"Housing market" and "dot-com" are a few words that have made millions of investors cringe in pain over the past 10 years. But Zillow's (Nasdaq: Z ) online real estate model has been on a stock market tear since its IPO last year. Yesterday, Citron Research released a report that called Zillow's hype out as heresy. Let's take a look at Citron's claims, and decide for ourselves whether this company's growth is a goner.
Zillow takes massive amount of housing data (home prices, leads, mortgage rates, etc.) and presents it in a coherent and transparent manner on its website. Companies like Zillow, Trulia (NYSE: TRLA ) , Market Leader (Nasdaq: LEDR ) , and Move (Nasdaq: MOVE ) , are all attempting to capitalize on the fact that the real estate market is full of middlemen taking unnecessary cuts using asymmetric information.
Citron's lemony lament
Citron Research represents a team of investors whose goal is to "provide truthful information in an entertaining format to the investing public," and who conclude each report with a warning: "Cautious investing to all." Today, the group published a report (link opens PDF) titled, "Zillow: It's Not Just the Ridiculous Valuation -- it's the Ridiculous Business Model." Generally speaking, Citron critiques four different aspects of the company. I'll address each of these in turn:
- Management transparency
- Value add
- Constrained real estate agent market
Zillow recently exercised its right to sell an additional $147 million in stock offerings. Citron critiques management's transparency leading up to this decision, citing the CEO's and CFO's nonchalant attitude toward their permission filing at the company's last quarterly earnings call.
While I agree that management was likely less than transparent, the subsequent claim that Zillow executives are selling off shares to make massive insider gains is unfounded. Although Citron states that officers and directors have made over $100 million in stock sales, the research group fails to mention that 33% of all Zillow shares are held by insiders. That means that management holds approximately $400 million in stock and most certainly isn't looking for that value to drop.
Citron criticizes Zillow's ability to provide useful information to its customers. The research group considers the company a middleman, citing its regurgitation of agent-created content and erroneous "Zestimates."
While Zillow isn't in the content-creation business, its value proposition has always been its ability to convey information better than anyone else. Would you rather buy a newspaper and read "Kenan st 4bed 2bath hot tub nice yard 0.2acre $425k" or click here? Zillow will need to balance its effectiveness with its pricing, but its middleman act is, in my opinion, the very reason that online real estate companies exist and will continue to grow.
Citron is right that Zillow's proprietary Zestimates are far from perfect, but every one of the 35 million user-input corrections has made this algorithm smarter than before. In a recent discussion with The Motley Fool, Zillow CEO Spencer Rascoff noted that Zillow's margin of error has decreased from 12% six years ago to 8% today. It's not "Zexact," it's a "Zestimate."
Constrained real estate agent market
Zillow has two revenue sources: advertising and "premier agent" subscriptions. The company increasingly relies on subscriptions, but a recent survey cited by Citron reveals a lack of satisfaction with Zillow's offerings. In general, results point to stagnant growth and questionable ROI for Zillow as compared to its competitors.
However, with a survey size of only 100 respondents and marginal changes, I question the statistical significance of these results. I would love to see this survey scaled and repeated, but the current findings don't hold water in my analysis bucket.
Citron also argues that Zillow has saturated its share of the real estate agent pie. The research group estimates (rightly so) that nearly every U.S. agent has heard of Zillow, but only 2.3% have signed on. In Citron's view, that means that 97.7% of all agents will never use this company's services.
I've got one word for this logic: Apple (Nasdaq: AAPL ) . Nearly every computer user in the U.S. had heard of Steve Job's company 10 years ago, but its sales have increased just a bit (2,330%) in the past decade.
I won't go into too much detail in this section, but suffice it to say that Citron believes that Zillow's heyday is behind it. I don't think they're necessarily wrong, but I also don't think they're necessarily right. Zillow's minimal profits render Citron's use of the P/E ratio useless, and its page view drops have yet to complete a seasonal cycle. Zillow's annual reports reveal a long-term steady increase, where visitor traffic almost perfectly mirrors real estate agent growth. As a long-term investor, I look forward to examining the company's 2012 results to see how it has fared in the past year.
Sources: Author's calculations and Zillow 10-K reports.
What does it all mean?
Citron raises several questions for Zillow's future, but most are concerns that have always been a part of the speculative nature of this new sector. Churn rates, acquisitions, and the ever-present shift to mobile will continue to challenge Zillow's status quo, but this fast-paced company isn't known for sitting on its laurels.
I bought shares of Zillow back in July, and neither Trulia's IPO nor Citron's report has managed to turn my bull horns into bear claws. The next earnings report will be a crucial page in the company's growth story, and I look forward to reading it with a critical eye. Until then, I'm sticking with my long-term investing strategy: long on Zillow.
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