Description

We have been following the online real estate industry since Zillow ipo’ed in 2011.  We wrote up Realor.com (MOVE) on VIC back in 2013 on the long side but have had a short bias towards Zillow ever since they entered the iBuying business in 2018.  This isn’t the forum to debate iBuying, the recent Opendoor writeup covers that well, but prior to announcing their exit from the business in November of 2021 it’s pretty fair to say that Zillow’s shareholder base and sell side contingents were die hard fans.  The subsequent 50% move down in the stock has created a great opportunity to buy the marquee property in online real estate, we think the stock can more than double from here, but first it’s important to quickly highlight why the opportunity exists:

• Massive business pivot

• Despite claiming to be fully committed to iBuying on their Q2 call mgmt announced a full unwind on their Q3 call, despite the controversy surrounding house flipping the shareholder base was highly supportive of the strategy

• Our back of the envelope math shows they will have burnt about $1.5B of cash trying to get this off the ground, not ideal

• Clearly this all brings trust in mgmt front and center

• Risk of being stuck with inventory that was mediocre to begin with causing greater financial damage than anticipated (higher interest expense, bigger mark downs)

• Fears around maturity and margin sustainability of their core IMT business

• Current tech rout bringing down all boats

So, from a 1000 foot view, what are we left with in 2023 pro forma for the unwind?

• The most dominant web portal in the US, which attracts double the eyeballs of the #2 player Realtor.com

• A core IMT lead gen/ad business that should grow low double digits from here

• Pro forma valuation of 13x EBITDA/5x Sales/20x EPS vs international competitors that trade at 22-25x EBITDA/15x sales/40x EPS

• Pro forma for their Homes portfolio unwind they will have between $7.00-$10.00 of net cash on their balance sheet 

• A $750m buyback, which may just be the beginning of their capital deployment program

Addressing the two main bear points, inventory unwind and maturity of the core business:

• Inventory

• To begin with, they have already sold ½ their inventory at cash flow breakeven, we spoke w/mgmt and the unwind has been an even mix of geographies/price points/buyer type/etc, ie–it wasn’t a cherry picked batch that a few institutional investors took down

• This shouldn’t be shocking, right now housing inventory is at historical lows and this bodes well for winding down the rest of the book, this is the chart from 2000 to present 

• Core business maturity

• A core bear point has always been maturity of the IMT business, even before they stopped disclosing agent count the number was flat/down, so the growth has been coming from ARPU.  Now, a few things have been influencing that, namely the industry shift towards “teams” vs solo agents, but it still makes it easy to pick on.

• We looked at IMT revenue vs US housing GMV (price * units) since 2015 to try to gauge whether Zillow’s claim that it’s only involved in a MSD % of housing transactions and is taking share to the tune of 50bps/year is directionally accurate.  To us, this indicates that despite maturity fears the business has continued to grow above market rates throughout the cycle

How does this resolve higher from here:

• Q4 earnings on 2/10 where we will get an update on the iBuying unwind

• Further clarity on core business margins as the iBuying business burns off allows more value oriented investors to have a better picture of what the pro forma entity looks like

• Stock re-rating based on

• Deep discount to comps

• Further deployment of cash balance

• A takeout….all the big guys (GOOG, FB, etc) have tried and failed in the housing ad business

• Our target is $103, or 25x EBITDA, inline with RightMove and REA Group

Risks

• The housing cycle imploding as rates move higher (short OPEN as a hedge in that case)

• Rich finds a new way to lose money instead of organically growing the golden goose 

Catalyst

-unwind updates

-clarity in Zillow 3.0