The Quiet Internet IPO
Stephen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Editor's Note: This article previously contained incorrect price and return data on Zillow.
The last twelve months or so were chock full of big name internet IPO's, causing some to wonder if we were in a collision course with another inevitable dot-com bubble. Zillow (NASDAQ: Z) was a popular punching bag around the time of its IPO. I remember giving it an Under perform rating on CAPS without even looking at the S-1 filing or trying to understand the business. It was an internet IPO, easy short call, right? Zillow has been a public company for about a year now. Opening at $20 per share on the day of its IPO, Zillow closed last week at $38.83. That's certainly a stronger performer than some other recent internet IPO companies. Zillow has been quietly chugging along, and I was curious to finally dig into the company to see what it is all about, and I was somewhat surprised.
Old Attitudes Don't Die Hard
I'm guilty of a certain bias against internet companies. I unfairly assume they are unsustainable business models that are just looking to cash out at IPO. Zillow has changed my attitude. For starters, I was surprised to find the company is in a strong financial position with $70 Million in cash and zero debt. They generated $15 Million in operating cash flow in FY 2011 and have already generated $17 Million in the first six months of 2012. The company turned a profit for the first time in 2011 and is nearly doubling Revenues every quarter. The principle money maker for Zillow is their Premier Agent Program and Mortgage Marketplace. Combined they account for 70% of sales in the latest quarter. The Premier Agent Program is a subscription service for local real estate agents to establish an online presence through Zillow’s website and mobile application, and the Mortgage Marketplace is a charge-per-click advertising service where users are directed to mortgage lending sites. Subscription services are great business models, and real estate agent subscriptions increased 70% year over year in the most recent quarter. Zillow must attract more users to maintain and grow this subscriber base, and so far the company is delivering with a 60% increase in unique users in the last quarter. Sales and Marketing expenses increased 116% over the same period; a positive indicator the company is upping its advertising efforts.
Zillow is making some smart acquisitions. Recently the company acquired RentJuice, a rental relationship software developer for landlords and property managers. This is clearly a big move into the rental space of real estate. While the website has already offered listings and Zestimates for both home sales and rentals, the focus has always been on the home sales side of things. Bringing property management companies and landlords into the Zillow ecosystem should open the door for a subscription service similar to the Premier Agent Program. Zillow can become the one-stop source for home buyers and rental shoppers alike. A 2011 report by Borrell Associates predicted mortgage lenders would spend $9.5 billion in advertising and marketing while real estage agents and brokers would spend an additional $6 billion in 2011. If Zillow can establish itself as the "Go-To" service for home buyers and renters, they stand to attract a significant slice of this pie.
It Can't All Be Good News
Zillow does face a lot of challenges in the short and long term. The biggest threat to Zillow is the hungry upstart with the same idea and a better delivery. There are no barriers to entry into this space, and while Zillow has the advantage of being first to market and establishing a fairly thorough database of homes in America, there is no guarantee it can hold onto its users if a better alternative comes around. Unfortunately unlike LinkedIn (NYSE: LNKD) or Facebook (NASDAQ: FB), whose users have created profiles, uploaded photos and videos, and established connections with other users, Zillow’s users have no ties to the website beyond its functionality. Zillow has done well with both the website and mobile app to get users invested in the ecosystem. Users can save searches and upload their own photos of homes they are interested in along with receiving notifications. These are great moves, but the company must continue to improve its offerings to keep customer loyalty. I would like to see them really work on the Zestimates, which have notoriety for sometimes being way off the mark.
The market clearly has big expectations for the company, judging by these valuation metrics:
P/E (fwd): 55
P/S (ttm): 14
EV/EBITDA (ttm): 115
Price/Cash Flow (ttm): 93
I am not convinced the company can meet these expectations, especially in the short-term. One slip-up and you can expect the share price to go plummeting. I might be taking that opportunity to find an entry point, because I do think there is a real business here with great opportunities to become the dominant player in a major market. Not to mention the growth opportunities overseas. I'm definitely keeping my eye on this one.
drfrank1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, LinkedIn, and Zillow. Motley Fool newsletter services recommend Facebook, LinkedIn, and Zillow. 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.If you have questions about this post or the Fool’s blog network, click here for information.