Zillow: Short Term Challenges, Long Term Opportunities

  • Zillow agreed to acquire Trulia in a $3.5B deal that should create an online real estate giant that controls around 60% of the market.
  • With only 6% of the real estate advertising originating on the digital players, the online real estate market withholds a massive growth opportunity.
  • News Corp acquired Move for almost $1B in cash in order to use its media network and seize the growth opportunity in the online real estate market.
  • Zillow faces not only increased competition but also a possible examination from the FTC that may impact the stock price in the short term.
zillow_cover

Online real estate portal, Zillow (NASDAQ:Z), will report its Q3 2014 earnings at the beginning of November, in light of the latest developments in the online real estate market. Zillow has the biggest number of monthly unique visitors among the US real estate websites and dominates 48% of that market, as shown in chart 1 below.

US real estate websites market share of unique visitors

Unique visitors US real estate pie chart

The online real estate market is highly centralized with three major players controlling 75% of the market (by total unique visitors) and twelve other small players that have a combined market share of 25%. The already centralized online real estate market is about to get more centralized, as Zillow announced at the end of July that it had agreed to acquire Trulia (TRLA) for $3.5 billion in stock. The Zillow-Trulia merger will create a real estate media giant with combined revenues of $341 million and 60% market domination, leaving the other 13 smaller players to compete over the remaining 40% of the market. The deal had an immediate impact on Zillow’s stock price, which spiked 26% in two days. However, the rise in stock price changed quickly to a decline fueled by Barron´s Sell rating.

Zillow stock price movement

Zillow stock_performance
Source: Zillow stock price chart by Amigobulls

Zillow and Trulia are expected to share their real estate and users’ data once the deal is finalized and to create a better advertising platform than currently available in the real estate market. Moreover, Zillow’s CEO, Spencer Rascoff, estimated that the merged company will save around $100 million by 2016 as a result of the synergies between Zillow and Trulia. The merger’s cost-saving is crucial to the profitability of the new business since Trulia and Zillow have more than $340 million in operating expenses and around the same amount in annual revenues.

As it seemed that the Zillow-Trulia merged company would take over the entire online real estate market, News Corp (NASDAQ:NWSA) announced it had agreed to acquire the third largest player in the market, Move (NASDAQ:MOVE), for $950 million in cash, which represents a 37% premium to Move’s stock price.

Rascoff estimates that the real estate market spends $12 billion on marketing each year, but only a fraction of that goes to the real estate websites. With Zillow-Trulia’s combined annual revenues of $340 million and Move’s annual revenues of $227 million, the online real estate advertising market accounts for only 6% of total real estate advertising revenues. A small percentage of the digital penetration in the real estate advertising not only represents the old-fashioned manner of the market but also highlights the possible opportunity this market holds.

Media giant News Corp sees the opportunity in the market and could leverage its Move acquisition through its own extensive network of digital information services, newspapers, cable stations, and professional financial information providers, thereby increasing the market share of its digital real estate acquisition. For Move, this is an excellent opportunity to use News Corp’s media network and deep pockets to fight back against the merged Zillow-Trulia company and increase market share, which otherwise (without being acquired by News Corp) could have been almost impossible.

Zillow faces a new competitive challenge from the News Corp-Move deal as well as regulatory challenges from the Federal Trade Commission (FTC) regarding the Trulia acquisition. In light of concerns raised by real estate professionals that the Zillow-Trulia merger will have an adverse impact on advertising fees in the real estate sector, the FTC requested additional information from both Zillow and Trulia that may lead to further investigation by the authorities. As the deal closing is expected only in 2015, the progress of the FTC examination will have a direct impact on Zillow’s stock throughout that period.

Conclusions

With the Trulia acquisition agreement pending FTC approval and increased competition from Move, Zillow is a risky short term investment opportunity. Zillow’s stock is in a downward trend and has already dropped 33% from the July highs. The upcoming earnings report of Zillow, Trulia, and Move will have a short-term impact on Zillow’s stock price as well as any progress with the FTC examination. However, in the longer term, the two companies could start merging once the Trulia acquisition deal is finalized, shedding off unnecessary overlapping activities between them. The increased efficiency between the two companies should result in a lean and efficient operation with lower operating expenses. Together with the market’s growth opportunity from attracting new real estate professionals to advertise online, Zillow should experience an improved profitability in the long-term.

Disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer's opinion about the companies mentioned in the article. Investors should conduct their own due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro Financial Consulting and Analysis are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.

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