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Investing in Zillow



March 13, 2014 – Comments (0) | RELATED TICKERS: ZG

Board: Pencils Palace

Author: TMFPencils

I recently opened a starter position in Zillow (Z), the company behind one of the largest online and mobile marketplaces for real estate and homes. This is a company that grew sales 69.05% in 2013 to $197.54 million and has expanded sales at an average annual pace of 59.57% since 2010. Not too shabby, and I think there is more to come.

Some investors are concerned that fellow competitor Trulia (TRLA) will overtake Zillow's market. I just don't see these concerns playing out: either people are biased toward Trulia for whatever reason, or (more likely) people are underestimating Zillow's strategy and moat. Here are some reasons why I think Zillow is slated to deliver market-beating returns over the long haul:

** Leadership. 35 year old Zillow CEO Spencer Rascoff, one of the founding employees of Zillow in 2005, has a 98% employee approval rating on Glassdoor. Zillow as a whole receives a 4.2/5 rating from employees on Glassdoor. Trulia's 38 year old co-founder, chairman, and CEO Pete Flint receives an 80% employee approval rating, and Trulia has a 3.6/5 employee rating on Glassdoor. While Trulia's reviews are hardly dismal, a determined Rascoff is leading the charge with a very enthusiastic base of employees at Zillow. If it really is true that "culture eats strategy for breakfast," Fools ought to prefer Zillow over Trulia.

** Strategy. In the Q4 2013 conference call, Rascoff outlined Zillow's continuing strategy:

"As we turn our focus now to 2014, our strategic priorities remain consistent, and they are: 1) grow our audience and widen our category lead, 2) grow our Premier Agent business, and 3) grow our advancing marketplaces."

Also in the conference call, Rascoff shared just how effective Zillow has been at generating traffic (and, in turn, sales):

"According to comScore, we are now nearly twice the size of our two closest competitors on combined mobile and Web traffic. And, we’re growing faster – on desktop, comScore shows Zillow tripling our category lead in 2013."

The biggest difference between Zillow and its rivals is probably Zillow's focus on reaching a wider consumer audience rather than primarily focusing on appealing to professionals such as real estate agents, landlords, brokers, and lenders. The reasoning behind this strategy is fairly simple: the larger the consumer audience, the bigger draw for advertisers to utilize Zillow's site (generating revenue for Zillow). If comScore's data is any indication, Zillow is crushing the competition in terms of audience reach.

This is really a "what came first, the chicken or the egg?" sort of question, from what I can gather. Zillow is operating with the understanding that cultivating a larger consumer audience through its mobile and web outlets will attract more professional advertisers. Other companies in this field -- such as Trulia -- are operating under the assumption that first appealing to the professionals will, in turn, lead to a more successful outcome in terms of consumer reach and sales generated. Neither strategy is necessarily right or wrong. However, I think Zillow's financial results reinforce the company's strategy when compared to Trulia's results.

** Cash flow production. While Zillow's cash flow production decreased slightly to $31.30 million in 2013, the company has expanded operating cash flow production at an average annual pace of 92.91% since 2010. This, along with stock issuance in 2012 and 2013, has helped the company build up $295.29 million in cash with no debt.

The most cash flow Trulia has been able to produce was $4.15 million in 2012, and that number turned negative in 2013. Trulia has $225.6 million in cash, but also carries a debt load totaling $230.08 million. Trulia has grown sales at an impressive average pace of 64.16% annually since 2010 to $143.73 million in 2013, but that growth has translated into no meaningful progress in terms of cash flow production. Thus, the company has been forced to issue extensive amounts of stock and debt over the past two years, with no improvement in cash flow production to show for it (thus far).

Zillow will undoubtedly be a volatile stock going forward, with a P/S ratio currently nearing 16. However, the company is guided by a young and innovative leader -- Spencer Rascoff -- who oversees one of the top company cultures in the country. The company's focus on building a service that attracts a wider consumer audience seems like a no-brainer to me, and the company has done a great job translating ever-expanding customer visits into consistent sales growth and cash flow production. As Rascoff explained in the 4Q 2013 conference call:

"55% of new sales bookings in the fourth quarter went to existing agents buying more impressions across mobile and Web, which is higher than recent trends and signifies strong underlying demand." -

In other words, Zillow's strategy is working. This isn't to say that Trulia is a bad business or can't succeed, but Zillow has a proven strategy that is already leading to solid financial results. Trulia is yet to prove that it can actually make money or generate cash with its strategy.

My investment in LoopNet -- an online database of sorts for commercial real estate -- several years back didn't turn out all that well, so I was hesitant to take Zillow (or this field) very seriously as an investor. Zillow, though, has an experienced and determined leadership team backed by an innovative company culture with proven (and quickly expanding) financial results which, in my mind, reinforce management's strategy for continued growth.

With that said, I opened a position in Zillow and look forward to following and learning about the company in more depth in the months and years ahead.

David K 

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