Description

Description

Thistle933 pitched Rightmove (RMV) in July 2008 in what was arguably one of the worst real estate environments in UK history. A fantastic write-up.

If you don’t know about RMV, I’d strongly recommend reading through it: Value Investors Club / Rightmove (RMV.LN). And if you are familiar with RMV, I’d strongly encourage you to read through it too: you’ll notice how little things have changed in the UK property market and in RMV’s business model, market position and more importantly, earnings power. There are very few businesses out there where you can say this with confidence after 15 years, but RMV is arguably one of the best businesses in the world.

Since Thistle933’s pitch, the stock has compounded at 22% annually even after a few dreadful recent years of underperformance.

Right until mid-October, RMV’s had compounded at 7.5% over the past five years. While better than its benchmark, this was below peers and what you’d expect from a dominant classifieds marketplace. Blame concerns about the UK property market.

Since mid-October, RMVs stock has fallen by 15%, taking the 5-year CAGR to 2.5%, subpar by any standards. Blame CoStar and its announced acquisition of OnTheMarket on 17^th October.

Higher interesting rates, cost-of-living concerns and macro woes are not great for the UK property market, but the downturn – as bad as it is for real estate agents and property developers – may not be as bad for RMV as implied by its stock performance up to mid-October.

And CoStar threats, while scary, are unlikely to cause the damage implied by the stock price move after the deal announcement. In fact, I doubt they’ll cause any damage at all!

In essence, at today’s price, you can buy an asset with a formidable moat at a ~5% 2023 FCF Yield that could grow at high single to low double digits in the next few years, for a potential low teens return in the next five years.

Preparing for the worst

RMVs revenues depend on the number of real estate and new housing developments paying for a subscription times the price of that subscription. Their pricing power arises from hard-to-replicate network effects: RMV is one of the most visited sites in the UK, with at least 2 monthly visits per capita, making it compulsory for real estate agents to advertise sale and rental properties on the site. In spite of a higher cost than alternative portals like Zoopla and OnTheMarket, RMV delivers high ROI for customers: more leads, more conversions.

Historically, RMV has been able to increase their annual subscription price by 13% CAGR since 2009. 

Here’s a good summary of the market and where RMV fits in:

Source: Various

New Homes represent a large investment (£244k average cost to build in 2022) that sits in homebuilders balance sheets for over a year typically. They have an interest in selling them as fast as possible to recycle capital; On the other hand, existing home sellers may or may not instruct agents depending on price expectations and their own personal circumstances (whether they have a mortgage and can they get a new one to move up the ladder, three Ds, etc). Worth considering is what a weak market may bring for RMV.

For reference, UK housing transactions peaked in 2007 at 1.6 million and then fell to 0.86 million in 2009. Still, the number of properties advertised on RMV INCREASED from 1.04 million in 2007 to 1.1 million in 2009. This makes sense: forced selling and repossessions accelerate in a declining property price environment.

In the 5 years to 2022, the number of UK housing transactions increased from 1.2 million in 2018 to 1.26 million, with a spectacular 1.5 million in 2021. Stamp duty holidays, low rates and the COVID craze all had an impact. Meanwhile, the number of properties advertised on RMV DECREASED, from 1 million in 2018 to 0.74 million. Again, this makes sense: houses were selling like hot cakes, so why bother uploading each new instruction to RMV.

The opposite should happen in a weaker market as agents revert to their most reliable source of leads: RMV’s share of all minutes spend on property portals in the UK is 86% and it receives well over 100 million visits per month via web and app. At least 95% of this traffic is free.

On average, there have been 150k new privately completed dwellings in the UK each year going back to the 1950s under different interest rate environments. 166k were completed in 2022. This translates into around 54 dwellings per site based on RMVs 3,082 New Home Developer sites throughout the year. Should completions fall to 2008-09 levels followed by a reversion to the historical mean over the next five years, you could expect ca. 2,700 New Home Developer sites advertising on RMV during the period. When times are tough, new homes take longer to sell, which means developers are/will keep their advertisings going for longer, this helps offset the lower number of advertisers.

Concerning agents, there were approx. 59 sale transactions per estate branch in 2022. In 2009, this figure was 48. As a departing message in his last annual results call in March 2023, former CEO Peter Brooks mentioned the estate agents three Ds: Divorce, Death and Debt. They drive transactions and are a reason why even in 2008 there were 900k housing transactions in the UK and 858k in 2009. He called this a natural floor. Since then, the total dwelling stock has increased by about 2.4 million, so I think you can consider a higher natural floor this time around. Still, assuming 48 closings per branch in a weak market gradually increasing back to the long-term average of 60, I can see RMV retaining ca. 15.4k branches on average in the next five years, compared to 15.9k at the end of 2022.

CoStar, Death Star?

For starters, competition is a constant in the UK online classifieds market. MickyS (Value Investors Club / OnTheMarket (OTMP)) presented a compelling case for OnTheMarket late last year that offers additional context on competition.

Here’s a summary of what Rightmove has fought against since inception:

• Boomin – launched in 2020, died in 2022 after burning through ~£70m of cash.
• OnTheMarket launched in January 2015
• Globrix, previously owned by DMGT, was sold in 2013 to Zoopla, who closed it. Zoopla became a larger competitor to RMV but as per RMVs 2012 annual report, its market share was unchanged regardless.
• DMGT operated Find A Property and Prime Location websites, then sold them to Zoopla in 2012, at the time privately owned by PE. In September 2012, Zoopla shut Find A Property down
• Google withdrew from the property advertising market at the start of 2011. Google had made it possible to see properties on their maps since early 2009 thanks to scraping of property portals websites. This was at the same time RMV partnered with Google to enable searching for properties on a map powered by Google. At times, the information offered was outdated and the user experience was poor and hard to monetize for Google.
• During 2011, RMV noticed that established competitors had increased their level of marketing activity but despite this, the gap between RMV and them had widened.
• “From its inception, Rightmove has experienced a regular flow of new property portal entrants, whether explicitly seeking to compete with us or not. They have exhibited a range of business models and frequently offer free advertising to agents. Those who attracted the most attention have failed to make any material impact on our market share and whilst we cannot rule out the appearance of a completely new entrant or business model, nothing we have seen to date gives us serious cause for concern” (2009 AR)
• “We believe that the tougher market conditions reinforce the view that the long-standing competitor property portals, all owned by larger media groups, represent the most tangible source of competition” (2008 AR)
• Competition has come from traditional media companies (print) who were in structural decline, as well as from new online media entrants: “Since the start of the year there has been no significant change in the competition from traditional media companies seeking to defend a threatened franchise and from potential new entrants to online media” (1H 2008)

From OnTheMarket’s prospectus:

Source: OTM IPO Prospectus

Looking at the list and chart above, you could argue that RMV has passed the “Buffett billion dollar test” (A Business State of Mind | Colossus® (joincolossus.com)), emerging unscathed from competitors picking multi-million-pound marketing fights with them. RMV will be tested once again soon.

On 17th October 2023, CoStar announced the acquisition of OnTheMarket, writing:

“CoStar Group intends to invest £46.5 million into sales and marketing in the first full year following the commencement of the integration of the portal into CoStar’s network of residential marketplaces. That amount represents six times OnTheMarket’s current annual media spend and more than three times the current annual media spend of Rightmove plc. The sales and marketing investment is the first stage of a multi-year investment program totaling hundreds of millions of pounds to drive more consumers to the OnTheMarket portal with the goal of significantly increasing the quantity of valuable leads to OnTheMarket’s agent clients."

And added, threateningly:

"CoStar Group has a track record of acquiring strong-performing property portals that are not the number one players and investing and building them into the most successful portals serving their market. CoStar Group acquired 5th place U.S. residential rental platform Apartments.com in 2014 and grew it to the number one player in the U.S. with revenue now approaching a billion dollars. CoStar Group recently acquired Homes.com, a 6th place residential property portal in the U.S. with 6 million unique visitors and turned it into the fastest growing U.S. residential portal with more than 100 million unique visitors in September of 20231. Homes.com is now the number two most trafficked residential marketplace in the U.S.”

A few days later, during their quarterly earnings call Q&A, CoStar expanded (apologies for the long transcript, but I think it’s relevant to my conclusion)

 “Q - Ryan Tomasello

Hi, everyone. Thanks for taking the questions. I guess, following up on the UK deal, Andy, obviously, OnTheMarket gives you a solid foothold in the UK specifically, but you also called out the optionality that that infrastructure brings you to expand the Homes brand across the European market more broadly. So just curious if you can elaborate on the strategic rationale of what a trans-European type residential portal brand, what synergies that could provide, what the strategy can look like from here in terms of perhaps participating in that consolidation wave that you're expecting across other portals perhaps in other countries? Just a finer point around what that could look like over the next several years. Thanks.

A - Andrew C. Florance

Sure. I mean, there's probably 80 portals operating in Europe, with a market cap very roughly because some are private, some are public, 30 billion plus. Some of them trade extremely high multiples, some of them trade at lower multiples. It's a very fragmented market and I do believe; I think there's two different camps. There's some camps that feel that technology does not play a meaningful role in the digitization of real estate and there's some people that think that technology will play a big role in the digitization of real estate.

We fall in the camp of thinking that technology is important and that having -- and that scale -- there'll be greater scale than individual countries over time and that fundamentally what these companies are doing is very similar. They're basically putting placards, maps, SEO strategy, SEM strategy, branding strategy. They're serving up digital twins, they're serving up videos. It's all very similar and there is the opportunity to differentiate one brand from another with technology. And so I believe there will be significant consolidation and there will be a little bit of a musical chairs occurring, and we are -- and there will be winners and losers in it, and we want to keep a careful eye on it. And I just would say that it reminds me very much of the United States maybe 10 years ago before a lot of consolidation occurred.

So I think it's an exciting opportunity. Again, the scale of the opportunity, both in the revenue potential in the $10 billion to $20 billion range and the market caps in the $30 billion plus, it's great to have a seat at the table and we believe that our technology is competitively advantaged in the market. And so, we're operating on that premise”

“A - Andrew C. Florance

Sure. I would just -- I don't know if I'll get that -- answer that in the proper order, but I would say that -- I wouldn't say that we're not interested in the number one asset in the market. We would be interested in the number one asset in the market. What we want to avoid is, we want to avoid overpaying materially for something. And one of the things we do when we look at a particular portal is we consider, if there are three portals in a market or four portals in a market, we will look at what the traffic is on the lead portal, the number two portal, number three, number four portal. We look at the potential cost or value, like acquisition costs of each of those portals and we'll also be mindful of how we can change the outcome.

So if we think that we can build traffic on a given portal up to the number one position, if we can take a portal from number four to number one, we can estimate the cost of what it takes to do that. And we know the cost of bringing the technology in. We balance that against the cost of buying the number one portal. And so if it's cheaper to build versus buy, we'll build, but build from the context of acquire and invest as opposed to acquire number one and try to hold that number one position.

So I think sometimes, you can do the calculation in various European markets and determine that it would be -- it would take you 60 years to get a payback relative to the cost of simply buying and building the traffic up. So you're looking for a better return. So we look at it through that lens, the value you get for the price you're paying. There is a mindset that you've heard that people believe that all of these 80 portals are set and locked in their stack rank and that there's no value to technology in any of these digital portals.

I think that's wrong. I think the positions will move and they always have moved. If you look at who was number one five years ago, it's different than who was number one seven years ago. So it's more dynamic than people appreciate and we just carefully are meeting some wonderful people in Europe, getting to know them, getting to know their companies, a lot of people we love to work with, but we want to make sure that our shareholders' dollar goes as far as possible and that we aren't -- that were optimizing the investments we're making”

“Q - Ella Smith

Understood. Thank you. And my follow-up question is around the market dynamics in the UK. So Rightmove has maintained a market dominant position in the UK for quite some time. And as we understand that many players have thought to disrupt Rightmove with marketing and digital investments, and they've largely failed. What do you think CoStar can do differently to disrupt the market despite the company's minimal presence in Europe currently?

A - Andrew C. Florance

Well, I tend not to assign godlike characteristics to mere companies. And when I see a 72% to 74% margin in a company with none of the major players actually materially investing in my view into significant marketing in the market, I think that the power of the technology we've developed with Homes.com and our experience in building traffic often against companies that have more traffic than we have when we begin, feel very comfortable we have something to bring to the table in the United Kingdom and that we can offer some real value in the market. I would flatly reject any concept that any company is impervious to competition, with the exception of a couple of the FAANGs”

RMV has taken a hit of ~£800m hit to its valuation since then, which suggests the market is concerned that this time, things will be different.

We don’t know how CoStar plans to spend the money. But there’s a recent example of an American company using a similar approach against Auto Trader in the UK that offers relevant insights for what’s to come.

CarGurus

In 2017, CarGurus’ CEO offered a justification for their investments in the UK:

“Third, we will grow internationally, as we continue to see the need for an unbiased transparent marketplace in countries around the world. In addition to the US, we currently operate in Canada, the UK. And Germany. And we have identified and are doing foundational work in other viable international markets.

It is important to note that the technology platform we have built is able to be quickly modified for use in countries outside of the US. Our financial strategy is to use the profits from our US business to fund our international investments. We believe that we have a significant opportunity to offer our disruptive value proposition on a global scale.” (Cargurus CEO - Q3 2017 Earnings Call)

This reads very similar to CoStar’s own ambitions.

Berenberg estimates CarGurus has invested ~$170m in their UK business since 2015. This level of investment and the fact that they managed to reach over 200k car listings on their site barely affected the time spent on Auto Trader’s properties:

Source: UBS

Although things got really nasty at the bottom end of the market:

Source: UBS

And CarGurus managed to make some progress, growing paying dealers to almost 3.8k with 8.2 million monthly unique visitors.

Source: Cargurus Investor Day 2019

To help with their quest, they bought PistonHeads in 2019 (they paid ~£15m, ca. 3.1x TTM sales and 11.5x TTM EBITDA, for EBITDA margins of around 28%). But as of September 2023, Auto Trader’s traffic is still 26x that of Cargurus/Pistonheads.

Cargurus’ last investor day presentation in May 2022 contained only three references to their International operations and the UK was mentioned once in three hours of presentation and Q&A, to say it was close to reaching profitability. CarGurus shut down their German, Italian and Spanish marketplaces in May 2020.

You could think that the pressure on Auto Trader, whose customers were in many cases getting CarGurus product for free, plus the money spent on traffic acquisition, would have forced Auto Trader to respond somehow. They did, but not the way you’d have expected: marketing spend DECLINED from 6% of revenue in 2015 to 5% in 2023 and their operating margin INCREASED from 52% to 70% in the same period. Their response was simply to continue investing in product development, in some cases copying the very good ideas proposed by CarGurus themselves.

RMVs starting op. margin is above 70% and for 2023, the company guided to 73% margins on the back of 8% ARPA growth (£100 absolute value) at their interim results.

CoStar appears to be making a similar mistake to CarGurus’: overestimating the power of Google in UK property search when the vast majority of searches are organic and directed at the #1 portal. Their comments suggest a serious underestimation of the power of network effects.

Even if CoStar could somehow make OnTheMarket a 10x better product than RMVs (difficult to see how, given how it does the job for UK property buyers and renters), all RMV has to do is copy those best features in response. Doing so enhances the offer to agents, who should still see higher ROI from paying RMVs higher subscriptions.

There would be no real need for RMV to match CoStar marketing push pound for pound, but rather a slight increase to let the UK property seekers they’re there as always would suffice.  

To conclude here, CoStar represents a real threat to RMV only to the extent it may lead to management mistakes. SeLoger, AutoScout and Autotrader (US) are examples of market leaders that lost their dominance because of management strategic mistakes: SeLoger didn’t match LeBonCoin’s private listings and lost prominence for not having whole-of-market view; AutoScout didn’t match Mobile free ads for individual sellers; Autotrader didn’t copy Cargurus’ relative pricing ranking for cars which improved the car buyer’s experience.

Unfortunately, RMV’s current board of directors lacks deep expertise in marketplaces, with only one member, Amit Tiwari, having direct involvement with the business model as an investor. New CEO Johan Svenstrom, however, is well versed with marketplaces both as an investor (partner in EQT) and as manager (former President of Hotels.com), so at a minimum he should be familiar with these three business cases to be able to shift strategy as needed. Investors should hear more about this in late November at the Capital Markets Day.

What else?

In the first half of 2023, RMV generated £17.5m of Other Revenues, of which £11m came from Commercial, Data Services and Mortgages. This was the first time they broke these revenue line down. They highlighted these three revenue lines as areas of focus going forward. At a £22m annualized clip, they represent less than 6% of total revenues, but are growing faster and according to management expectations, the market opportunities are large and growth should accelerate in coming years, delivering similar margins to the core business at scale.

Investments in mortgages (Mortgage-in-principle leads to lenders and brokers) and data services are expected to deliver accelerated growth and profit post 2025 after a £20m planned investment over three years starting in 2024. RMV has been slow to monetize data and traffic in different ways in the past, so the initiatives in these two areas are encouraging.

RMV is itself a challenger in UK commercial real estate, where CoStar’s Loopnet has a dominant presence and better data, making success an open question.

Watch out for (risks)

Property market – My base case is based on avg. of 15k agents and 2.8k new home development sites over the next few years. These numbers will be too high if housing transactions fall below 800k/year. 

RMV response to the CoStar threat: I would want them to increase marketing spend to capture the little share of Google traffic available; accelerate product development and copy any good features OTM comes up with. Not doing so would increase CoStar chances of success.

What to expect (valuation)

I’m counting on RMV responding to CoStar’s threat by doubling marketing spend from 4% to 8% of revenues over a three year period and reverting back to 4% after this. Product development investment increasing by a third to 8% of revenues and gradually declining after three years. Also, I’m modelling New Home Developments to fall to 2,2k in 2024 and recovering to around 3,000 in 2026; I’m modelling the agent count to decline by 1% in 2023, falling to 14,9k after 2026.

I apply a terminal multiple of 20x to my final cash flows. For context around this multiple I’d refer you to my VIC write-up on Auto Trader.

Also, I’d point out at Silver Lake’s acquisition of Zoopla in 2018 at 25x the business 2017’s EBITDA. Zoopla’s EBITDA margin as No2 in the market was 39%. Very good but materially below RMVs >70%s and even the 67% I would expect the business to realize after investments made to defend against CoStar.

Under this assumptions, the current share price is implying 0% ARPA growth going forward, which I think is beyond extreme considering their historical 13% annualized ARPA growth since 2009 and the most recent 7.3% CAGR between 2017-2022. Anything above 1% ARPA growth delivers IRRs in the double digits which I think is quite attractive for a business like RMV. I would expect ARPA of at least 5% going forward, for a mid-teens expected IRR.

Catalyst

CMD in late November offering clarity into the investment opportunity set, management’s approach to the CoStar threat and views on the UK’s property market prospects.

In recent days, an activist investor in OnTheMarket has sent letters to the company’s shareholder arguing for a negative vote on CoStar’s offer. While unlikely to succeed, a rejection of the offer would automatically simplify RMVs investment case.

Time and management delivery.