Is Zillow's Stock a Buy?

Editor's Note: This story has been updated since its original publication. An earlier version of this story incorrectly stated that Trulia was the leader in real estate Web sites. Zillow is the most-visited site in this category.

The way some analysts talk about Zillow (symbol Z), you’d think the real estate Web site would change the way homes are bought and sold in America. Truth is, it already has in some ways.

But is this a good time to invest in Zillow shares? As great as the story may be, the answer is no.

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Before Zillow came along, home shoppers and sellers were at the mercy of their real estate agents. For instance, if you wanted to know what the house across the street cost when the new owners moved in last month or how much the home’s new kitchen affected its property taxes, you’d have to get the info from an agent or do your own digging at the local public-records office.

But now, anyone who wants to know that stuff -- and more -- can find it in seconds on Zillow. The real estate database is chock full of info on 100 million homes across the country, whether they’re up for sale or not. Just plug in a street address and voila: You’ll get property-tax history; the change in value over the years; when it sold before and at what price; the age of the house, square footage, lot size and a brief description; plus photos, maps and street views.

That’s powerful ammunition for anyone buying or selling a home. In the first quarter of 2012, on average, nearly 32 million clicked onto the site monthly, according to the company. And thanks to Zillow’s smart-phone apps, millions of shoppers can arm themselves with pertinent facts about a prospective new home before they even step inside.

During the housing boom, the biggest buzz about Zillow was about its proprietary “Zestimates,” the property-value estimates it calculates for every home in its database. Its “Make Me Move” function -- you set your price on Zillow and wait for buyers to come to you by e-mail -- also had people talking.

Of course, this kind of information is bound to sideline real estate agents a little -- or at least irk them…a lot. Says analyst Bradley Safalow, of PAA Research, a New York City-based stock-research firm: “If Zillow becomes a de facto real estate residential engine, the loser will be traditional brokerage firms.”

But Zillow has bet its business model on that very market. “Zillow wants to become a marketing partner to real estate agents and brokers,” says Safalow. The Seattle-based company generates revenue by selling space -- basically advertising -- on its Web site to real estate agents and mortgage brokers, all of whom pay a monthly fee to be featured on the site when consumers search in specific zip codes. The monthly fee averaged $342 at last report, but it ranges between $100 and $1,000 a month, depending on Web site traffic within the zip code. In 2011, Zillow pulled in more than $66 million from those ads, a 117% jump from the year before. Safalow thinks the average monthly ad price could grow within the next three to five years to as much as $1,000, based on prices charged by similar real estate sites in Australia and the U.K.

Meanwhile, Zillow has scarcely tapped the $20 billion real estate advertising market, says Citi analyst Mark Mahaney. Today, about 19,000 real estate agents advertise on the site, but the company is testing a new pricing method that may draw as many as 100,000 agents. Under the new model, agents would pay fees based on the number of times their ads are displayed, rather than a set monthly rate.

The company also has a mortgage business, called Zillow Mortgage Marketplace, which offers consumers rate quotes for free. Mortgage brokers provide the quotes, and consumers can choose whether to contact them afterward. Zillow logged more than 5.5 million such requests in 2011. Plus, Zillow’s recent $40 million acquisition of RentJuice, which was completed in June, gives it access to the country’s growing rental market, and adds 1 million rental listings to the 300,000 already in Zillow’s database.

What’s more, the company has $54 million in cash and zero debt. Revenue has doubled in each of the past two years, and analysts expect it to rise 70%, to $112 million, in 2012. Analysts expect earnings to more than double in 2012, to 28 cents per share, and in 2013, to 65 cents per share.

Still, there is good reason for pause. For starters, Zillow’s stock is richly valued. At the June 12 close of $31.24, it trades at a sky-high 112 times estimated 2012 earnings. Based on 2013 estimates, the price-earnings ratio is still a hefty 48. (Zillow shares dropped 3.2% on June 12, a strong day for the overall market.)

Although the stock has dropped 28% since May 9, we’d look for additional declines before buying. As promising as the outlook is, there’s a lot going on that might put pressure on the shares later this year. Analysts have trimmed their earnings estimates in recent weeks, in part to accommodate plans for Zillow to spend more later this year. For example, Zillow is opening a new office in Orange County, which will require hiring more people. More acquisitions may be coming, too. And the company is spending heavily on technology for its mobile applications and Web site.

There’s the competition, too. Trulia, for instance, is the second-most visited real estate Web site, and it now offers a home-value estimate function that’s similar to Zillow’s Zestimates. (Realtor.com, the Web site of the National Association of Realtors, ranks a distant third in traffic.) Analysts expect Trulia to go public later this year.

And finally there’s the housing market. Though it has shown a few signs of life this year, it may sputter, along with the economy. If it does, that could dampen results at Zillow, too.

For now, given that “if” and others -- including whether more agents will beat a path to its door to advertise -- we think you’ll get a chance to buy the stock at a significant discount to where it now trades.

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