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Zillow Group, Inc. Earnings Reveal What's Holding It Back

By Steve Symington - Feb 12, 2016 at 6:56AM

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Zillow's fourth quarter exceeded expectations, but a lawsuit from News Corp. is pulling precious resources aside.

Image source: Zillow Group.

Zillow Group (Z -1.99%) (ZG -1.75%) released fourth-quarter 2015 results Thursday after the bell, and the market doesn't appear particularly happy with shares down nearly 10% in after-hours trading. But that doesn't mean Zillow's results were bad.

Keeping in mind Zillow's pro forma numbers assume its Feb. 2015 acquisition of Trulia would have closed at the start of last year, quarterly revenue came in at $169.4 million. That's up 7% from pro forma revenue of $158.5 million in the same year-ago period and near the high end of Zillow's guidance, which called for revenue of $165 million to $170 million. Excluding revenue in last year's fourth quarter from Market Leader, a real estate CRM software company Zillow sold in September, revenue would have increased 18%.  

One way to hold Zillow back
Next, pro forma adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) fell nearly 71% year over year to $20.4 million, largely due to $8.1 million in legal costs during the quarter related to Zillow's "necessary defense" of legal claims brought by News Corp. (NWS 1.29%). By comparison, that's near the low end of Zillow's guidance, which called for adjusted EBITDA in Q4 of $20 million to $25 million.

Based on generally accepted accounting principles (GAAP), that translated to a net loss of $25.7 million, or $0.14 per share. On an adjusted (non-GAAP) basis, which adds perspective by excluding items like share-based compensation and acquisition expenses, Zillow's net loss narrowed to $0.01 per diluted share from a loss of $0.08 per share in last year's fourth quarter.

Specifically regarding the legal expenses, recall in early 2014, News Corp. subsidiary (and Zillow competitor) Move, filed suit after Zillow hired president Errol Samuelson as it its chief industry development officer. Move initially tried to block Samuelson's employment at Zillow, claiming he was privy to proprietary information that should not be shared, then later alleged Zillow tried to hide that information. All told, Zillow said it incurred $27 million in legal costs last year related to this suit, and projects these costs to increase to $36 million in 2016.

Zillow Group CFO Kathleen Philips lamented, "Absent this lawsuit, these financial resources could otherwise be used to support innovation and growth, or margin expansion."

Digging deeper
But before we delve into guidance, let's take a closer look at what drove Zillow's results in Q4. First, the top line included 14% growth in marketplace revenue to $148 million, driven by a 27% increase in real estate revenue to $136.6 million, and 48% growth in mortgages revenue to $11.7 million. But marketplace growth was held back by a 25% decline in display revenue to $21.1 million, albeit primarily due to Zillow's previously outlined strategy of purposefully underinvesting in display to place greater focus on its more promising marketplace business.

Nearly 124 million average monthly unique users visited Zillow Group's four primary consumer brands, including Zillow, Trulia, StreetEasy, and HotPads, up 61% from the same year-ago period. Note that's down from 142 million average monthly unique visitors in Q3, though primarily due to typical seasonality -- Zillow's monthly users predictably reached an annual seasonal peak in July at around 150 million. As it stands, mobile usage comprised around two-thirds of Zillow's total traffic, and Zillow Group brands continue to represent around 70% market share of all mobile exclusive visitors to the category. 

Zillow is also benefiting from increased scale, having several of the largest mobile and online real estate brands under one company. Since Jan. 2015, almost 400 MLSs have signed agreements to send listings directly to Zillow and Trulia, up from around 350 last quarter and 300 in Q2.

Meanwhile, Zillow Group's number of agent advertisers totaled 92,366 as of Dec. 31, 2015, down from 96,965 three months earlier and marking its third straight sequential decline. Similar to last quarter, however, keep in mind this reflects Zillow's ongoing strategic focus on "high-performing agents who provide a superior customer experience." 

Zillow's monthly revenue per advertiser increased 29% year over year to $438. This result was driven not by increasing prices, but rather by those high-performing agents purchasing more advertising inventory from the company. Same agent advertiser sales during the quarter were over 50% higher than last year, and agent advertisers who spent more than $5,000 per month increased 48% in advertiser counts, and 62% on a total dollar basis.

Subsequent to the end of the quarter on Feb. 3, 2016, Zillow also announced its impending $13 million acquisition of Naked Apartments, a rentals-only platform focused on New York City that nicely complements its StreetEasy real estate platform. This purchase is expected to close before the end of this month.

Looking forward
For the current quarter, Zillow expects revenue of $174 million to $179 million, or 8% year-over-year growth at the midpoint on a pro forma basis. Excluding market leader, growth would have been over 18%, including 22% growth in primary agent revenue to $130 million to $132 million.

For full-year 2016, Zillow expects revenue of $805 million to $815 million, representing 26% growth at the midpoint on a pro forma basis from 2015 and, notably, a reacceleration from 18% revenue growth last year. Zillow also took the novel step of breaking out premier agent revenue, which should be in the range of $590 million to $595 million within that total. Looking further out, Philips noted by providing this additional transparency, Zillow expects to begin phasing out reporting of advertiser counts and average revenue per advertiser starting in 2017. In addition, EBITDA for the full year is expected to be $115 million to $125 million, including the aforementioned $36 million negative impact from legal costs.

Nonetheless, Zillow's relative outperformance is encouraging today, especially as it begins to enjoy the fruits of its newly increased scale following last quarter's successful integration of Trulia, as well as the resulting fresh acceleration in revenue growth going forward. Though legal expenses continue to temporarily hold back Zillow's bottom line, this was an undeniably solid quarter with which investors should be more than pleased.

Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Zillow Group (A shares) and Zillow Group (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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