The Case for Owning Zillow
On the cusp of turning its first profit, the housing site has real value and a foothold in an important Web space.
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How has the business changed since 2006? From the MD&A section of the S-1:
- In November 2007, its launched its listings feed program, allowing real estate brokerages to feed their listings directly to Zillow.
- In April 2008, it enabled mortgage lenders to show mortgage quotes directly on the site, and by January 2010 was charging for that ability.
- In October 2008, it launched its Premier Agent program, which now has over 10,000 paying subscribers (more on this in a bit).
- In December 2009, it began showing rental listings, and in March 2011 began showing estimates for rent values.
- In December 2010, it began collecting and displaying consumer-generated real estate agent ratings and reviews.
Who are the folks behind Zillow? The current CEO in 1999 co-founded Hotwire, one of the early travel websites. The co-founder and executive chairman founded Expedia (EXPE) as a unit within Microsoft (MSFT) in 1994, and served as Expedia's CEO when it spun out of Microsoft in 1999. The vice chairman and CTO were also part of the original Expedia team. These aren't folks who caught lightning in a bottle in a dorm room, or who scribbled a joke on a napkin which led to a money-losing daily deals site. They survived both the dot-com bust and the housing bust and run a company that is disrupting the housing industry and has grown over 50% a year during a housing collapse.
How does Zillow make money? Two ways. First, there's good old-fashioned advertising (display revenues). Second, it allows real estate agents to purchase subscriptions that allow them to connect with individuals interested in buying a house, and also has a similar service for mortgage lenders looking to do the same (marketplace revenues). Display revenues are doing well, and grew 26% YoY in Q1, but it's the marketplace revenues that are really compelling, as they grew 271% YoY. Marketplace revenues have gone from 17% of revenues to 61% of revenues over the past two years.
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In the race to build what Professor Pinch and I have dubbed the "data economy," Zillow is the leader of the housing industry the same way LinkedIn (LNKD) is the leader of the employment industry. And the way the leaders of the data economy work is that it takes them years to build out their data presence, often with very little revenue, followed by a period of explosive revenue growth as they become able to monetize the value of their data networks, creating a virtuous feedback loop.
As the chart below shows (again, apologies for the size), Zillow is growing revenue much faster than its costs, with revenue up 111% YoY and costs up 49% YoY in Q1. It's on the cusp of profitability heading into its Q2 results, which has been its seasonally strongest quarter. In Q2 2009 revenues grew 64% sequentially while costs grew 6% sequentially. In Q2 2010 revenues and costs grew 38% and 14%. If Q2 2011 mirrors Q2 2010, with revenues growing 38% sequentially and costs growing 14%, it will turn its first profit.
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Valuation, of course, is what we care about. Some have said, "There are no bad assets, only bad prices." The opposite is true. Trailing 12-month revenues are $36.4 million. We're now through July and Zillow hasn't reported Q2 results yet, so if we want to assume Q2 revenues of $14 million, then trailing 12-month revenues are roughly $43 million. With around 27 million shares outstanding and a price of $32.22 per share it's got a market cap of $867 million, so we can say it's trading at roughly 20 times sales. Making some assumptions about LinkedIn's Q2 results, LinkedIn trades at something like 27 times sales. OpenTable (OPEN), which grew revenues 59% YoY in Q1, trades at 13.5 times sales. It's really hard to find good comps for companies growing revenues this quickly.
I look at the valuation of Zillow in two ways. One, I believe in the product and as a business I think it's a "platform" the way Google (GOOG) or Amazon (AMZN) or Facebook or LinkedIn is. So I do think the growth is sustainable for years. Even in the worst housing market since the Great Depression the value of residential real estate transactions is still $1 trillion a year. With just $36 million in revenues over the past 12 months, I see no reason why a company like Zillow can't eventually capture many billions of dollars a year in revenue as it improves its product, gains share, and adds new revenue lines. Second, I look at it as a strategic Web asset the way the United States and Soviet Union might have carved up the world map 40 years ago. With tech companies flush with cash and looking to solidify their standing on the Web, there are plenty of reasons why companies like Google ($37 billion in cash) or Microsoft ($50 billion in cash) would want to snap up Zillow for a few billion dollars.
The caveats are twofold. First, like any growth company lacking a proven track record, there's no reason why the market couldn't say it's only worth 10-15 times sales instead of 20. I own the stock knowing it could easily drop 30% over the next month. Second, it's got a minuscule float of 3.5 million shares. At current prices the total value of all publicly traded shares for the company is $110 million. It's a terrible trading vehicle, with bid/offer spreads often exceeding $0.20. Hedge funds have no ability to trade the name at its current level of liquidity, making it a plaything for the StockTwits crowd. I am uncomfortable with the fact that a few people acting on this piece could move the stock a few dollars, so as always do your own research first.
That being said, I think management knows what it's doing, I love the data economy theme, and a housing recovery sometime down the road will act as a tailwind going forward. I own it hoping that it'll be a $5 billion company in five years.
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