The Zillow-Trulia merger is the result of a fast courtship, which only hit the financial news wires last week. Since then, Trulia stock has popped by more than 40% and Zillow stock is up 25%.
But despite the enthusiasm by investors about this merger deal, it’s really more of an accounting trick than a true acquisition.
The terms of the deal involve 0.444 shares of Z stock replacing each single share of TRLA stock.
That’s it. Not a single real dollar has changed hands.
Now, all-stock deals are not uncommon — and among high-growth tech companies, stock-based deals are often preferable as ways to grow without bringing on big debt or spending big cash.
That has been true for ages, whether we’re talking about Google (GOOG) with its 2006 all-stock deal to acquire YouTube, or whether we’re talking about recent Facebook (FB) deals for virtual reality company Oculus VR and for messaging player WhatsApp that were made mostly in stock.
But it’s worth exploring what this deal means for current and future shareholders of Zillow stock after the Trulia deal, since these kind of transactions can really mess with valuations.
Zillow Stock Now Grossly Overvalued
Investors should ask themselves if the value of the two companies combined is worth a roughly 45% premium over what the two companies were valued at apart.
Here’s how the math works:
- Trulia stock market cap: $1.5 billion
- Zillow stock market cap: $4.2 billion
- Total: $5.7 billion
- Trulia stock market cap: $2.3 billion
- Zillow stock market cap: $6 billion
- Total: $8.3 billion
That’s more than 45% in value added to the duo simply because of the alliance.
That alone is enough to ring some alarm bells for me.
Even more disturbing, however, is that at current valuations Zillow is sporting a forward P/E ratio of about 150 and Trulia is sporting a forward P/E of about 300!
These stocks were already trading at huge premiums on future earnings, and now the combined company is trading for even more. That means there is no room for error.
Sure, I believe in the long-term growth prospects of online real estate companies like Zillow and Trulia, and had been bullish on these stocks in particular for much of last year.
However, the efficiency gained from this merger and the lack of competition as a result does not guarantee Zillow will be able to ramp up its profits fast enough to justify its sky-high valuation after the big premium now baked into shares after the Trulia deal.
There is a chance that Zillow and its now-acquired pal Trulia will prove the naysayers wrong. However, if you’re sitting on a big profit after this post-buyout pop … I would dump at least part of your stake and move on to other investments.
The risk is just too high with premiums like this, and the chance for a stumble in the next several months is just too great.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.