RTMVF - Rightmove plc: Strong Network Effect That Is Hard To Displace

2024-01-19 10:45:48 ET

Summary

• I am bullish on Rightmove as it has a solid competitive position.
• RMV is the leading online real estate portal in the UK.
• The company's strong network effect and organic traffic make it difficult for newcomers or subscale players to compete, and as mortgage rates ease, RMV is expected to achieve its guidance and revert to its historical valuation.

Summary

My recommendation for Rightmove plc (RTMVF) is a buy rating, as I believe its competitive position remains solid and that the market may have overestimated the competitive threat. RMV has built a solid market position with a strong network effect that is hard to displace. Given that its traffic is 85% organic, it makes it even harder for a newcomer or subscale player to compete with this traffic. As the mortgage rate eases, I believe RMV can achieve the guidance set out by management, and valuation will revert back to its historical average.

Business description

RMV is the leading online real estate portal in the UK. The economic model is simple. RMV charges real estate agents a fixed fee per office per month to advertise properties on its website. 75% of its revenue comes from agencies, 16% from new homes, and the rest comes from other products. RMV has grown at an outstanding pace over the past two decades, from a business with less than GBP10 million in revenue to its current size of GBP350 million. Notably, it has generated positive growth for most of the 2 decades, except in 2009 and 2020, which are years impacted by outlier events (subprime and COVID). Because of the nature of the RMV business, it has always been profitable for the entire 2 decades, generating a very attractive operating margin that has improved from 40% to the current 71%. The company has also remained in a net cash position throughout its listed history, and as of 1H23, it has a net cash position of GBP35 million.

Comments

RMV is one of those businesses that, despite having a strong track record over the years, still faces doubt when a new competitor comes along. I believe the current valuation is unnecessarily reflecting competitive threats and underestimating how resilient RMV business is.

RMV is essentially a marketplace business that has an extremely strong network effect. As a result, once RMB achieves substantial scale, it typically wins a huge chunk of market share. I term this the winner-takes-most market position. To better illustrate, consider the journey of a home buyer or seller and the participating agent. The home seller wants to sell his property as fast as possible at the best price. The home buyer wants to buy his ideal property at the most affordable price. In order to connect these two parties, they can either look around themselves or consult an agent. As you can imagine, the former is not efficient as it is extremely time-consuming. What are they going to do? Knock on every door. As such, the typical choice is to consult an agent. However, the agent is not a magician; he needs a channel for him to broadcast to all the buyers out there and find a buyer or seller as fast as possible. If not, he risks losing his client. The ideal channel is one that has a large pool of readily available buyers and sellers and has a good reputation (no scams). RMV fits the bill. It has built up a solid track record over the years and is the go-to brand in the UK for property transactions. Because of this, it has the best organic traffic (a readily available pool of buyers and sellers) that makes it easy for agents to find a buyer or seller. While this seems like an easy thing to replicate (just spin up a web), it is extremely difficult to scale. All the agents in the UK are familiar with RMV because it works, and since it works, there is little incentive for agents to fork out more fees to list on another website. As such, for a newcomer or subscale player, if there is a lack of supply (listings), it will have little buyer traffic (agents representing the buyers). This competitive advantage of RMV remains strong today. During its capital market day , RMV's management emphasized the company's strong competitive positioning and moat, which are supported by the high-quality data, customer leads, and brand perception. These factors contribute to RMV's dominant market share of 85% in the UK. The fact that this 85% market share has not changed much in the last 20 years is significant.

“The backbone of our strength is capturing 85% of all time spent on portals in the U.K. This is where consumers go. We get over 2.2 billion visits every year and close to 90% of that comes organically.” Capital markets day

As such, I don’t see the threat from CoStar as anything major. An important thing to note regarding competition is that RMV’s traffic is organic, which means RMV does not need to spend to acquire this traffic. The implication here is that competitors cannot simply spend $500 million (for example) on marketing to snatch traffic away from RMV, making RMV's competitive position extremely solid. If CoStar were to invent a way to make OnTheMarket better than RMVs, RMV would simply have to mimic those top features. To agents, this means a better deal, since they should still see a return on investment from paying RMVs more for their subscriptions.

Furthermore, now that mortgage rates are high, it makes it even harder for competitors to scale because there is less transactional volume. In good times, agents might splurge more on advertising because they want to utilize all available opportunities to close the deal. However, in bad times (like now), agents are likely to cut down on budget and only focus on the channel that brings them the highest ROI, which is RMV since it is the largest portal.

Valuation

Based on my view of the business, the RMV growth trajectory should follow management’s guidance that was set out in the capital markets day. While the current mortgage rates are high, the Bank of England has set out their intention to cut rates , which will have a direct impact on mortgage rates. The idea is that lower rates will spur more property transactions, which is helpful for RMV traffic and conversion rates for agents. With RMV's competitive position remaining strong, I think a high single-digit growth rate is not unachievable (RMV has historically grown higher than this). Management guidance for margin is to achieve group margins at 70% across 2024 to 2028 (somewhat stable), and as such, I expect net margins to stay at around the 60% level. I believe the market misunderstanding of RMV's competitive position has caused valuation to decline to 20x forward PE, and as RMV grows as guided with no market share loss, valuation should revert back to 26x forward PE, its historical and through-cycle valuation multiple.

Risk & conclusion

RMV is heavily exposed to the macroeconomic cycle given its exposure to property transactions. A repeat of the subprime crisis will decimate the number of transactions, and in this case, RMV, being the largest player, will suffer the most.

In conclusion, I recommend a buy rating for RMV. My view is that RMV will remain as the largest player in the industry, underpinned by its robust market position with a strong network effect that is difficult to displace. Importantly, substantial portion of its traffic is organic, which provides a significant competitive advantage that shields against competition that are willing to splurge on marketing to capture traffic share.

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