zillow + trulia: acquisition amplifies leadgen prowess, signals

17
Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals New Market Development Muddy Waters Investment Competition In collaboration with The Economist Group’s Which MBA? Analysis prepared by: Keaton Gray Yu-jui “Ray” Lin Yue Sun

Upload: buihanh

Post on 02-Jan-2017

217 views

Category:

Documents


1 download

TRANSCRIPT

Page 1: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals New Market Development

Muddy Waters Investment Competition In collaboration with The Economist Group’s Which MBA? Analysis prepared by: Keaton Gray Yu-jui “Ray” Lin Yue Sun

Page 2: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

2   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

Abstract

Accurate analysis of the pending merger between Zillow and Trulia requires a

deep understanding of the executive teams’ experience building lead generation

businesses in the real estate industry and elsewhere.

The following report will combine such an understanding with primary research

compiled through interviews with industry insiders. The resulting hypotheses identify

new market development opportunities in the commercial real estate and mortgage

lending industries on which a combined Zillow-Trulia is likely to capitalize.

These new market development opportunities set the stage for enormous growth.

Current opportunities, as well, play an important role in the analysis. The combined

company will leverage pricing power gained from 61% usershare over a market that

already delivers significant value, even while combined, the companies command only

4% marketshare. This is a story of growth.

“My priorities for Zillow are simple: 1) Grow our audience, 2) Grow our Premier Agent business, 3) Grow our emerging marketplaces of

Mortgages, Rentals and our New York real estate marketplace, and 4) Ensure that our company can properly scale to the size of the opportunity

in front of us.” - Z, 10K

“Our online marketplace is experiencing rapid growth”

- TRLA, 10K

Page 3: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   3  

1| ZILLOW PRIMES PATH TO PROFITABILITY THROUGH EFFICIENCIES & NEW MARKET DEVELOPMENT; WINS DEAL Which company is getting the better deal and why? Zillow gets the better end of its merger with Trulia. Both parties appear to be happy with

their deal – indeed, the newly combined entity will capitalize on its future successes

together. An all-stock transaction weighted in Zillow’s favor, however, should similarly

weigh future benefits in the same direction. Zillow can expect a boost in new customer

leads and value creation for existing users in the short term, as well as long-run benefits

including cost saving in overlapped divisions, faster technology innovation, and high

growth potential in commercial real estate market and mortgage service business.

This analysis will dive deep into this last point throughout its course, identifying the vast

stores of profit potential created when lead generation titans join forces.

If a merger is approved, Zillow will immediately inherit Trulia’s 54 million users. An

intense rivalry that competed for customers will become a cohesive cooperation between

two industry leaders. Where the former scenario aligns incentives such that both parties

lose (through competitive pricing, for example), the latter allows for network effects and

pricing agreement. This is especially important when a company’s primary revenue

stream comes from selling pockets of pixels that carry no real monetary value in-and-of

themselves.

Page 4: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

4   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

Combined with Zillow’s current 83 million users, the merger will result in a dominant

61% of total users in the online real estate listing industry. Zillow will become stronger

with a leading number of users and market share, a weakened competition structure in the

online real estate search industry, and the ability to redirect competitive efforts to

expansion.

Distinguishing user share from market share becomes critical when we consider their

implications. A combined 61% usershare creates pricing power. If a realtor concedes that

potential homebuyers’ likelihood to research online is high and getting higher, the realtor

will very probably conclude that she needs a presence on the portal that commands the

attention of 61% of web-using potential homebuyers. Whereas analysts of mature

markets might rightly cite constricting growth potential as cause for concern, the context

of this deal may require us to reasses that idea. Compared against 61%, the 4%

combined-marketshare figure looks downright small – small, and promising for growth

potential.

61%

combined usershare

4%

combined marketshare

Page 5: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   5  

One startup mantra encourages companies to build userbases now and figure out how to

make money later. It can be a frustrating strategy for potential investors, but it

demonstrates a property of digital markets that is relevant here: a userbase is easier to

expand than a market. For Zillow and Trulia, it means that 96% of residential real estate

advertising dollars go elsewhere, including placements like fliers and bus stop benches

that deliver zero insight into their performance as tools to send realtors new leads.

Zillow’s CEO explained this to Business Insider in 2012:

“Agents collect $60 billion in commissions a year and they turn around and

spend about 10% of that in advertising, $6 billion a year. So despite our significant revenue growth — five straight quarters of over 100% year-over-year

revenue growth — we have less than 1% wallet share of what agents spend on advertising. Think about that for a second. We are the biggest real estate site on

the web, by far the biggest real estate site on mobile, and yet agents spend 99% of their ad budgets elsewhere.”

– Spencer Rascoffi In the course of our research, an interview with a former Zillow employee confirmed that

Zillow is actively considering broadening the range of services it offers current

customers. Feasibly, the newly merged company could compete in the large branded-

stationary market long popular with real estate agents. More likely, we’ll see an extension

of services that allow for measurement and optimization of leads generated.

Zillow, Trulia, and a small cohort of peers are early iterations of a real estate marketplace

that will inevitably catch up with technology-enabled markets like auto and travel.

Page 6: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

6   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

2| ALL-STOCK TERMS ASSUAGE ZILLOW RISKS, APPEASE TRULIA SHAREHOLDERS Does the structure of the deal make sense for each company? Management from both companies arrived at a rational deal structure through

negotiations. For Zillow, using only stocks as an exchange for Trulia's stocks can save a

large quantity of cash and increase the company's liquidity ratio compared with using

only cash. Good for Zillow does not mean bad for Trulia, however. The New York Times

reports Trulia management “requested that it be an all-stock deal to give Trulia’s

shareholders a chance to benefit from the merger.”ii Based on the latest balance sheet and

cash flow statement of Zillow on June 30, the quick ratio of Zillow is approximately 7.95,

current ratio is 8.09, and the operation cash flow ratio is 0.31.

In $000s

Although the quick and current ratios are large enough to show Zillow’s outstanding

ability to pay off the short-term debts, its low operation cash flow indicates that Zillow

has not generated enough cash from operations against its current debts, which will raise

Page 7: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   7  

a concern about the sustainability of the firm. Therefore, the stock-only transaction

removes Zillow's worry of raising any additional great amount of money, the influence

on its working capital and the influence on its liquidity level.

Zillow can decrease the risk it bears by splitting part of risks to Trulia through the stock-

only transaction. Compared to a cash transaction, exchanging only in stocks does not

require the acquiring side, Zillow, to assume all risks of paying cash, but enables the

selling side, Trulia to share the risks of the acquisition premium. Since Zillow would like

to pay 0.444 of one of its shares for one of Trulia and its shareholders would own two

thirds of the combined company, it will bear the synergy risk based on the proportion and

Trulia takes the rest.

For Trulia, the biggest advantage of the stock exchange is the benefits for shareholders.

As mentioned above, Trulia's shareholders can get one third of the combined company

and transfer their one stock into Zillow's 0.444 stock. The price provided for Trulia is

$70.53 per share, a 25% premium on Trulia's closing price on July 25th. Based on the

price premium and our bullish expectation of the combined company, Trulia's

shareholders should be willing to get Zillow's stocks and obtain financial interest in the

future.

Taking both companies into consideration, Zillow and Trulia can share some benefits

from the stock-only transaction. For instance, first, they can save time, labor and

expenses on renegotiating some specific contracts, which would be required in a cash

Page 8: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

8   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

purchase. Second, the corporate structure for each will remain the same and both

companies are able to operate continuously and smoothly as before. Third, tax issues and

laws of restrictions on sale of assets can be avoided or reduced due to noninvolvement of

cash.

Technically, there is no doubt that the stock-only transaction has cons for Zillow and

Trulia. For example, the deal structure influences both companies' equities through

exchange of shares, which means each company will take the risk of the other.

Additionally, the selling side, Trulia, bears the risk of converting Zillow's stocks into

cash.

Page 9: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   9  

3| ZILLOW EXPANDS LEADGEN MARKETS, TRULIA TESTS BUSINESS MODELS What will the futures likely be for each company on a standalone basis if the transaction fails to close? Through interviews detailed in a later paragraph, we learned that Zillow understands its

role as a lead generator, and is patiently pursuing new markets to enter. We have first-

hand information that Zillow has engaged in talks to acquire a commercial real estate

marketplace that would increase its total addressable market to include not just residential

real estate, but virtually all real estate. This potentiality does not require Zillow to stay

independent, of course, and is factored into our bullish analysis of the transaction writ

large. While we expect Zillow to forge ahead in any scenario, we learned that Trulia was

more willing to consider business models very much outside its core competency of lead

generation.

“Within Zillow, we are doing really exciting things like creating new product

lines, new platforms, expanding our rental category and acquiring companies.”iii -Spencer Rascoff

The future for each company separately is more challenging on a standalone basis than at

merged scale. On a standalone basis, each company will compete on siphoning new

customers and maintaining existing users. On the contrary, combined company will be

able to focus on expanding new customer base as an entity.

We interviewed a former Zillow employee, the founder of an industry competitor, and an

employee of a commercial real estate online marketplace in an effort to better understand

the specific directions these companies may have headed, were they not to merge. One

response imagined a Mac-Windows-type future, where the companies would largely

Page 10: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

10   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

continue to mimic each other while users bifurcated into distinct camps based on

preferred design or experience. The second respondent hinged his hypothetical bet on

video, suggesting that the company to successfully integrate or acquire video technology

would leave the other in the dust. The third and most interesting speculation asserted as

fact that Trulia had considered pivoting to compete with Redfin, essentially becoming a

broker itself, before killing the idea in the face of a pending merger. Imagining that

scenario is a compelling experiment, but that it was struck down is actually more

indicative of what we can expect from Trulia independently or as part of Zillow in the

future. We rely on primary research and industry interviews heavily in our analysis, but

this specific question is addressed more reliably by economics than individual

speculation.

The underlying market dynamics impacting the companies’ futures were discussed in

section 1, which affords a good opportunity to pick up where that section left off, in its

prediction that this industry will mature to even more closely resemble the online auto

and travel-booking marketplaces.

Page 11: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   11  

4| EXECUTIVES PLAN LEADGEN MARKET EXPANSION, BROAD & DEEP Based on the companies’ present combined market valuations, what assumptions about their future would you have to make in order to buy stock in the combined company? A lead-generation business can be expanded broadly, by offering the same services to

new customer groups – think acquisition of a corporate real estate marketplace – and

deeply, by offering new services to the same customer group – think branded-stationary

for brokers. We believe the Zillow and Trulia management teams have the preparation,

capacity, and intention to expand in both these ways.

“When we left the travel industry, we started looking at other industries that

hadn’t been impacted very much by the Internet. Real estate is a huge industry. It’s information-intensive, and it begged for consumer empowerment.”iv

-Spencer Rascoff

“Real estate is an industry about data, about money and about emotion. The data has changed how marketing is done.”v

-Pete Flint The executive teams responsible for founding Zillow and Trulia, as well as for operating

them today, share common professional backgrounds — maybe surprisingly, not in real

estate. According to Zillow management biographiesvi, no fewer than four current

members of the company’s executive team first collaborated as the two sides of a 2003

acquisition analogous to the Zillow-Trulia deal we’re analyzing today.

Expedia (then part of InterActiveCorp), the leading online travel booking website,

purchased Hotwire in September, 2003. Current Zillow CEO Spencer Rascoff was a

Hotwire co-founder who joined the Expedia team post-acquisition. Fellow Hotwire

employee Amy Bohutinsky would later join Zillow as its CMO. Expedia veterans Lloyd

Page 12: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

12   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

Frink (Zillow co-founder and vice chairman) and Rich Barton (Zillow co-founder,

executive chairman, and former CEO) round out the group of four mentioned above.

Trulia CEO Pete Flint likewise came from the online travel booking industry, having

launched LastMinute.com, which would become Europe’s leading online travel booking

site before a 2005 acquisition by Travelocity. Both Zillow and Trulia tell a cute founder

narrative that starts with a couple of cofounders’ frustrations over their own house search,

but the parallel paths of the two teams is no coincidence. Lead generation connects these

two industries, and the two executive teams’ expertise in lead generation has empowered

the past and present successes. We’re confident that it will continue to spur the combined

company’s growth as a revenue-generating engine behind opportunities to expand into

generating leads for commercial real estate transactions, for mortgages, and more. Lead

generation isn’t as sexy as disruption, of course, so we don’t often see companies talk

about it. Lead generation has even built a bit of reputation as a dirty little secret behind a

certain class of tech companies — where they would prefer to be exalted for their

superior technologies, their success is much more causally tied to their ability to

aggregate and disseminate contact information.

To add a caveat to the first paragraph of this section, management can add value to a lead

generation business in a subset of the “deep” definition above, by adding to the customer

group itself. Zillow approaches this strategy by selling ad placements across the entire

residential real estate spectrum, including properties that are not currently on the market.

Contrasted against the 3% of properties in the US that are listed for sale, Zillow’s

Page 13: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   13  

inventory is massive, and its opportunity to replicate the model in markets that might

include corporate real estate and mortgage lending is promising for investors.

The strategic assumptions that lead to our bullish outlook rely on practical assumptions,

including:

• Our sources are trustworthy & reliable

o Employee of commercial real estate marketplace disclosed that Zillow

is looking into acquisition, signaling potential growth into commercial

real estate sector, whereas it now only operates in residential real

estate

• Network effects will produce growth and generate cost savings through

redundancy elimination

• Cannibalization is avoidable through market expansion

• Potential for antitrust regulation is minimalvii viii

• Historical gain of market share in legacy industries predicts future likelihood

of the same

o Ex: Realtor.com was hailed as a strong incumbent with 9mm users,

Zillow now order of magnitude larger

• Historical use of strategic acquisition to bolster business model predicts

future likelihood of the same

o Ex: Acquired ListHub 3 years ago, now owns the largest "shared

upload portal" in the market

Page 14: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

14   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

o Around the same time, shifted from advertising-only to subscription-

based, which strengthened likelihood of recurring streams and now

represents 80% of revenues

Page 15: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   15  

5| BUY COMBINED Z+TRLA AFTER SETTLING

What trades, if any, would you recommend around this transaction and why?

Our analysis culminates to show a combined company that possesses almost unrivaled

experience in growing profitable technology companies by using lead-generation

business models. Speaking with highly knowledgeable people from the industry in which

the companies operate, as well as representatives from the companies themselves, we

developed a clear understanding of both Zillow and Trulia fostering ambitions to grow by

testing new business models and extending their current, proven model to new markets.

At the time of this report’s publication, Zillow and Trulia stocks have recovered from

volatility surrounding the acquisition news, and we recommend purchasing both Z and

TRLA as long-term investments, anticipating value to increase moderately over the next

6 to 12 months, and to increase substantially in years 1 to 5 thereafter.

It is important to note, as well, that we would have tempered this recommendation if it

were sought earlier. Just after the announcement of acquisition news, we recommend not

taking action on the stocks of either company, anticipating abnormal returns amid undue

volatility. Around the time of the announcement, between July 23rd and July 28th,

Zillow's stock price climbed straight from $126.47 per share to $160.32 and Trulia's stock

jetted from $40.59 to $65.04. Meanwhile, the S&P 500 just fluctuated between

$1,978.34, achieved on Jul 25th, and $1,987.98, achieved on Jul 24th. The remarkable

increases for Zillow's and Trulia's stocks at that time are full of bubbles and easy to go up

Page 16: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

16   GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY  

in smoke. Finally, during recent days from Oct 15th, Zillow's stock price fluctuated

around $106, with an error of nearly $3, and Trulia's stock price fluctuated around $45,

with an error of nearly $2. Both stocks' prices have decreased and had fewer standard

deviations compared to those at the time of announcement, which proves that it should be

a wise decision not to buy the stocks from both companies just after the release of the

acquisition announcement.

Holding the stock as a long investment will allow synergy to take effect, decreasing cost

of revenue by achieving economies of scale. Also, the merger will help the combined

company spend salary only on its best retaining talented employees while achieving

meaningful savings in redundant human capital cuts.

Zillow envisions and plans on taking the mobile device market of real estate searching,

one step further to take the future trend. The company wants to improve current valuation

tools and provide more accurate value for users in assessing house price. The acquired

data from Trulia’s users will help Zillow understand customers. To establish a solid

position, Zillow plans to acquire commercial real estate searching companies, as

confirmed by sources familiar with the matter.

Together, Zillow and Trulia have the ambition to extend services from only residential

real estate to new markets. By doing so, Zillow will not rely on only residential real estate

lead generation but also commercial lead generation. It gives the companies the

opportunity to diversify services and grow in a massive way that will benefit investors

who buy now and hold.

Page 17: Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals

GRAY,  LIN  &  YUE  –  JOHNS  HOPKINS  UNIVERSITY   17  

i http://www.businessinsider.com/zillow-chief-heres-why-we-can-be-a-billion-dollar-company-2012-4#ixzz3HsoPEW4N ii http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/ ii http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/ iii https://www.americanexpress.com/us/small-business/openforum/articles/qa-spencer-rascoff-founder-of-hotwire/ iv https://www.americanexpress.com/us/small-business/openforum/articles/qa-spencer-rascoff-founder-of-hotwire/ v http://www.mercurynews.com/business/ci_21811772/mercury-news-interview-trulia-ceo-peter-flint vi http://www.zillow.com/corp/WhoWeAre.htm vii “The companies estimate total spending on real estate advertising in the U.S. is $12 billion a year, of which Zillow and Trulia together currently have less than 4 percent of the market.” http://www.bloomberg.com/news/2014-07-28/zillow-to-acquire-trulia-for-3-5-billion-in-stock.html viii “real estate industry is highly fragmented, with scores of local sites for each cities.” http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/?_php=true&_type=blogs&_php=true&_type=blogs&_r=1