Zillow Group Inc: Investor Discussion

DeMatteo Research hosted a discussion on Zillow Group Inc (Z) with six investors. With the iBuying experiment behind it, Zillow maintains a robust 2025 financial target. Investors in the stock shared thoughts and ideas about how the company can execute from here. The following is a compilation of their thoughts and ideas from the discussion:

Highlights

Four months after Zillow announced in its 3Q earnings that it would exit iBuying, investors in the stock agreed that the thesis on the company has changed considerably. Many institutional investors who owned the stock prior to the iBuying debacle last year were in it because of the potential promise behind iBuying. Some expressed a measure of relief that the iBuying experiment was shut down quickly.

Investors are left with a business that has significant NOLs, generates plenty of free cash, and has a balance sheet that will look very clean once the mortgages and real estate assets are netted against one another as iBuying winds down.

Most investors in the discussion held Friday, March 4, said they envision a lower multiple, cash flow generating business with a monopolistic nature in the marketplace, and with the potential to keep growing. However, investors find it difficult to assess what the growth rate will be going forward. There remains an aggressive 2025 financial target set by the company and questions about how to get there. The 2025 financial target is $5 billion in revenue and 45% adjusted EBITDA margins.

Historically, Zillow’s core IMT business has grown in a haphazard manner. It has not had growth measured the way a traditional classifieds business would be measured. It is not as simple as measuring the number of advertisers times average revenue per account (ARPA). Instead, Zillow has experimented repeatedly with revenue models, trying different strategies in pre-paid, post-paid, auction, and dynamic pricing. This has led to less clarity today than investors would like.

At this point, the most exciting avenues investors see from the perspective of the client (advertiser) are ShowingTime (the Scheduling feature) and the Flex business, where Zillow provides connections and leads to Premier Agents at no upfront cost but then collects a sizeable success fee once a home is sold by the agent. The investors agree that a planned all-encompassing, consumer-oriented Marketplace Vision super-app platform could be a catalyst for future visibility into the business. Such an endeavor would contain a much more robust ad model than the current skinny model. The investors are expecting to hear more about this in the coming months. As far as hitting the 2025 goal, if growth is anywhere close to the trajectory management has guided for, investors are getting close to one-third of the business’s current share price in net cash in a couple of years.

Many other factors contribute to the difficulty in understanding the future growth rate, however. The most notable factors are the rise in interest rates, the prospect that we may be near max home price appreciation, and the extremely low level of home inventory on the market. New home inventory drives demand for advertising, so the current seller’s market and extreme tightness of supply bodes poorly for Zillow’s aggressive 5-year growth plan.

While that 5-year growth plan is in line with historical experience, management hasn’t clearly communicated how that growth rate can be achieved given the more difficult market dynamics, according to several participants. In order to achieve the 5-year revenue and growth targets, the company will have to demonstrate much higher growth with ShowingTime and a higher mortgage attachment rate.

One investor places a valuation on the core IMT business alone at $70 - $80 per share, arguing that the stock has dramatically overcorrected on the iBuying stumble and subsequent tech stock correction. Despite the debacle of iBuying, this investor has high confidence in Rich Barton as CEO. The investor sees an opportunity to drive ARPU by cultivating more Premier Agent teams that really embrace the model.

On the risk/bear case side, this investor points out that one large segment of the housing market data is now available across many competing platforms. There are several sites now with similar user interfaces and much of the same data as Zillow. Furthermore, Zillow faces competition from well-funded CoStar Group (CSGP), which acquired Homes.com in 2021 and Homesnap in 2020. CoStar is spending north of $100MM to create proprietary content to try to change the browsing behavior of homebuyers. One investor noted that Zillow missed its Premier Agent numbers for Q4 (reported in February) and guided down for Q1.

Lastly, Zillow has a good relationship with the top 10% of brokers, but the company needs to improve its relationship with the other 90%. Some percentage of that 90% already have a more friendly relationship with rival Homesnap. This investor believes that Zillow can address all these issues but is concerned that it will take significant near-term investment to do so properly. 

The Flex business was a point of much discussion. Several investors spent time lauding the potential for the Flex business. They view it as a way for Zillow to monetize more transactions at higher levels. Another investor feels that Flex represents the middle of a Venn diagram between the old business and iBuying as far as taking some of those leads and putting them through to higher-converting platforms. Within Flex, he views the expense side of that business as more of a recruiting model as opposed to a pure commission-based model. With one Flex/Premier broker in a ZIP code, as that broker hires more agents, the business grows for Zillow and for the broker. 

One investor has been in the stock since 2019 in spite of iBuying. He bought the stock based on the company sitting at the “top of the funnel” of a massive ecosystem—not simply broker commissions but also the promise of monetizing all the ancillary services associated with buying a home. This investor points out that over the last three years, the core business has done extremely well. If Zillow had not gone through iBuying, he believes there would be much less skepticism around the stock. He acknowledges that he didn’t appreciate just how much iBuying had attracted the attention of momentum investors who then abandoned the stock.

His bull case at this point rests around all the ancillary services and monetization opportunities like mortgage, title, and escrow. He points out that Zillow’s push into these areas was really focused on and tied to the iBuying business. Now that it’s gone, Zillow still has big plans for ancillary services. However, there’s been a sort of reset for how those new services will be created and sold since it won’t be under the iBuying umbrella anymore.

He views Flex as somewhat less central to the growth from here. For Flex to work well, he thinks Zillow must carefully qualify and recruit excellent, top-tier broker teams in each ZIP code who understand Flex and really embrace it. Only then is it truly a great deal for Zillow, the broker, and the buyer. It can and should be just that in many more large markets than it is currently used in today. 

Multiple investors believe that at 12x EBITDA, the pressure is off Zillow to need to grow as fast as they were in the past. 

The outlook for stock buybacks is one real positive. Zillow announced a $750MM buyback on Dec. 1, and then proceeded to spend half of that amount in one month. That demonstrates an aggressive posture toward buybacks, and with $3B of cash on the balance sheet and another $1B in free cash flow generation over the next several years, Zillow seems poised to be very supportive of its stock price.

On the M&A front, investors couldn’t name a company that would be a natural fit to acquire Zillow. However, one investor felt that Zillow itself could and should go after acquisition targets that give it better immediate penetration into these ancillary services.

On CEO Rich Barton, the consensus view is that he’s the right person for the job and investors appreciate his humbleness and transparency. One investor felt that his credibility was damaged by the iBuying reversal. Another said that in the last call with investors (Q4 earnings reported on Feb. 10th), Barton engaged in a lot of “hand-waving” on questions about how they can achieve their 2025 financial targets. This investor expects to get more clarity when Zillow reports Q1 earnings in early May. Another investor bought the stock after the iBuying debacle in part because he was impressed by the frank and candid communication of Barton.

One investor surmised that, from a tech investment perspective, iBuying seemed to put much of the other Zillow initiatives on the back burner. The silver lining is that it was a rapid effort and failure from beginning to end. The pivot in their focus away from iBuying was fast.

He referred to Zillow as a site that serves as the “port of call” for virtually all real estate investors. With the treasure trove of data Zillow manages on each user, Zillow doesn’t really need 6% transactions to make the trade work. They are starting from a small base of business in selling ancillary services to a massive market. Given these dynamics, it only takes 100-200 bp of incremental transaction revenue to really move the needle going forward. 

An investor with a small position in Zillow said he is long the stock but in-line with Street numbers and, in creating a model for growth, he can’t quite square how the company gets to its 2025 targets. He has played around with the numbers: modeling out increased conversions around Flex, increased penetration around Flex, and increased conversions around ShowingTime, but he still cannot get there.