MIT Sloan School of Management
Zillow’s Acquisition of Trulia - The Door to the
Online Real Estate Market
Muddy Waters Investment Competition
The Economist MBA Investment Case Competition 2014
Participants:
Samuel Horn
Reegy Laloi
Ting Sun
ZILLOW’S ACQUISITION OF TRULIA - THE DOOR TO THE ONLINE REAL ESTATE MARKET
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Contents Abstract ............................................................................................................................................. 3
Zillow and Trulia on a Standalone Basis............................................................................................... 4
Summary ....................................................................................................................................... 4
Zillow as a Standalone Company ..................................................................................................... 5
Overview ................................................................................................................................... 5
Mobile & Website Users.............................................................................................................. 5
Partnerships ................................................................................................................................ 6
New Services: Brokerage ............................................................................................................. 6
Trulia on a Standalone Basis ............................................................................................................ 7
Overview ................................................................................................................................... 7
Mobile & Website Users.............................................................................................................. 7
New Services/Acquisitions .......................................................................................................... 8
Risks ............................................................................................................................................. 8
Combined Companies ....................................................................................................................... 10
Deal Structure Summary ............................................................................................................... 10
Deal Approval .............................................................................................................................. 12
Trade Strategy and Opportunities ...................................................................................................... 13
Scenario One: Shareholders Restructure Transaction Terms ............................................................. 13
Merger Arbitrage ...................................................................................................................... 13
Options Trading – Bull Call Spread ............................................................................................ 14
Scenario Two: Acquisition Gets Approved by Shareholders and FTC ............................................... 14
Portfolio Diversification ............................................................................................................ 14
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Abstract
As consumers get more reliant on online real estate listing for pricing information and
services, the industry is shifting from traditional to online marketing. We expect this
online market to expand rapidly in their share of advertising revenue. In this
consolidating market, we believe, Zillow’s all-stock acquisition of key competitor Trulia,
with other acquisitions such as News Corp buying Move and Google taking a minority
stake in Auction.com, is healthy and will continue. Trulia, the target company, is
undervalued based on our analysis and is receiving a premium at the time of
announcement. If this merger is stopped by the FTC the two companies will continue to
search for other streams of revenue. This highly concentrated online real estate sector is
very dependent on partnerships with premier agents, brokerage firms and mortgage
advertising. Given our confidence in the target company to increase value in the short
term, we recommend merger arbitrage combined with a bull call option to hedge risk.
Purchasing another company such as HomeAway and Realogy is also a diversification
play in this deal.
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Zillow and Trulia on a Standalone Basis
Summary
We have a fair value price of 105.64 for Zillow and 63.19 for Trulia if the merger falls
through, either rejected by FTC or by shareholders’ vote. This was forecasted on a
discounted cash flow analysis from with a 60% and 50% growth rate for the next five
years using a terminal growth rate of 10%. Expected costs, specifically, advertising and
working capital remained per the historical ratio analysis. The two companies will
remain competitors in a tough and fragmented market. Zillow is maturing its growth and
with an unlevered balance sheet, is more attractive if the revenue dries up. Trulia will
have to compete with more advertising dollars to continue to gain market share from the
market leaders. The company will be unable to go to the equity or debt markets because it
is already levered.
Figure 1 Zillow Fair Price
Figure 2 Trulia Fair Price
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Zillow as a Standalone Company
Overview
Since 2011, Zillow has acquired 8 companies and will continue this acquisitive strategy
to expand its products and services. In alignment with its product portfolio growth,
Zillow will expand into new sectors within the real estate industry and disrupt the
brokerage market with its own online brokerage firm with end-to-end service, leveraging
a network of independent real estate agents, lenders and the mobile consumer.
If the transaction fails to close, despite initial market reaction, we will continue to witness
robust growth in Zillow’s Average Monthly Unique Users and Premier Agent
Advertisers, two main advertising revenue streams. Zillow will continue to leverage
partnerships with premier agents, brokerage firms and TV networks, power real estate
search engines, and seek out new viable partnership opportunities in social media and
advertising.
Mobile & Website Users
For the past 22 quarters, Zillow has grown its average monthly unique users at a 12%
QTQ growth rate to more than 80M users. The number of Premier Agent Advertisers
faired even better at 29% QTQ, averaging a record $320 monthly revenue per agent
versus $206 in Q1 2011. Based upon Emarketer’s outlook, smartphone users will grow to
2.5B users by 2017 from less than 1.5B in 20131, further illustrating Zillow Mobile App’s
lucrative penetration potential.
1 EMarketer. "Smartphone Users Worldwide Will Total 1.75 Billion in 2014 - EMarketer." Smartphone Users Worldwide Will Total 1.75 Billion in 2014. <http://www.emarketer.com/Article/Smartphone-Users-Worldwide-Will-Total-175-Billion-2014/1010536>.
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Partnerships
Zillow has seen significant increases in traffic on its site through its national TV spots,
TV network partnerships and real estate search and will continue investing in these
channels. It will try to partner with Google to power Google’s real estate search engine.
We have already seen Google target another online housing website Auction.com by
buying a minority stake in the company in March 2014. In addition, Zillow may share
their listings through international real estate search engines such as ListGlobally and
partner with global brokerage firms to expand their footprint into active global markets.
Acquisitions: Since 2011, Zillow has made 8 acquisitions, averaging a $27M price tag for
the published acquisition targets. Currently, Zillow does not have a strong footprint in the
foreclosure market and companies like RealtyTrac, a prominent source of foreclosed
properties, will increase its market share if acquired. Auction.com, valued at 1.2B,
represents another strategic acquisition target. The company is said to predict home
prices faster and more accurate than the market based on their robust data. This company
sold $7 billion in real estate online last year and 26 billion of assets since 2007 charging a
5% transaction fee2. With an unlevered balance sheet and salient sales and marketing
resources, Zillow will strategically build its brand and expand.
New Services: Brokerage
The brokerage industry has low barriers to entry with Realogy revenues over 5.6B in
2014 and has a strong annual growth outlook. Leveraging its mobile capabilities, quick
lender approval, and an independent network of real estate agents, Zillow Brokerage, a
2 Gittelsohn, John. "Google Invests $50 Million in Property Broker Auction.com." Bloomberg.com. <http://www.bloomberg.com/news/2014-03-05/google-invests-50-million-in-property-broker-auction-com.html>.
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new subdivision, could exploit the brokerage market and become an end-end solution for
customers. This service will help consumers put their house for sell independently or
through a network of commission-based independent agents, leverage a huge 80M+ user
base, and extend lending options to a buyer for a seamless deal execution. This will also
be a great diversifier the company’s highly concentrated marketplace revenue model.
Trulia on a Standalone Basis
Overview
Leveraging its unique platform of providing users with statistical data such as agents,
neighborhoods, schools, crime and commute times, Trulia will find more data points to
limit the opacity in real estate search. Trulia will also continue to build partnerships, such
as the PRIMEA Network, to enlarge its listing and unique visitor volume. With its recent
acquisition of Market Leader, Trulia will diversify its portfolio of products and become a
major player in the real estate software industry, offering unique CRM tools to real estate
agents and venturing into property management software through acquisitions, such as
Yardi and Nestio.
Mobile & Website Users
With its recent acquisition of Market Leader, Trulia will service over 50,000 premium
subscribers, more than any other online real estate marketplace3. Trulia’s paying
subscriber base and unique visitors metric are both growing at accelerated levels, 16%
3 Shuman, Ken. "Trulia to Transform Real Estate Industry with the Close of the Market Leader Acquisition." Businesswire. <http://www.businesswire.com/news/home/20130820006466/en/Trulia-Transform-Real-Estate-Industry-Close-Market#.VFaxVI0tCM9>.
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and 11% QTQ respectively. This trend will continue, especially with Tulia’s investments
in mobile.
New Services/Acquisitions
With its salubrious acquisition of Market Leader, Trulia has expanded its product
portfolio into the highly fragmented real estate software sector. Revealing the lucrative
nature of software, Market Leader has an existing and established revenue stream that
grew approximately 32% in 2012, the second consecutive year of 30% growth4. Not only
will Trulia leverage the cross-promote synergies with this acquisition but also will
enlarge its SaaS solution offerings by revamping these solutions and acquiring software
companies such as Yardi systems, a property and asset management software, and Nestio,
a real time listing database. According to Gartner, the SaaS industry is poised to grow
over $22 billion in total market revenue through 2015, up from more than $14 billion in
20125. Trulia will capitalize on this opportunity and diversify its product portfolio scope
to mitigate risk and maximize return.
Risks
Despite these future strategic initiatives, Zillow and Trulia are overly exposed to real
estate’s cyclicality, volatile mortgage rates and consumer demand uncertainty.
4Lomas, Natasha. "Trulia Acquires Market Leader For $355M To Take Its Business Beyond Listings And Into SaaS For Real Estate Professionals | TechCrunch." TechCrunch. <http://techcrunch.com/2013/05/08/trulia-to-buy-market-leader/>. 5 Kanaracus, Chris. "SaaS Predictions for 2014." PCWorld. <http://www.pcworld.com/article/2082820/saas-predictions-for-2014.html>.
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They will also continue to compete with each another and with other online real estate
listing companies, challenging them both to remain competitive, cost-effective and
dynamic.
If the merger fails, Zillow and/or Trulia may decline in share price. The
magnitude of their respective potential drops is uncertain but based upon a few
unsuccessful M&A deals, including Pfizer and AstraZenca, AT&T and T-Mobile and
Yahoo and Microsoft, transient share price decline is possible. Zillow and Trulia may
devise strategies to counteract such a risk.
Finally, Zillow and Trulia are highly dependent on maintaining and establishing
relationships with real estate brokerages, real estate listing aggregators, multiple listing
services, apartment management companies, home builders and other third-party listing
providers and advertisers. Many of their contracts with these partners are short-term,
exposing their revenue risk if contracts are not renewed.
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Combined Companies
Deal Structure Summary
Together the two companies will innovate with technology to “create even better
products and services for both the consumers and real estate professionals, “as stated by
Pete Flint CEO of Trulia, on the third quarter 2014 earnings call. At this point in time a
consolidation of real estate information companies is healthy. With the continued decline
in refinancing mortgages, the focus of mortgage providers is now on new loan
origination. Since the slowing of mortgage origination has continued, “large mortgage
lenders have reassessed their overall business and subsequently their marketing spend,”
stated by Sean Aggarwal CFO of Trulia.
At the time of the announcement on July 28th Zillow was trading at 158.86 and Trulia
56.35. The target price was 70.53 at the time of the deal which translated to a 25%
premium to the valuation. We project at total of 80m in cost savings in synergies through
a mix of systems in integration, advertising, and restructuring. We do not foresee any
tangible / intangible asset write-up from this acquisition. Goodwill of the combined
company will be increased from 255.9 and 96.4 for Trulia and Zillow, respectively by
2,399.6 less Trulia’s current goodwill to 2,495.9. The 2,399.6 comes from the equity
purchasing price of 2,614.6 of new stock less identifiable assets of 215. There has been
an uptick in stock-based compensation exercised since the acquisition and will continue
in the near term.
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After the release of Trulia’s Q3 results it is apparent this business is stabilizing its growth
phase based upon the softening mortgage origination in the quarter. Trulia had
experienced headwinds in their mortgage market however we do believe this company to
be cyclical in nature and took a midscale approach during our analysis by projecting
Zillow revenue sales of 65%, 40% in 2014 and 2015 respectively with Trulia’s sales
similar in nature. While we recognize Zillow and Trulia are growing actual sales 70%
and 100% respectively, we believe this not to be sustainable in the long run.
We forecast combined revenue of 578.9 and 781.2 for 2014 and 2015 respectively and
net income of 64.17 and 108.48, which translates to net EPS of 1.45 and 2.45
respectively. We expect costs to increase the first year due to an increase in advertising
spend and rebranding as well as legal and IT related costs to the merger, however once
the companies combine their platforms we should see a significant cost savings. If the
company is able to realize the 80m in synergies we believe this deal to be accretive.
Figure 3 Historical and Projected Revenue Growth 2009-2015E
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As of 10/31 Zillow’s stock price is trading at 104.24 and Trulia at 44.34, translating into
a 46.28 target price with the deal yielding only a 4.4% premium for Trulia shareholders.
Keeping forecasts constant this acquisition will be 287.0% accretive based of off the P/E
required to maintain the share price. The new equity value of Trulia will be 1,737.5M
with the enterprise value as 1,755.5M.
Deal Approval
This transaction is highly likely to gain approval since both the Zillow and Trulia Board
has approved the deal at a rate of 100% and 91% respectively. There are still pending
approvals from both companies’ shareholders; the result will be announcement mid –
December. Since the Federal Trade Commission has already approved the News Corp
and Move Inc. acquisition we believe the Trulia-Zillow to be permitted.
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Trade Strategy and Opportunities
While we believe both companies have growth potential, Trulia is undervalued in the
market comparing to Zillow. Based on our analysis, we considered a few trading event-
driven strategies: Event-driven Merger Arbitrage, Options Trading and Portfolio
Diversification with Alternative equities.
Scenario One: Shareholders Restructure Transaction Terms
Our analysis shows that Trulia is undervalued comparing to Zillow. This has been shown
by market reaction since the announcement of the acquisition. Therefore we have reasons
to believe the target shareholders may push to renegotiate transaction terms to better
reflect value of the business.
Figure 4 Market Reception of Zillow -Trulia Acquisition
Merger Arbitrage
Given it is a stock deal and the target is undervalued, we recommend buying the target’s
stock and short the acquirer’s stock in a dollar amount equal to the number of shares the
speculator would receive in exchange for the target’s shares.
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Options Trading – Bull Call Spread
Based on our valuation of Trulia, we anticipate the price of Trulia to continuously
increase before closing of the transaction. Choosing moderate risk options, we
recommend employing bull call spreads. E.g., given Trulia options in the market, we buy
both call and put options with the highest strike. The expected payoff is shown in the
diagram below.
Figure 5 Trulia Bull Call Spread Payoff Diagram
Scenario Two: Acquisition Gets Approved by Shareholders and FTC
Portfolio Diversification
To help manage risk and rebalance to maintain your portfolio, we recommend a
diversification with one or combination of several stocks with correlation negatively
correlated to Zillow and Trulia in the past year: HomeAway, Inc (AWAY)., Realogy
(RLGY) both have stock performances strongly negatively correlated with Zillow (Z) and
Trulia (TRLA). Reis, Inc. (REIS) shows positive correlation and is therefore not fit for
diversification purpose.
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AWAY REIS RLGY TRLA Z
AWAY 1
REIS -0.36 1
RLGY 0.80 -0.53 1
TRLA -0.46 0.83 -0.51 1
Z -0.59 0.75 -0.74 0.85 1 Table 1 Correlation of 1-Yr Stock Performance