zillow’s acquisition of trulia - the door to the online ... · 11/3/2014 · zillow’s...

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

zillow’s acquisition of trulia - the door to the online ... · 11/3/2014 · zillow’s...

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