Zillow Group, Inc. (NASDAQ:Z) is the number one online real estate portal in the U.S.A. 67% of U.S. home buyers use one of their services, and their monthly unique users figure was 211 million in Q1. The company’s stock price has been butchered, falling 80% from all time highs of ~$202 in February 2021.
This decline was driven by a few factors (interest rates, housing cycle), but the most damaging was the company’s decision to wind down their Zillow Offers business, after their models failed to predict housing prices. This was a bloody and red-faced moment for Zillow, as they slashed their workforce by 25% and wrote down ~$300 million. In the words of their veteran tech founder & CEO Rich Barton “We swung for the fences and missed.”
The good news for Zillow is that, by Q421, they had already reached an agreement to sell 50% of the homes, and the wind down is progressing faster than expected. The company now has a prime opportunity to refocus the business on a capital-light, pure online business model. They plan to attack the $300B real estate transaction market, as only ~3% of transactions are currently done through the platform.
Zillow aims to generate $5 billion by 2025, and the company has plans to create a “Super App” for home buying. Given this renewed focus, margins are expected to climb, and dominance is set to continue. The stock is currently undervalued both intrinsically and relative to historic multiples. Thus, I believe this could be a great long-term opportunity to invest in the U.S. housing market leader.
Online Business Model
Zillow’s new business model aims to refocus the company on its core online transaction platform. This is a capital-light business, which is easily scalable and has high margins, and unlike their former iBuying segment, which is capital intensive and was out of their circle of competence.
Zillow’s platforms (which include Trulia and Hotpads) still dominate the U.S. online housing market, with 67% of US home buyers using one of their services. They had 211 million monthly unique users in Q1, down 5% year over year due to low inventory and the cyclical housing market decline. However, website visits reached a staggering 2.6 billion, up 5% year over year. According to CEO Barton, “New for sale listings were down year over year, but our average page views per listing were at a record high.” This is just part of the general housing cycle in my eyes, but shows demand is still strong.
Zillow’s new strategy will focus on easy to implement “mid funnel” efforts to increase engagement, transactions and revenue per transaction. They aim to focus on five growth pillars which include:
- Seller Servivers;
- Enhancing Partner Network;
- Integrating Services.
The company has already made great progress in these areas. Their 3D home tour technology brings together previously disjointed information such as floor plans and building plans into a seamless experience. With the increasing popularity of Virtual Reality (VR) and the Metaverse, these experiences are set to become more interactive.
Zillow has also integrated ShowingTime, a platform which they acquired for $500 million in 2021. This enabled viewers to quickly see available viewing times and book showings.
They also plan to launch StreetScape this summer, a new feature which uses augmented reality to overlay StreetEasy data and listings into a home shopper’s physical space on the streets of the city. The idea of this is to cater to the way New Yorkers shop for real estate, as ~79% of residents pull up listings when walking through the city.
All these features are nice, but the real opportunity is the $300B real estate transaction market. 67% of US home buyers use Zillow today, but only ~3% of buyer and seller transactions were captured in 2021. This is a major opportunity, as the real estate transaction market is notoriously fragmented. Thus, capturing this in one app would solve a major problem for people.
The company also has other large total addressable markets (“TAMs”) to attack, such as the Home Insurance Market ($119B), Moving ($18B) and Appraisal ($9B). This is all part of the larger $2 trillion real estate market.
The ultimate goal for Zillow is to create a “Super App” which can help buyers and sellers with the end to end property process. The company’s dominant top of funnel position and “mid funnel” opportunity is forecasted to generate them $5 billion in revenue by 2025.
The CEO and co-founder Rich Barton started the company 16 years ago. He stated in an earnings call he still remembers buying the domain name “Zillow.com.” Barton is an experienced veteran in running online businesses, as the founder of Expedia and Glassdoor, and is also on the board of Netflix (NFLX). Insiders own 9.11% of shares, up from 8.93% of shares in Q321. With Barton owning around 4.19% of those shares, he thus has “Skin in the Game,” which is great to see.
Before, I dive into the most recent earnings, here is some context. Zillow’s overall revenue has increased by 57% since 2018, while their IMT adjusted EBITDA is up 255% since 2018. For Q1, revenue came in at $4.3 billion, which was up 250% year over year.
Now before you get excited, remember this is mainly from the home buying segment, and thus that number is skewed. Moving forward, the business will be mostly focused on it’s IMT (Internet, Media & Technology) segment, which generated revenue of $490 million, up 10% YoY. But growth did slow down from the 14% seen in Q4. This was mainly due to a housing market slowdown, which I have explained in the “Risks” section further on.
Premier Agent revenue, which is the ad revenue from real estate agents, increased by 9% year over year. This also slowed down from the 13% YoY growth in Q4. Rental revenue came in at $61 million, which was a -5% year over year decline. This was driven by high occupancy rates and a slowdown in rental advertising.
The mortgages segment generated $46 million, which was a large -32% year over year decline. This was driven by rising interest rates and low housing inventory which was driving up housing costs & impacting affordability.
After stripping out the low margin iBuying business, Zillow’s adjusted EBITDA margins increased to 45%, up from 38% in FY2020. They generated $220 million in Adjusted EBITDA for Q1, up 21% YoY. This was higher than expected thanks to higher resale prices for their homes segment.
Zillow still had 1,300 homes in Inventory at the end of the quarter, It has entered into agreements to sell most of these homes, with ~100 homes not under contract to be sold yet. They expect the sale of the majority of inventory to be complete by Q2 and have a small amount left in Q3. They now estimate net losses of ~$300 million as of the end of Q1.
The company has issued bold targets of $5 billion in revenue by 2025, at an adjusted EBITDA margin of 45% or ~$2.25 billion.
Adjusted EBITDA doesn’t include stock based compensation, restructuring costs, income, and more (full details on Page 11 of their investor presentation).
Zillow has cash position $3.6 billion in cash and investments, which is an increase of $500 million from the prior quarter and also includes the impact of $348 million in share repurchases during Q1. In terms of debt, they have $3.6 billion, which is manageable.
They also have $100 million remaining under their share buyback program, and their board has approved an additional, $1 billion share buyback. This shows management has confidence in the company and their “ironclad” balance sheet.
In order to value Zillow stock, I have plugged the latest financial data into my model, which uses the discounted cash flow method of valuation. As Zillow is currently going through a business model transition, valuing the business is not simple. To cover all bases, I have estimated the fair value in multiple ways but the same outcome was achieved on all. I haven’t included any “revenue” from the iBuying segment, as that side of the business is being wound down. This was large part Zillow’s prior revenue, but the margins were low on this segment.
Moving forward, I have estimated the IMT segment to drive approximately $2 billion in revenue for 2022 based up $490m achieved in Q122. Then I have added, approximately $200 million for the mortgages segment based on Q1 figures of $49 million, which was a substantial decline (32%) from the prior year, thus this is a conservative estimate. This gives me a “baseline” revenue for FY22 of $2.2billion (not including any home sale proceeds).
From this “baseline” I have forecasted revenue to grow by 10% per year for the next 5 years, which is inline with the prior segment growth for IMT at 10%. After 5 years, I am conservatively predicting the revenue growth rate to steadily decline to a 2% terminal rate after year 10.
As this is a higher margin business segment, I have forecast the operating margin to expand substantially to 35% in the next 5 years.
Given these factors, I get a fair value of $60/share. The stock is currently trading at $40/share, after a 7% single day pop recently.
Zillow is also trading at the lowest price to sales ratio (0.9) relative to historic levels (8 to 10), although this figure may be slightly skewed from the recent home-selling revenue. As for PS (forward) ratio = 1.5, this is also lower than historical metrics, but still higher than competitors Redfin (RDFN) = 0.4 and Opendoor (OPEN) = 0.2. I believe this slightly higher valuation than competitors is due to the company’s market leading position and higher margins than Opendoor, which is operating with the risky “iBuying model.”
My previous post on Zillow stock went into further details on Zillow peers. In addition, I wrote a section on Rightmove (LON:RMV) the “Zillow of the UK.” They have a virtual monopoly on the UK real estate market, but have played it safe and not innovated much when compared to Zillow. However, they are immensely profitable and trade at a staggering 74% Operating Margin (not adjusted EBITDA). They also trade at a very high price to sales ratio = 16.
The market cap for Rightmove is $4.7 Billion, while the UK population is 67 million. Zillow has a market cap of $9.9 billion, while the U.S. population is 4.7 times larger at 329 million. Now, although this is an extremely rough indication of value. I think it does act as a “proof of concept” for Zillow to create an extremely high margin business moving forward.
Cyclical Housing Market
The housing market is notoriously cyclical with boom-bust cycles being common place. Zillow CEO Barton stated in the recent earnings call that inventory was down 23% year-over-year, and new for-sale listings were down 9% YoY. Simultaneously, higher page views per listing were at a record high in Q1, which has created a supply and demand imbalance which has drove house prices up. If we combine this with rising interest rates, then affordability is affected for the home buyer.
Freddie Mac forecasts housing demand to cool down from a strong 2020 and 2021. Home sales were ~7.1 million in 2021 and are expected to decrease to 6.9 million in 2022. Then they expect sales to pickup to again in 2023, coming in at 7 million.
Rising Interest Rates
Morgan Stanley predicts at least 6 interest rate hikes in 2022, as the Fed tries to curb the high inflation numbers. High inflation creates higher living costs and higher interest rates affect affordability. These forces combine to cause lower demand for housing, and thus Freddie Mac predicts growth to decrease from 15.9% in 2021 to 6.2% in 2022 and 2.5% in 2023.
This is not great news for Zillow over the next 2 to 3 years, but as they continually improve their platform, they will be ready to ride the next wave in housing demand. In addition, high inflation increases building material costs, and thus Zillow’s exit from the low margin iBuying business has come at an opportune time. They have also managed to agree to a sale of the majority of their homes at the top of the housing market.
Insider selling can often be an extra signal to indicate management’s view of a business. It should be noted in February 2022, the Chief Investment Officer and a Director have sold a substantial portion of shares. Now, although people can sell for a variety of reasons, i would personally like to see more insider buying. The good news is that, in the past 6 months, there have been more insider purchases (435,644) shares vs insider sales (127,533).
Zillow is still dominant housing portal in the USA. Their recent foray into iBuying proved to be a disaster, but now they are picking up the pieces and refocusing on their core business. CEO Rich Barton is an experienced founder and tech veteran, he has been open, honest and candid about the situation. They “swung for the fences and missed.”
Moving forward, they have been proactive and are refocusing on the company’s core online business, which is capital light and has higher margins. Personally, I think this is the smartest strategy long term, and the large $300B real estate transaction market is up for grabs.
The company is undervalued intrinsically and thus represents a great long term buying opportunity. However, be aware this is still a “growth stock” in that the majority of their future revenues will need to come from their new initiatives. The cyclicality of the housing market and rising interest rate environment will be a headwind moving forward. The wind down of Zillow Offers is expected to be complete by Q2/Q3, and thus I expect the stock to remain depressed in the short term. But long term, this looks like a great opportunity to own the market leader in online real estate.