Monday, May 11, 2015

Zillow deserves a higher valuation than $100

As the housing market shows signs of revival, perhaps due to jobs or low rates, the biggest bargain is not in home builders, probably not in housing-related services such as HD/LOWS, but in the newly enlarged and dominant online real estate information site Zillow (Z).

Suntrust has come out today to upgrade the stock from neutral to buy and raised its target from 110 to 130. It listed six key positives:

1) Secular shift – growing trend of researching and discovering properties online, enabled by greater information, data and attribution, esp. in the younger generations;

2) Mobile usage increasing – smaller brokers and MLSs will have a tough time justifying continued tech spending to keep up;

3) Dominant position – Z/Trulia combination creates a scale that is unmatched and creates a “must buy” for agent advertisers and a “must be on” for home sellers;

4) Strong ROI – we believe that as the better performing agents get more leads, conversion rate and ROIs will rise, creating significant pricing power for Z;

5) Optionality - around Rentals, mortgages, and digs are underappreciated;

6) Margin leverage – we think the margin profile is misunderstood and can approach levels >45%.

When the merger with Trulia was announced last July, the stock promptly jumped from 125 to over 160. But as the merger was finally completed with most potential in tact, the stock was punished to below 85 at one point on January 27. We couldn't resist and bought into it in a big way. As the stock recovered somewhat, the short interest rose to 50% of float according to Yahoo Finance. Short-covering can make this stock soar like any hot dot-com high flyer.

When Zillow reports tomorrow we'll have a chance to see how much progress it has made since the merger with Trulia in terms of numbers. It could still be a transition story, but as long as the six  points above are in tact, we should be unfazed by any short-term negative.

And then there is the threat of Realtor.com and Murdoch. But judging from the spectacular failure of MySpace, how much credibility would you give Murdoch this time?

(2/7/2016 Note)

The stock has dropped below $20 (or $60 before the share split into Z and ZG). This is very surprising development. For a completely different take on the Zillow story, see Barron's article:
Zillow Share Could Fall By Half.

Safalow believes that the real market for Zillow and its rivals is much smaller than their fans suppose. Residential real estate is an "80/20" business, where a small portion of the nation's 500,000 active real estate agents do enough business to justify advertising with Zillow. He thinks it could be 15% or less. With Zillow claiming more than 55,000 agents as advertisers and Trulia, more than 70,000, the two portals may be reaching saturation -- especially given the companies' assertion that their customer overlap is modest.

It has already fallen more than half from the $140 level. It looks cheap. But if we believe the story of agent saturation in the article, and given how internet stocks have been hammered in the market, we may very well see further weakness of the shares.

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