August 24, 2011

While Zillow might be forgiven for its single letter ticker selection given a likely lack of competition, certainly relative to P or N, it still rang the hubris meter in a similar fashion and remains one of the few remaining poster children for wildly overvalued IPOs.  As I have mentioned in the past, 15x revenue on nominal profitability in a still troubled real estate end market seemed like more than a bit much.  Post the company’s first earnings report as a public company this afternoon, that should become a bit more clear and I would expect Z to follow P to a level well below its $20 IPO price.


Heading into the report Z has about 33M shares outstanding post IPO and including the effect of 5.4M options struck in the $4’s, for an $866M enterprise value at today’s close and a $770M enterprise value post cash and IPO proceeds.  This compares to a second quarter report featuring $15.6M in revenue, $3.9M in EBITDA and $1.6M in earnings.  While the headlines focus on the company’s profitability in the first quarter out compared to a loss in Q1, very muted guidance in likely to quickly weigh on the shares after any early profit euphoria.  Even without the poor guidance, investors might think twice about paying 12X revenue and 50X EBITDA even with pretty impressive 100% plus Y/Y and nearly 40% sequential revenue growth.



Z guided to a significant flattening in revenue for the year and even more significant reductions in EBITDA and profit margins.  Revenue was guided to $16-17M for Q3 and $60M for year, implying flat Q4 revenue in the $16.5M range as well.  Direct questions as to what’s driving the top line flatness were dodged.  EBITDA margins were guided down to “north of 15%” in Q3 and 15% for the year on increased opex of all stripes, compared to a 24% EBITDA margin in Q2 which implies something near an EPS loss in Q4.  So in sum we have $60M in revenue and $9M in EBTIDA for 2011 with three quarters of essentially flat revenue for a growth IPO with “only 1% of the local real estate advertising market” (another historical red flag).   Which is to say, on the one hand there are only 13,000 paying broker subscribers out of likely 1M on the service, on the other hand the pay service has been launched for nearly three years and there are only 13,000 subs.


And this guidance was described only as “achievable” to a small and grumpy group of analysts (- at least the Citi lead was- only two of five underwriters on the call, all of whom have yet to initiate given the quiet period) prior to a candid discussion of the awful housing macro in which the company forecast a bottom sometime in 2012.  The company did reiterate its long term model of EBITDA margins in the 30-35% range on revenues in the $200-250M range, representing only a nine fold increase in EBITDA on a four fold increase in revenue from 2010 levels.  Oddly, $27 seems about right were the company achieving those metrics now, given that it’s not $10-15 makes more sense and is actually still pretty generous.


Like P, Z has a nice website and a nice business in a real estate market that makes the Department of Commerce look technically advanced, and could even be a long at some point, just nowhere near current levels.  Also like P and a lot of these new management teams, there doesn’t seem to be much understanding about the intersection of valuation and expectations.  And beyond a reasonable distance from the IPO price, its really not their responsibility what the market does with the shares.  However, I doubt at $20 the pitch was three flat quarters, and management’s leaning on still impressive (though “decelerating”, to use the inverse of today’s growth CEOs favorite term)  year and year growth rates underscores that point.