In 2018, leading real estate marketplace Zillow (Z 2.50%) (ZG 2.63%) embarked on a new strategy dubbed Zillow Offers, where it began purchasing homes of its own. Fast forward about three years and a couple of billion dollars' worth of home purchases later, and the company is now in the process of completely shuttering the initiative.
Since announcing this wind-down in fall 2021, Zillow stock has dropped by more than 57%. But with Zillow Offers on its way out the door, investors might actually be better off. Let's see why.
Exiting iBuying
Before getting into Zillow's future prospects, it's worth understanding why Zillow exited the homebuying business in the first place.
When rationalizing the end of Zillow Offers during the third-quarter 2021 conference call, CEO Rich Barton stated, "Put simply, our observed error rate has been far more volatile than we ever expected possible." In other words, the value of the homes Zillow acquired strayed too far from the company's estimates. This hurt Zillow's profitability and increased the riskiness of its balance sheet, as the value of the homes could swing wildly.
But pricing uncertainty wasn't the only reason iBuying hurt Zillow. Zillow's core business (everything but Zillow Offers) generates revenue through its online marketplace, where it helps people discover and move into new homes. As the premier destination for real estate search, Zillow must maintain a strong brand in the eyes of consumers.
Zillow Offers, however, was starting to put that brand at risk. 90% of Zillow's offers on homes were rejected by sellers, suggesting that Zillow was hurting its reputation with many homeowners. This caused worries that homeowners would be less inclined to adopt Zillow's other products in the future.
While it's now quite obvious that Zillow's entrance into the iBuying space was a mistake, the resulting pivot hasn't actually been all bad. For starters, management stated at the end of 2021 that the wind-down of Zillow Offers was going better than anticipated. Zillow has already sold or entered into contracts to sell 85% of the homes in its inventory. And the company now even expects to generate positive cash flow as a result of the liquidation. Now, Zillow has amassed more than $2 billion in losses it can carry forward to help offset some of its future taxes.
What's next for Zillow?
Despite the wild ride for the company and its shareholders over the last year, Zillow's marketplace was still home to 198 million unique users in the fourth quarter, and the company name continues to be synonymous with the real estate market. Not only does Zillow have more than three times the number of daily app users as its next-closest competitor, but according to Google Trends data, more people search for the term "Zillow" than "Real Estate."
From this broad user base, there are several ways in which the company generates revenue. The most significant way Zillow makes money is through its "Internet, Media & Technology (IMT)" segment. Within IMT, Zillow leverages its vast marketplace to connect prospective buyers or renters with real estate agents; in return, Zillow is compensated by the agents.
Over the years, Zillow has added some additional products, like closing services and home loans. Still, IMT makes up just under 90% of Zillow's business once you exclude its closed iBuying unit.
It appears this IMT segment is a solid business on its own. IMT generated about $1.9 billion in revenue and $545 million in earnings before taxes in 2021, up 30% and 107%, respectively, over the prior year.
As Zillow continues to close out of its home offers business, the profitability of Zillow's remaining operations should become more evident.
Is Zillow a buy?
Since announcing the closure of its iBuying segment, Zillow's market cap has dropped by more than 50% and today stands at $11.8 billion. Although valuing Zillow on any trailing profits is tough, given the losses from the Zillow Offers segment, the entire market cap is roughly equal to just over 20 times the earnings before taxes from its IMT segment.
All this goes to say that investors today are essentially getting the same growing and industry-leading marketplace as before, but now with less balance sheet risk and greater profitability. As a bonus, Zillow stock is now trading at a substantially cheaper valuation. For investors who have considered Zillow in the past, this looks like an opportune time to pick up some shares.
