Zillow + Trulia: Acquisition Amplifies LeadGen Prowess, Signals New Market Development
Muddy Waters Investment Competition In collaboration with The Economist Group’s Which MBA? Analysis prepared by: Keaton Gray Yu-jui “Ray” Lin Yue Sun
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Abstract
Accurate analysis of the pending merger between Zillow and Trulia requires a
deep understanding of the executive teams’ experience building lead generation
businesses in the real estate industry and elsewhere.
The following report will combine such an understanding with primary research
compiled through interviews with industry insiders. The resulting hypotheses identify
new market development opportunities in the commercial real estate and mortgage
lending industries on which a combined Zillow-Trulia is likely to capitalize.
These new market development opportunities set the stage for enormous growth.
Current opportunities, as well, play an important role in the analysis. The combined
company will leverage pricing power gained from 61% usershare over a market that
already delivers significant value, even while combined, the companies command only
4% marketshare. This is a story of growth.
“My priorities for Zillow are simple: 1) Grow our audience, 2) Grow our Premier Agent business, 3) Grow our emerging marketplaces of
Mortgages, Rentals and our New York real estate marketplace, and 4) Ensure that our company can properly scale to the size of the opportunity
in front of us.” - Z, 10K
“Our online marketplace is experiencing rapid growth”
- TRLA, 10K
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1| ZILLOW PRIMES PATH TO PROFITABILITY THROUGH EFFICIENCIES & NEW MARKET DEVELOPMENT; WINS DEAL Which company is getting the better deal and why? Zillow gets the better end of its merger with Trulia. Both parties appear to be happy with
their deal – indeed, the newly combined entity will capitalize on its future successes
together. An all-stock transaction weighted in Zillow’s favor, however, should similarly
weigh future benefits in the same direction. Zillow can expect a boost in new customer
leads and value creation for existing users in the short term, as well as long-run benefits
including cost saving in overlapped divisions, faster technology innovation, and high
growth potential in commercial real estate market and mortgage service business.
This analysis will dive deep into this last point throughout its course, identifying the vast
stores of profit potential created when lead generation titans join forces.
If a merger is approved, Zillow will immediately inherit Trulia’s 54 million users. An
intense rivalry that competed for customers will become a cohesive cooperation between
two industry leaders. Where the former scenario aligns incentives such that both parties
lose (through competitive pricing, for example), the latter allows for network effects and
pricing agreement. This is especially important when a company’s primary revenue
stream comes from selling pockets of pixels that carry no real monetary value in-and-of
themselves.
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Combined with Zillow’s current 83 million users, the merger will result in a dominant
61% of total users in the online real estate listing industry. Zillow will become stronger
with a leading number of users and market share, a weakened competition structure in the
online real estate search industry, and the ability to redirect competitive efforts to
expansion.
Distinguishing user share from market share becomes critical when we consider their
implications. A combined 61% usershare creates pricing power. If a realtor concedes that
potential homebuyers’ likelihood to research online is high and getting higher, the realtor
will very probably conclude that she needs a presence on the portal that commands the
attention of 61% of web-using potential homebuyers. Whereas analysts of mature
markets might rightly cite constricting growth potential as cause for concern, the context
of this deal may require us to reasses that idea. Compared against 61%, the 4%
combined-marketshare figure looks downright small – small, and promising for growth
potential.
61%
combined usershare
4%
combined marketshare
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One startup mantra encourages companies to build userbases now and figure out how to
make money later. It can be a frustrating strategy for potential investors, but it
demonstrates a property of digital markets that is relevant here: a userbase is easier to
expand than a market. For Zillow and Trulia, it means that 96% of residential real estate
advertising dollars go elsewhere, including placements like fliers and bus stop benches
that deliver zero insight into their performance as tools to send realtors new leads.
Zillow’s CEO explained this to Business Insider in 2012:
“Agents collect $60 billion in commissions a year and they turn around and
spend about 10% of that in advertising, $6 billion a year. So despite our significant revenue growth — five straight quarters of over 100% year-over-year
revenue growth — we have less than 1% wallet share of what agents spend on advertising. Think about that for a second. We are the biggest real estate site on
the web, by far the biggest real estate site on mobile, and yet agents spend 99% of their ad budgets elsewhere.”
– Spencer Rascoffi In the course of our research, an interview with a former Zillow employee confirmed that
Zillow is actively considering broadening the range of services it offers current
customers. Feasibly, the newly merged company could compete in the large branded-
stationary market long popular with real estate agents. More likely, we’ll see an extension
of services that allow for measurement and optimization of leads generated.
Zillow, Trulia, and a small cohort of peers are early iterations of a real estate marketplace
that will inevitably catch up with technology-enabled markets like auto and travel.
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2| ALL-STOCK TERMS ASSUAGE ZILLOW RISKS, APPEASE TRULIA SHAREHOLDERS Does the structure of the deal make sense for each company? Management from both companies arrived at a rational deal structure through
negotiations. For Zillow, using only stocks as an exchange for Trulia's stocks can save a
large quantity of cash and increase the company's liquidity ratio compared with using
only cash. Good for Zillow does not mean bad for Trulia, however. The New York Times
reports Trulia management “requested that it be an all-stock deal to give Trulia’s
shareholders a chance to benefit from the merger.”ii Based on the latest balance sheet and
cash flow statement of Zillow on June 30, the quick ratio of Zillow is approximately 7.95,
current ratio is 8.09, and the operation cash flow ratio is 0.31.
In $000s
Although the quick and current ratios are large enough to show Zillow’s outstanding
ability to pay off the short-term debts, its low operation cash flow indicates that Zillow
has not generated enough cash from operations against its current debts, which will raise
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a concern about the sustainability of the firm. Therefore, the stock-only transaction
removes Zillow's worry of raising any additional great amount of money, the influence
on its working capital and the influence on its liquidity level.
Zillow can decrease the risk it bears by splitting part of risks to Trulia through the stock-
only transaction. Compared to a cash transaction, exchanging only in stocks does not
require the acquiring side, Zillow, to assume all risks of paying cash, but enables the
selling side, Trulia to share the risks of the acquisition premium. Since Zillow would like
to pay 0.444 of one of its shares for one of Trulia and its shareholders would own two
thirds of the combined company, it will bear the synergy risk based on the proportion and
Trulia takes the rest.
For Trulia, the biggest advantage of the stock exchange is the benefits for shareholders.
As mentioned above, Trulia's shareholders can get one third of the combined company
and transfer their one stock into Zillow's 0.444 stock. The price provided for Trulia is
$70.53 per share, a 25% premium on Trulia's closing price on July 25th. Based on the
price premium and our bullish expectation of the combined company, Trulia's
shareholders should be willing to get Zillow's stocks and obtain financial interest in the
future.
Taking both companies into consideration, Zillow and Trulia can share some benefits
from the stock-only transaction. For instance, first, they can save time, labor and
expenses on renegotiating some specific contracts, which would be required in a cash
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purchase. Second, the corporate structure for each will remain the same and both
companies are able to operate continuously and smoothly as before. Third, tax issues and
laws of restrictions on sale of assets can be avoided or reduced due to noninvolvement of
cash.
Technically, there is no doubt that the stock-only transaction has cons for Zillow and
Trulia. For example, the deal structure influences both companies' equities through
exchange of shares, which means each company will take the risk of the other.
Additionally, the selling side, Trulia, bears the risk of converting Zillow's stocks into
cash.
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3| ZILLOW EXPANDS LEADGEN MARKETS, TRULIA TESTS BUSINESS MODELS What will the futures likely be for each company on a standalone basis if the transaction fails to close? Through interviews detailed in a later paragraph, we learned that Zillow understands its
role as a lead generator, and is patiently pursuing new markets to enter. We have first-
hand information that Zillow has engaged in talks to acquire a commercial real estate
marketplace that would increase its total addressable market to include not just residential
real estate, but virtually all real estate. This potentiality does not require Zillow to stay
independent, of course, and is factored into our bullish analysis of the transaction writ
large. While we expect Zillow to forge ahead in any scenario, we learned that Trulia was
more willing to consider business models very much outside its core competency of lead
generation.
“Within Zillow, we are doing really exciting things like creating new product
lines, new platforms, expanding our rental category and acquiring companies.”iii -Spencer Rascoff
The future for each company separately is more challenging on a standalone basis than at
merged scale. On a standalone basis, each company will compete on siphoning new
customers and maintaining existing users. On the contrary, combined company will be
able to focus on expanding new customer base as an entity.
We interviewed a former Zillow employee, the founder of an industry competitor, and an
employee of a commercial real estate online marketplace in an effort to better understand
the specific directions these companies may have headed, were they not to merge. One
response imagined a Mac-Windows-type future, where the companies would largely
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continue to mimic each other while users bifurcated into distinct camps based on
preferred design or experience. The second respondent hinged his hypothetical bet on
video, suggesting that the company to successfully integrate or acquire video technology
would leave the other in the dust. The third and most interesting speculation asserted as
fact that Trulia had considered pivoting to compete with Redfin, essentially becoming a
broker itself, before killing the idea in the face of a pending merger. Imagining that
scenario is a compelling experiment, but that it was struck down is actually more
indicative of what we can expect from Trulia independently or as part of Zillow in the
future. We rely on primary research and industry interviews heavily in our analysis, but
this specific question is addressed more reliably by economics than individual
speculation.
The underlying market dynamics impacting the companies’ futures were discussed in
section 1, which affords a good opportunity to pick up where that section left off, in its
prediction that this industry will mature to even more closely resemble the online auto
and travel-booking marketplaces.
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4| EXECUTIVES PLAN LEADGEN MARKET EXPANSION, BROAD & DEEP Based on the companies’ present combined market valuations, what assumptions about their future would you have to make in order to buy stock in the combined company? A lead-generation business can be expanded broadly, by offering the same services to
new customer groups – think acquisition of a corporate real estate marketplace – and
deeply, by offering new services to the same customer group – think branded-stationary
for brokers. We believe the Zillow and Trulia management teams have the preparation,
capacity, and intention to expand in both these ways.
“When we left the travel industry, we started looking at other industries that
hadn’t been impacted very much by the Internet. Real estate is a huge industry. It’s information-intensive, and it begged for consumer empowerment.”iv
-Spencer Rascoff
“Real estate is an industry about data, about money and about emotion. The data has changed how marketing is done.”v
-Pete Flint The executive teams responsible for founding Zillow and Trulia, as well as for operating
them today, share common professional backgrounds — maybe surprisingly, not in real
estate. According to Zillow management biographiesvi, no fewer than four current
members of the company’s executive team first collaborated as the two sides of a 2003
acquisition analogous to the Zillow-Trulia deal we’re analyzing today.
Expedia (then part of InterActiveCorp), the leading online travel booking website,
purchased Hotwire in September, 2003. Current Zillow CEO Spencer Rascoff was a
Hotwire co-founder who joined the Expedia team post-acquisition. Fellow Hotwire
employee Amy Bohutinsky would later join Zillow as its CMO. Expedia veterans Lloyd
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Frink (Zillow co-founder and vice chairman) and Rich Barton (Zillow co-founder,
executive chairman, and former CEO) round out the group of four mentioned above.
Trulia CEO Pete Flint likewise came from the online travel booking industry, having
launched LastMinute.com, which would become Europe’s leading online travel booking
site before a 2005 acquisition by Travelocity. Both Zillow and Trulia tell a cute founder
narrative that starts with a couple of cofounders’ frustrations over their own house search,
but the parallel paths of the two teams is no coincidence. Lead generation connects these
two industries, and the two executive teams’ expertise in lead generation has empowered
the past and present successes. We’re confident that it will continue to spur the combined
company’s growth as a revenue-generating engine behind opportunities to expand into
generating leads for commercial real estate transactions, for mortgages, and more. Lead
generation isn’t as sexy as disruption, of course, so we don’t often see companies talk
about it. Lead generation has even built a bit of reputation as a dirty little secret behind a
certain class of tech companies — where they would prefer to be exalted for their
superior technologies, their success is much more causally tied to their ability to
aggregate and disseminate contact information.
To add a caveat to the first paragraph of this section, management can add value to a lead
generation business in a subset of the “deep” definition above, by adding to the customer
group itself. Zillow approaches this strategy by selling ad placements across the entire
residential real estate spectrum, including properties that are not currently on the market.
Contrasted against the 3% of properties in the US that are listed for sale, Zillow’s
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inventory is massive, and its opportunity to replicate the model in markets that might
include corporate real estate and mortgage lending is promising for investors.
The strategic assumptions that lead to our bullish outlook rely on practical assumptions,
including:
• Our sources are trustworthy & reliable
o Employee of commercial real estate marketplace disclosed that Zillow
is looking into acquisition, signaling potential growth into commercial
real estate sector, whereas it now only operates in residential real
estate
• Network effects will produce growth and generate cost savings through
redundancy elimination
• Cannibalization is avoidable through market expansion
• Potential for antitrust regulation is minimalvii viii
• Historical gain of market share in legacy industries predicts future likelihood
of the same
o Ex: Realtor.com was hailed as a strong incumbent with 9mm users,
Zillow now order of magnitude larger
• Historical use of strategic acquisition to bolster business model predicts
future likelihood of the same
o Ex: Acquired ListHub 3 years ago, now owns the largest "shared
upload portal" in the market
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o Around the same time, shifted from advertising-only to subscription-
based, which strengthened likelihood of recurring streams and now
represents 80% of revenues
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5| BUY COMBINED Z+TRLA AFTER SETTLING
What trades, if any, would you recommend around this transaction and why?
Our analysis culminates to show a combined company that possesses almost unrivaled
experience in growing profitable technology companies by using lead-generation
business models. Speaking with highly knowledgeable people from the industry in which
the companies operate, as well as representatives from the companies themselves, we
developed a clear understanding of both Zillow and Trulia fostering ambitions to grow by
testing new business models and extending their current, proven model to new markets.
At the time of this report’s publication, Zillow and Trulia stocks have recovered from
volatility surrounding the acquisition news, and we recommend purchasing both Z and
TRLA as long-term investments, anticipating value to increase moderately over the next
6 to 12 months, and to increase substantially in years 1 to 5 thereafter.
It is important to note, as well, that we would have tempered this recommendation if it
were sought earlier. Just after the announcement of acquisition news, we recommend not
taking action on the stocks of either company, anticipating abnormal returns amid undue
volatility. Around the time of the announcement, between July 23rd and July 28th,
Zillow's stock price climbed straight from $126.47 per share to $160.32 and Trulia's stock
jetted from $40.59 to $65.04. Meanwhile, the S&P 500 just fluctuated between
$1,978.34, achieved on Jul 25th, and $1,987.98, achieved on Jul 24th. The remarkable
increases for Zillow's and Trulia's stocks at that time are full of bubbles and easy to go up
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in smoke. Finally, during recent days from Oct 15th, Zillow's stock price fluctuated
around $106, with an error of nearly $3, and Trulia's stock price fluctuated around $45,
with an error of nearly $2. Both stocks' prices have decreased and had fewer standard
deviations compared to those at the time of announcement, which proves that it should be
a wise decision not to buy the stocks from both companies just after the release of the
acquisition announcement.
Holding the stock as a long investment will allow synergy to take effect, decreasing cost
of revenue by achieving economies of scale. Also, the merger will help the combined
company spend salary only on its best retaining talented employees while achieving
meaningful savings in redundant human capital cuts.
Zillow envisions and plans on taking the mobile device market of real estate searching,
one step further to take the future trend. The company wants to improve current valuation
tools and provide more accurate value for users in assessing house price. The acquired
data from Trulia’s users will help Zillow understand customers. To establish a solid
position, Zillow plans to acquire commercial real estate searching companies, as
confirmed by sources familiar with the matter.
Together, Zillow and Trulia have the ambition to extend services from only residential
real estate to new markets. By doing so, Zillow will not rely on only residential real estate
lead generation but also commercial lead generation. It gives the companies the
opportunity to diversify services and grow in a massive way that will benefit investors
who buy now and hold.
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i http://www.businessinsider.com/zillow-chief-heres-why-we-can-be-a-billion-dollar-company-2012-4#ixzz3HsoPEW4N ii http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/ ii http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/ iii https://www.americanexpress.com/us/small-business/openforum/articles/qa-spencer-rascoff-founder-of-hotwire/ iv https://www.americanexpress.com/us/small-business/openforum/articles/qa-spencer-rascoff-founder-of-hotwire/ v http://www.mercurynews.com/business/ci_21811772/mercury-news-interview-trulia-ceo-peter-flint vi http://www.zillow.com/corp/WhoWeAre.htm vii “The companies estimate total spending on real estate advertising in the U.S. is $12 billion a year, of which Zillow and Trulia together currently have less than 4 percent of the market.” http://www.bloomberg.com/news/2014-07-28/zillow-to-acquire-trulia-for-3-5-billion-in-stock.html viii “real estate industry is highly fragmented, with scores of local sites for each cities.” http://dealbook.nytimes.com/2014/07/28/zillow-to-buy-trulia-for-3-5-billion/?_php=true&_type=blogs&_php=true&_type=blogs&_r=1