines record around 1.5 million monthly visitors (source: Google Analytics). With its primary focus on property listings, LoopNet's revenue results are more appealing as a marketing-driven model. As a combined entity (with LoopNet), CoStar Group should provide some economies of scale and the dominating CRE search engine should become more efficient, driving revenues to around $350 million after the first year of integration. Once that unfolds, I expect that CoStar will continue to grow revenues by around 20% and annual net income should hit $40 million by year-end 2012.

CoStar generated a high revenue growth last year. The company has a negative three-year EPS growth rate and a low 2.85% ROE, but it reported the highest revenue growth since 2007. I find it attractive that CoStar has exposure to a recovering real estate industry. That, combined with projected top line growth tells me that the company could do great in the near future.

Sell-side analysts estimated different scenarios for CoStar shares. Several analysts projected that CoStar could get to $85 in the next 12 months. The mean target is $77.50 based on the company´s historic valuation metrics and future growth. I do not base my investment decisions on analyst targets, but it is important to add them to my complete research routine.

According to the company's fillings, its competitors are Thomson Reuters (NYSE:TRI), IAC/InterActiveCorp (IACI), Google (NASDAQ:GOOG), AOL (NYSE:AOL), and Reis (NASDAQ:REIS).

In conclusion, I think that CoStar trading at 350 times P/E ratio does not represent a value opportunity, but is one of the real estate stories I find most compelling. With five quarters of consecutive revenue growth, record annual revenue growth, strong balance sheet fundamentals (9.17 quick ratio plus only 1,17 of financial leverage), and growing institutional interest, the stock could get to the most optimistic analyst target.

Data sourced from Morningstar, Zacks, Barron's, Wall Street Journal, Google, and Bloomberg.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CSGP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.