When Zillow Group (NASDAQ:Z)(NASDAQ:ZG) released solid third-quarter 2018 results two weeks ago, it seems an understatement to say it was surprising at first to see shares plummet 26% the following day. That is, at least until we saw the online real estate platform leader reduced its full-year outlook due to a number of industry and business-specific headwinds.
In both Zillow's latest letter to shareholders and its subsequent conference call with analysts, however, management offered crucial perspective on exactly what drove its business over the past few months and what investors should be watching in the coming quarters. Read on for crucial insight to those ends.
Mortgage segment headwinds won't last forever
The year-over-year decrease in average revenue per loan information request was due primarily to our ongoing transition to our new Connect subscription-based platform, which began during the second quarter of 2018, from the cost-per-lead Long Form product. The Connect platform delivers
higher-quality leads to our lender advertisers and we expect will improve monetization in future quarters.
-- Zillow CEO Spencer Rascoff
First, some shareholders might be tempted to balk after seeing revenue from Zillow's existing mortgage business -- which does not include its recently closed acquisition of Mortgage Lenders of America -- fell 12% year over year, as sales collected under the company's new subscription approach more than offset the fruits of a 13% increase in the number of mortgage loan information requests. But this decline was technically in line with expectations, and Rascoff insists that focusing on quality over quantity will yield superior results over the long run.
Zillow Offers is ramping quickly
During the third quarter of 2018, Zillow purchased 168 homes and sold 36 homes. All of the homes purchased and sold were in the Phoenix and Las Vegas markets. Zillow Offers launched in Atlanta in September and Denver in October. Demand for this service in our new markets is already exceeding our expectations, and the Denver launch was the most successful start so far. [...] Just a few months after launching this new business, Zillow Offers is ramping fast and our team is seamlessly executing the roll-out into new markets. The Zillow Offers team is managing renovations on time and under budget. On average, during the third quarter, homes were sold well ahead of our 90 day target. Our unique data set provides insight into the homes that consumers are shopping for and allows us to effectively advertise the homes we buy even before we are ready to relist them.
Despite the market's initial discomfort with the thought of Zillow entering the homebuying and selling business, there's no denying that the new Zillow Offers platform is off to a great start. Rascoff added that Zillow's primary goal is not to flip houses but rather to "provide a home-selling option that eliminates the hassle and uncertainty of selling a home for the consumer."
Almost 20,000 homeowners have already requested an offer from Zillow from the three markets in which it operated this quarter, and Zillow only opted to actually purchase around 1% of those homes. With Zillow's unique perspective on the health and pace of the real estate market, it should come as no surprise that the company is rapidly expanding the initiative into new metropolitan markets.
The cause of Zillow's Premier Agent revenue shortfall
In 2017, Zillow Group surveyed consumers who submitted a request for information on a for-sale listings from our Premier Agent to measure how much of a push-button experience we were delivering. Consumers reported that they never heard back from a Premier Agent 49% of the time. [...] To address these opportunities, we began rolling out our new lead validation and distribution process in April 2018 that first vets consumers before connecting them with Premier Agent and then significantly improves the connection rates by contacting the next available Premier Agent in an automated queue if the first did not answer the phone. We are now delivering nearly instant service that consumers deserve. [...] However, we faced some challenges during the rollout of these changes. Our third quarter Premier Agent revenue was lower than our guidance because of higher-than-expected advertiser churn. Not all of the changes we made were well received by our advertisers.
Perhaps most concerning to investors, however, is the relative weakness of Zillow's core Premier Agent platform. In short, because consumers told the company they only heard back from a Premier Agent 49% of the time under the old system, Zillow revamped its lead-validation and distribution processes to ensure those consumers were properly served. In the process, however, Zillow annoyed some advertisers due to a combination of timing its changes with a slowing home market and regular seasonality, as well as its decision to prioritize quality of leads over quantity.
Moving forward, Zillow has taken a number of actions to appease those agents and advertisers while continuing to offer a more consistent experience for consumers.
Zillow is playing the long game
Zillow Group's mission remains the same: To build the largest, most trusted and vibrant home-related marketplace in the world. In 2018, we pledged to create better experiences for consumers as we accompanied them further down the funnel and closer to the transaction. We also said that we would evolve our business models to better align our results with our industry partners'. These were big promises and we kept them.
It may seem as though Zillow has yet to deliver on its promise to industry partners, namely as it pertains to providing a high number of good-quality leads. But Rascoff also notes the most recent adjustments to its Premier Agent platform "are already dramatically improving connection rates, and we are now shifting our focus to helping agents increase conversion of those connections into transactions."
If all goes as planned, Zillows believes advertiser churn and Premier Agent revenue should show tangible improvements in early 2019. So while our market hates being told to essentially hurry up and wait, I think patient investors would do well to use this pullback to open or add to their positions in the meantime.
Steve Symington has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Zillow Group (A shares) and Zillow Group (C shares). The Motley Fool has a disclosure policy.