In a Dismal Environment, Zillow Reports Profits in First Earnings Report Since IPO

• More homes covered, better estimates: Zillow now provides "Zestimates" for an additional 25 million homes, for 100 million total, nearly all homes in the United States. A new algorithm which incorporates user-provided data for 29 million homes has improved Zestimate accuracy by 33%, to within 8.5% for the median home, and within 6% in key markets like Washington, DC, Denver, and San Diego. Zillow's service is becoming more and more useful, and more and more difficult for a competitor to replicate.
  
  
• Average monthly unique users rose 93% YoY to a record 20.8 million. July accelerated from that, to 23.2 million users, up 98% YoY.
  
  
• Thanks to IPO proceeds, Zillow now has $96 million in pro forma cash and no debt, which at a price of $27 represents 13% of its market cap, and a huge war chest for growth and acquisition opportunities.
  
  
• The total market for local real estate advertising is $6 billion across roughly 1 million real estate agents. Zillow's trailing 12-month revenues of $45 million and 13,400 paying real estate agents represents roughly 1% market penetration.
  
  
• They are not housing permabulls -- after all, they've got the best housing database in the world. They're not looking for home prices to bottom until 2012.

Guidance/Forecast:

Zillow laid out Q3 guidance for revenues of $16-17 million, and for the full year $59-61 million. This has sandbagging written all over it.

Zillow breaks its revenues down into two buckets, marketplace revenues (real estate agents purchasing ads for listings, as well as their mortgage marketplace offering), and display revenues (traditional advertising). Display revenues have shown pretty consistent seasonality and growth over the past couple of years rising roughly 35% in Q2 and dropping a bit sequentially in other quarters. If we model a slight drop in display in Q3 then to get to $16.5 million in overall revenues we'd need to see marketplace revenues grow just 9% sequentially. For reference, marketplace revenues have grown 31% sequentially per quarter over the past nine quarters, including 41% in the most recent quarter. Additionally, in Q3 2009 overall revenues grew 23% sequentially and in Q3 2010 they grew 12% sequentially. Midline guidance of $16.5 million implies 4% sequential growth. Adjusting marketplace revenue sequential growth to 20%, which may be a bit low given publicity benefits of the IPO (LinkedIn noted this in its Q2 results), leads to overall revenue growth of 11% instead to $17.6 million. I won't bore you with the details, but an adjustment following a similar line of reasoning gets you to full-year revenues of $63 million, up 107% YoY, which is probably a reasonable base line with room for upside up to $68 million.

Valuation:

At Wednesday's closing price of $26.26 Zillow has a market cap of $708 million, of which $96 million is cash. On a price/sales basis it's currently at 15.7x, and using a FY11 revenue estimate of $63 million trades at 11.2x, and if you want to strip out the cash it's more like 9.7x. For comparison, OpenTable (OPEN), growing about half the rate of Z, has a price/sales ratio of 12.4x. LNKD, growing about as fast as Z, trades at 19.9x. Skype, a much slower grower, sold to Microsoft (MSFT) for 10x. As late as 2006 Google (GOOG), eBay (EBAY), and Yahoo (YHOO) all traded at price/sales ratios north of 10x.

Valuing growth companies is way more art (some would say guessing) than science. You have to make a lot of assumptions about revenue growth, profit margins, the likelihood and threat of competition, and a whole host of other variables. When it comes to the Internet, I like platforms with valuable user-generated and algorithmic data that are difficult to crack and hard to imitate. I like Zillow and LinkedIn but not Groupon, Pandora (P), or Shutterfly (SFLY).

Zillow and LinkedIn are both market leaders in their sectors, are disrupting old business models, growing over 100%/year, and should have sustainable and high profit margins (on its earnings call Zillow said Q2 EBITDA margins were 24% and should trend towards 30-35% over time). I would value both at 25x trailing 12 month revenues, 20x FY11 revenues, and 15x FY12 revenues. If I think Zillow can do $65 million in revenues in 2011 and grow 70% in 2012, that puts 2012 revenues at $110 million, its market cap at $1.65 billion (15x $110 million), and the stock at $61. Sounds outrageous to be calling for an Internet housing growth stock to rally 130% in 16 months in this environment, but that's my target.

Twitter: @conorsen