Description

 

Summary & Background

 

Rightmove is the leading online real estate portal in the UK.  The Company charges real estate agents fixed fee per office per month to advertise properties on its website. Rightmove was founded in 2000 by England’s largest estate agencies –Countrywide, Connells and Halifax who are also its largest customers. Rightmove has  #1 market share—nine out of 10 homes for sale in the UK are advertised on its website. The Company enjoys close to 90% penetration of estate agents, 80% penetration of lettings only offices and 50% penetration of new home developers.  Some of the characteristics which I believe make Rightmove an attractive investment are:

 

§         Defensible, cash generative business model, which benefits from ongoing shift in advertising spend from newspapers to online advertising, while not directly impacted by the volume of real estate transactions

§         Substantial pricing power—since it first started charging for services in 2003, the Company raised prices every single year for 4 consecutive years  

§         Cash rich balance sheet, with some of the cash returned to investors through dividends and share buybacks 

§         Attractive valuation—currently trades at 7.5x 2008E EBITA and 11x  2008E earnings per share

 

Market Overview

 

England has one of the largest residential property markets in the developed world, with an average of 1.3m transactions being completed each year, and an average of 2.2m properties being marketed each year (estimated by the Company). RMV believes there are approximately 14,000 estate agencies in the UK, 3,000 rental businesses and 7,750 new home developments being actively marketed at any one time.

 

UK property advertising market was about £630 m in 2006 with ~88% of the market still dominated by regional and national newspapers and the balance divided between online portals, TV, radio and outdoor advertising. Internet is poised to take a larger share of advertising pie going forward and RMV is well positioned to capitalize on it. In 2006 33% of people who bought a house first saw it on the Internet compared to 14% who first saw it in the newspaper.  ¾ of people who bought a house in 2006 used internet as part of their search; out of those 82% used Rightmove. 

 

Unlike US and Canada, there are no free MLS services in the UK, so estate agents have to advertise either in newspapers, or on RMV or their own web sites. There are free aggregator sites like Globrix and Dothomes but they have minimum penetration and therefore do not pose any sort of credible threat to RMV. To increase their penetration those players would have to invest heavily to attract traffic to their sites which would be questionable strategy given RMV market dominance. Another key difference between US and UK market is that in the US both buyer and seller are typically represented by an agent and they split commissions. In the UK estate agent represents sellers only and buyer hunts for the property himself.  That’s why agents target property buyers directly, not other estate agents. 

 

Pricing Structure

 

As of January, 2008 the Company offered the following pricing structure:

 

·        Estate agents

 The company charges £250/office/month plus £50 if also displaying rental properties.

For new estate agents or customers who have joined since July 2007, Rightmove charges £325/office/month plus £75 if also displaying rental properties.

 

·        New home developments

The company charges £290/development/month for up to four developments, with various discounts down to £230/development/month if advertising more than 200 developments. For new developers or those who have joined since July 2007, Rightmove charges £450/month/development for up to four developments, or £270/development/month for those advertising more than 200 developments.

 

·        Overseas homes rental  

The company charges £250/month for each overseas customer although this can be higher for agents advertising a large number of properties.

 

·        Lettings-only agents

The company charges £125/rental office/month. For new rental agents or those who have joined Rightmove since July 2006, the company charges £150/office/month.

 

The above pricing structure translates into average ARPA (Average Revenue per Advertiser) of £259 per office per month, up from £192 in 2006 and £157 in 2005. The reason average ARPA may seem lower than above figures suggest is because older customers are locked into long term contracts with lower fees.

 

Investment Thesis

 

The stock is down from £5.00 in April to £2.90 currently primarily on concerns over the UK housing market. The UK market is undergoing substantial contraction with transaction volume anticipated to decline by at least 30% and possibly as much as 50% from a typical yearly volume of 1.3 m.  This will likely drive marginal estate agents and home developers out of business. In fact, my forecast (discussed in more detail below) assumes declines of  3,000 and 1,100 estate agents (on a base of 14,000) and 1,100 and 1,600 new home developments (on a base of 7,750) for 2008 and 2009 respectively. However, despite (or because of) this difficult environment, RMV will continue to gain market share. Why? Because it will capture it from newspapers and other portals. It is estimated that average estate office spends £30,000-£35,000 per annum in advertising, with most of it going to regional newspapers. At roughly £3,100 per year, RMV is still about 10% of that. There is no question that web advertising gives agent much more “bang for the buck”. Local newspapers are expensive, and this downturn is an opportunity for agents to move away from them and use more efficient advertising media.

 What about other sites?  RMV, with more than 1 million homes listed for sale or rent, is the market leader, followed by Findaproperty.com  and Primelocation.com with more than 400,000 each, Propertyfinder.com with 280,000 and a long tail of smaller sites. A look at number of listings alone is somewhat misleading -- if market share is measured by clicks that generate inquiries (which is what estate agents really care about) Rightmove has 79%, Primelocation—10%, Findaproperty—6% and Propertyfinder—5%. Due diligence calls confirmed that estate agencies advertised on multiple sites when “times were good” in order to enhance their brand recognition but this is unlikely to continue in a tough market when they watch every penny. In fact, some of the competitors started price cutting already in order to entice agents to keep the listings with them. Rightmove, on the other hand, did not feel the need to do that.  It may not raise prices outright in 2009 but experiment with bundling products instead to give customers more perceived “value”. Last year the Company introduced its Choice product range—essentially a tool for agents to brand themselves on the site. Now when estate agent spends £200 per month on Choice products, they get add’l £200 worth of advertising for free as well as a guaranteed price freeze for the next 12 months. Of course, by encouraging an agent to purchase £200 worth of Choice the Company just raised this customer’s ARPA from £325 to £525 per month with very little incremental cost.

Management believes that in 5 years online will represent 50% of the total spend of £600 m and the Company will capture 80% of that, which translates into £240 m annual revenue opportunity. Assuming RMV has 20,000 subs by then (up from  est. 18,000 in 2008 which accounts for estate agents and developers going out of business discussed above) it means that average subscriber should spend £1,000 per month with the Company.  This may be aggressive but is not needed to generate a respectable return—my forecast assumes RMV reaches annual revenue of £105 m in 2012 with average ARPA per sub per month of £427. So even if total advertising pie shrinks to £400 m, RMV share would only be slightly more than 25% of the total, which I regard as fairly conservative.

 

 

Financial Metrics / Valuation / Target Price

 

At £2.90 per share, and 111.2 m shares outstanding (after recent buybacks) market cap is £323 m, which equals TEV as well since modest net cash amount of £12 m was spent on recent share buybacks. This represents 8.1x 2008E EBITA of £43.6 m and 11.2x estimated 2008 EPS of £0.25. With projected dividend of £0.12 per share in 2009, the stock offers 4% dividend yield.

 

Expect total revenues to grow at 10% CAGR over the next 5 years and reach £105 m in 2012 (driven by increase in ARPA and very modest penetration growth) and operating margins to expand by 200 bps from 60.0% in 2008 to 62% in 2012 due to effect of scale and operating leverage. Since the business is essentially working capital neutral and requires only a modest capital investment (estimated to be £10.5 m over the next 5 years) this should translate into free cash generation of £170 m between 2008 and 2012. Substantially all of it should be returned to shareholders in the form of dividends and share buybacks (management indicated it will utilize additional £40 m credit facility to fund buybacks).

 

Target price is £5.60 per share represents 12.5x estimated 2012 earnings of £0.44 per share plus £0.10 per share in excess cash. This results in an IRR of 22% over 5 years or cash-on-cash return of 130% (from exit price of £5.60 and dividend stream of about  £1.07 per share over the next 5 years)

Catalyst

Accelearting transition to cheaper and more efficient online advertsing media and away from newspapers

Likely demise of secondary online portals such as Primelocation and Propertyfinder, leading to the stronger competitve position of RMV