Last summer, Zillow Inc (NASDAQ:Z) agreed to buy its biggest competitor, Trulia Inc (NYSE:TRLA), in a stock swap deal valued at $3.5 billion. Late last month shares of Z stock gained 8.2% in one day on reports that the Federal Trade Commission (FTC) had finally given its OK to the long-pending merger of the two companies.
With a move of this magnitude you would think analysts and investors would be very bullish on Z stock in advance of the company’s earnings announcement on Wednesday. However, there’s a lot of uncertainty surrounding the real estate information provider — the company does not seem to be profitable.
Revenue is great. Margins are the problem. So as the company reports earnings this week, we need to hear how it will address this long-term problem going forward for Z stock.
Z Stock: The Business Model
Zillow represents a paradigm shift in the home-buying process by moving the initial steps of searching for real estate online. And initially it has worked, as seen by its substantial revenue growth. The ease in searching for homes and the growth would signify that Zillow is at the forefront of how we buy and sell houses today.
Zillow’s revenue stems from its housing database, which makes available maps, pictures, price estimates and agent listings. The site acts as an online platform to connect all the players who partake in the process. The platform generates money through agents paying listing fees, subscriptions and advertising.
So it would seem that revenue would only increase when you buy your biggest competitor in the space. Actually, according to comScore, Zillow and Trulia drove 89% of the total traffic to the 15 most-visited real estate sites in August 2014 with unique visitors exceeding 92 million.The addition of Trulia’s portfolio should benefit Zillow both new listings and scope. This is a good thing going forward.
However, Trulia is just like Zillow — neither company is very profitable.
Can Growth Carry Z Stock Through?
Bulls will tell you that Z stock is still in its growth phase, so the bottom line is not as important as growing the number of users — that was one of the perks in acquiring Trulia.
But bulls needs to ask themselves if the Zillow business model will ever be profitable. Remember, Zillow’s bread and butter is derived from real estate agents who subscribe or advertise with the company to acquire buyer leads. Zillow draws potential home buyers and sellers with a top-quality site providing maps, photos and a host of real estate information.
This all costs a good deal of money and so margins suffer. This is something that needs to be addressed this Wednesday by Zillow management.
Along with its margin problems, Zillow is facing accuracy issues, especially with property value estimates — what it calls “zestimates.” Zillow CEO Spencer Rascoff, when asked about this question, stated that nationally the company is off about 8%. However, agents in other parts of the country claim that the disparity can be even greater causing issues between agents and clients.
This is a serious problem for Z stock. Why would agents pay for leads that are inaccurate and give them nothing but headaches?
Z Stock: Looking Ahead
Revenue growth is a wonderful thing, but a company cannot pretend that margins do not mean anything. It was understandable the bump Zillow’s stock received from the Trulia purchase, but we need to know if or how that will make the company more profitable going forward.
It also would be nice to know how or if Zillow can make the site more accurate. Incorrect data will just spur real estate agents to go elsewhere.
If these problems aren’t addressed, I can see hard times ahead for Zillow and Z stock.
As of this writing, Jason Jenkins did not hold a position in any of the aforementioned securities.
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