Zillow: Like Landing On The Moon

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About: Zillow Group, Inc. (ZG)
by: William Sabin
Summary

Sales were up in the 2Q by 84%.

I have added shares to my portfolio Friday afternoon.

Prepare for a bumpy ride as Zillow transforms the industry.

The foundation of Zillow’s business is its IMT (Internet, Media & Technology) segment. In order to keep this segment growing, it will largely depend on the Premier Agent segment improving.

Source: Zillow

Overview

Zillow's (NASDAQ:ZG) Chief Executive Rich Barton compared the company's disruption of the real estate industry to landing the first man on the moon.

Sales at Zillow were up 84% in the 2Q19. They are growing, and I continue to see even more growth coming. However, the home-flipping business called Zillow Offers discussed in more detail below made investors nervous as that segment is generally has lower margins and is more labor-intensive than what the company is historically used to experiencing. Rich Barton, co-founder and CEO of Zillow Group Inc., stated:

We're in the early stages of a bold expansion of our company that opens up exciting opportunities for our customers, partners, shareholders and employees. We are uniquely advantaged by our brand awareness, audience size, technology, data science, industry partnerships and operational know-how and are well on our way to rewire real estate.

While overall losses were also smaller than expected, the company mentioned that the stellar results that were anticipated in the home-flipping business might take longer than expected. However, I'm patient and believe that ZG has the potential to make a huge change in an industry that is much in need of change.

2Q19 Highlights

From their 2Q19 reporting, highlights of the quarter include:

Our second quarter results reflect the momentum we are seeing across our businesses," said Rich Barton, co-founder and CEO of Zillow Group, Inc. "The demand signal for Zillow Offers is incredibly impressive as seen in the annualized revenue run rate going from zero to $1 billion in just a year.

  • Total Q2 consolidated revenue grew 84% year over year to $599.6 million, driven primarily by significant growth in the Homes segment.
  • Consumer awareness and demand for Zillow Offers is growing rapidly. More than 69,000 homeowners requested an offer from Zillow to purchase their home during Q2, up 94% sequentially from Q1.
  • The addition of seven Zillow Offers markets since the end of Q1: Dallas-Fort Worth; Minneapolis; Orlando; Portland, Ore.; Nashville, Tenn.; and Colorado Springs and Fort Collins, Colo.
  • Today, the company separately announced four new Zillow Offers markets expected to open in early to mid-2020: Cincinnati, Tucson, Ariz.; Oklahoma City, and Jacksonville, Fla.
  • Traffic to Zillow Group's mobile apps and websites accelerated with more than 194 million average monthly unique users in Q2, an increase of 4% year over year, while visits reached a new high of nearly 2.2 billion, up 14% year over year.

The foundation of Zillow's business is its IMT (Internet, Media & Technology) segment. In order to keep this segment growing, it will largely depend on the Premier Agent segment improving.

Source: Zillow 2Q19 Press Release

Zillow entered the business of buying and selling homes back in 2017 with Zillow Instant Offers. Over time, this program has morphed into Zillow Offers.

Zillow Offers

Launched last year, Zillow Offers lets people sell their home directly to Zillow, which allows people to avoid the potential hassle and uncertainty that often comes with a traditional home sale. More than 170,000 homeowners have requested an offer from Zillow to buy their home since the program launched in April 2018 and 70,000 of those requests were in the second quarter of 2019 showing continued strength in the 'iBuying' space. According to Zillow, grabbing just 1% of market transactions today would translate into a $20 billion business.

Zillow Offers is currently available in 15 markets across the country and will have 26 planned by mid 2020. The service is marketed in Phoenix, Las Vegas, Atlanta, Denver, Charlotte and Raleigh, NC, Houston, Riverside, Calif., Dallas, Minneapolis, Orlando, Fla., Portland, Ore., Colorado Springs and Fort Collins, Colo., and Nashville, Tenn. It will soon be coming to launch in Austin, Texas, Los Angeles, Miami, Sacramento, Calif., San Antonio, San Diego and Tampa, Fla.

Zillow Offers Current and Coming Soon Markets

Source: Zillow

There is more detail on their website, but the process works as follows:

A homeowner contacts Zillow through the website that they are interested in getting a n offer on their house. The seller adds basic information and add pictures of their house to Zillow's website. Zillow calls the homeowner and discusses their situation. Zillow then works to value the house and determines a bid working with local premier agent. They build a comparative market analysis ('CMA') for the home. Within a short time - usually just a few days - Zillow presents their bid along with the CMA to the homeowner.

If the homeowner accepts the offer, an inspector visits the house. If that process is cleared, Zillow can close from a week to 60 days out allowing flexibility to the homeowner. Zillow charges a service fee in the range of 6-9% for this service.

If the homeowner declines the offer, then Zillow asks if they want to list with a Premier Agent. Seller leads are inherently valuable - more valuable than buyer leads. Zillow monetizes these leads by obtaining a referral fee at the house closings.

Transformation

As with any business transforming an industry, there will be bumps and learning curves. However, it appears so far so good for Zillow especially if you look at the bigger picture and not just a few days of trading or even a few quarters. The disruptive service is the key using their AI technology - people want an easy, convenient, hassle-free way to sell a home.

Source: Zillow

It is not all green grass and picket fences for Zillow as they lowered their forecast for its mortgage-lending business, Zillow Home Loans, explaining that the technology was still being developed. In addition, Zillow has had to write down the values of homes that took longer than expected to sell. I will be watching this area closely as I have no patience for software delays - it will be telling of management's ability to transform in a relatively straight forward area. If they cannot get this off the ground in the next quarter, I will most likely be moving on from owning the stock.

Zillow has made monetization changes to its ad business, charging a percentage for converted sales rather than a flat rate for each lead. This could be a good change for the company as it provides a better service to the home buyer, potentially higher profits for Zillow, and a crisper marketing and cost management process for agents. In certain markets, agents pay once a transaction has closed on leads generated through Zillow rather than upfront. I believe this is a good strategy to retain agents. However, investors need to understand from an accounting perspective, this potentially could cause revenue to be deferred as it is effectively earned at a later point in the process.

In addition, not only does Zillow has high hopes for a rapid growth in home transactions, but also sees value in the mortgage origination, title and escrow transactions.

Trade

I have waited for an entry into this stock. With a decline over the last few days of over 20%, now is the time for me. According to Elliott Wave theory, the next target price is approximately 37. For ZG, it appears that we have entered Wave 3, which is usually the longest and most tradeable wave in the Elliott Wave cycle. The Wave 3 target price is determined using Fibonacci ratios and should typically be 1.618 or more times the movement of Wave 1.

Source: Fidelity

I have bought at 39.22 today - this might prove to be slightly early, but I still feel good on the entry point.

Source: Fidelity

Summary

While overall losses were smaller than expected, the company mentioned that the stellar results that are anticipated in the home-flipping business might take longer than expected. There have been software delays for its mortgage-lending business. In addition, there have been positive changes in agent retention and lower churn. I'm patient and believe that ZG has the potential to make a huge change in an industry that is much in need of change. As such, with an over 20% drop in the last few days, I decided this was a good entry point for me. Long ZG.

Disclosure: I am/we are long ZG. 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.

Additional disclosure: This article is intended to provide educational information to readers and in no way constitutes investment advice. Investing in public securities is speculative and involves risk, including possible loss of principal. The reader of this article must determine whether or not any investments mentioned in this article are suitable for their portfolio, risk tolerance, and accepts responsibility for their decisions. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer or a recommendation to buy, sell, or dispose of any investment or to provide any investment advice or service. An opinion in this article can change at any time without notice.