2024-01-11 07:58:03 ET
Summary
- CoStar is a powerhouse in the commercial real estate industry, providing analytics and tools for commercial real estate agents.
- They essentially have a monopoly on this information, allowing them to raise prices every year and beat their competition.
- CoStar is building a residential real estate marketplace platform to replicate the success it's having in the commercial real estate space.
- The company outshines its competitors by investing heavily into marketing and finds ways to monetize its platforms to support profitable growth.
- CoStar is a misunderstood company when it comes to its business model as well as its valuation, which looks expensive at first glance.
Investment Thesis
If you've never heard of CoStar ( CSGP ), the company is essentially a powerhouse in the commercial real estate industry. The company operates several marketplaces but its primary service gives commercial real estate agents data analytics and tools. These analytics and tools are crucial to their function as agents and include data on a property's construction, prior sales, market comparables, current tenants and rents, the demographics of the neighborhood, and even loan and building operating statements in certain cases.
Let's walk through an example to get a better understanding of the business. Say you are a company looking for an office space. Let's assume you need a space for 25 people with 8000 square feet close to a city center. You might also have specific needs unique to your company that you require. To find an office space, you'll likely contact a commercial real estate agent. A commercial real estate agent will then get onto CoStar's website and CoStar will recommend a variety of listings to show you with all the necessary information that the agent would require.
To collect and aggregate all of this data in one central location, CoStar has deployed $300 million a year on average and has so far spent $2.5 billion in just collecting this data for its customers to provide them with all of this information.
As you can probably imagine, most other players don't invest nearly as much as CoStar, so the company has effectively become the only game in town. This is significant for two reasons.
Firstly, having sticky revenues where customers (commercial real estate agents) keep coming back makes this a highly attractive business in my view and essentially provides CoStar with a monopoly over all of this information. You simply can't find all of data anywhere else. This data is so valuable, some competitors have even tried to sue CoStar (unsuccessfully) over anti-trust claims because of its dominance in the market.
Secondly, because customers of CoStar can't switch and find this range of information from another competitor, the company is able to raise prices consistently each year, exhibiting pricing power that is inherently entrenched in its ability to dictate its revenues without fear of losing agents.
In the last few years, seeing the success of the model in the commercial real estate space, CoStar started getting into other public marketplaces to replicate the same strategy. It essentially went on an acquisition spree to buy up the largest marketplaces for selling real estate and businesses. Some of these acquisitions included purchasing apartments.com for $585 million in 2014, the largest apartment rental site in the U.S, and Loopnet , which does the same thing but for leasing of office buildings and industrial spaces. Other key acquisitions included purchasing Land.com , an online marketplace for farms and other rural real estate, as well as a marketplace for small businesses called BizBuySell , which is the world's largest online marketplace for listing businesses for sale.
So with all of these online marketplaces, this has essentially made CoStar the dominant player and owner of some of the biggest marketplaces.
Recent Results
When looking at the recent results for CoStar, the company announced Q3 revenues of $625 million which was up 12% from last year. In the company's largest segment, we saw 14% growth in the commercial real estate information and marketplace segment. We also saw an increase in net new bookings clocking in at $65 million.
Revenue Growth (Investor Presentation)
This growth is in line with the growth seen over the last five years, with sales growing at a 16% CAGR. Overall, as shown from the chart above, we've seen increases in all of CoStar's segments with slight fluctuations in residential (but this makes up only a tiny percent of revenues). That said, on the residential side through Homes.com, the company reached a record 100 million monthly unique visitors, which speaks to the growing nature of the platform, and the fact that its marketplace for homes is growing.
In discussing the business results for the company, CEO Andy Florence said the following:
I believe that CoStar Group's revenue will grow tenfold again over the next 12 years because of the careful, significant calculated investments we're making that optimize our competitive advantages and capabilities. We firmly believe that Homes.com can compete and win in the residential opportunity, just as we lead today in all the prior asset class we have entered in the past, including office, industrial, retail, hospitality, multifamily, land, et cetera. Homes.com delivered over 100 million unique visitors in the month of September according to Google Analytics. That's an increase of 1,290% over the same period a year ago, making Homes.com the fastest growing residential marketplace in the United States.
To me, this speaks to the confidence management has in the business and the significant opportunities for growth the company has, particularly in residential real estate. According to data from ComScore, the company says that they are now beating Realtor.com and Redfin in monthly unique visitors by 35% and 90%, and that spread is only widening over time. I view this as extremely positive for the company as it proves the company's strategy is working and that the investments they are making today in their residential platform will pay off down the road.
One of the reasons I'm excited about Homes.com's future growth is because the opportunity here is so large. The total addressable market in North America alone is projected to be over $15 billion, compared to commercial real estate at $4 billion and apartments at $9 billion. Even though Homes.com makes up a relatively small percentage of revenues right now, I fully expect this segment to outpace the other segments and likely grow in the triple digit percents' for the foreseeable future.
Total Addressable Market (Investor Presentation)
It's not lost on me that these are big numbers and big future plans so I think it's helpful to zoom out and look at the company's track record over time. As shown by the graph below, this quarter marked 50 quarters of consistent increases in revenue in the commercial real estate segment. This shows that in just the commercial real estate space alone, CoStar is able to put up fantastic growth in all types of market conditions. Revenues were about flat in the 2008-09 housing crisis, and we saw consistent growth both during and post-pandemic. I think this is a testament to the company's track record of investing in profitable growth and doing well regardless of the market.
Company Track Record (Investor Presentation)
In my view, this can't be said about the competition. Earlier last year, there were rumors surfacing that CoStar was going to acquire Realtor.com in a transaction worth $3 billion. On the Q3 conference call, management had this to say about the rumors:
If that was true the primary objective in acquiring Realtor.com could have been to take the number two traffic position in the United States. Given that speculation did not come to pass, we might have been good stewards of our shareholders' $3 billion that we saved by building the traffic to Homes.com for a fraction of the cost of buying it. Clearly, successfully building traffic is no longer Homes.com's primary risk factor. At this point, shrewd investors seeking a new risk factor to replace the now reduced traffic risk factor will now need to turn to monetization as the next key risk factor. Unlike its competitors, Homes.com has never invested in any material brand marketing. Because of that Homes.com's unaided awareness is in the low single digits, while our competitors' unaided awareness is in the mid to high double digits.
This clearly demonstrates that CoStar is confident enough in its own strategy of investing in SEO, optimizing investments, building brand awareness, and monetizing the platform – something that its competitors are completely lacking. With CoStar's platform outpacing and stealing market share from rivals, I look at this as a key indicator that it'll replicate the success it had with Apartments.com and do the same thing here in the residential space with Homes.com.
What the Market is Missing
When evaluating CoStar's business, there's two main factors I view as completely misunderstood or unappreciated by the market today. The first is that CoStar's demand drivers are not driven by the cyclicality of real estate and the second is that its valuation isn't as expensive as one may think.
On the first point, there seems to be a narrative about CoStar that their business is driven by the ups and downs in the real estate market and that they will face pressure when prices fall or when transaction volumes in real estate fall.
I believe this is a false premise because as shown by the 50 consecutive quarters of positive revenue growth, this wouldn't have been possible if CoStar's revenues were a direct result of fluctuations in housing prices or changes in transaction volumes. For example, in good times, when there's high occupancy, landlords simply don't need to advertise because the property (be it office space or otherwise) is already tenanted. In slower periods, when there isn't anyone to bite right away, landlords will turn to CoStar to advertise their listings on the site. This increases revenue on the platform as site visits increase.
And so in that sense, CoStar is in effect a countercyclical business; doing well in slower periods and experiencing less growth when occupancy rates are at all time highs. So this is all the more peculiar to me when we see that its share price moves along with the rest of real estate related stocks, like REITs for example, when it should in fact be the opposite.
The second factor, valuation, can be really tricky. CoStar is a platform company playing the long game of building something much larger that will hopefully be a free cash flow machine in the future. For now, the company has an impeccable moat with several barriers to entry, but no question it looks expensive.
Most analysts might look at the EV/EBITDA ratio or even the P/E ratio and are quick to assume that the stock is overvalued. Sure, on the raw numbers, 62.7x EBITDA and 84.8x earnings, these are valuations that on their own look very high without context.
However, I think it's important to remember that CoStar is a growth company, investing everything back into their business. Over the last few years, the company has put a lot of that to work in the development of Homes.com. So because of the nature of not always recording intangibles on the balance sheet, a lot of that investment gets recorded as expenses, rather than capex. If CoStar was investing in a manufacturing plant, for example, then that would not have an impact on the income statement, just the cash flow statement by way of capex.
We can see from the income statements below that CoStar generates pretty consistent and stable gross margins in the 81-85% range (83.2% currently for the last twelve months). As SG&A is mostly investment, rather than true operating costs, a gross margin multiple is likely a better way to look at the business. It's also a common way to value marketplace businesses.
With just under $2 billion of gross profit generated in the last twelve months, a market capitalization of $34.1 billion, $5.2 billion of cash and $1.1 billion of long-term debt, this put the EV to Gross Profit multiple at 15.0x (34.1 + 5.2 - 1.1 all divided by 2.0). With most marketplace businesses being valued in the 10.0-20.0x range, this seems like a fair price to pay for the company today.
Income Statement (Author, based on data from S&P Capital IQ)
While there isn't many, there are a few risks to investing in CoStar that investors should consider. The first, and most important in my view, would be the significant marketing investment required by CoStar to make its platforms the dominant marketplaces in the industry. In the near term, this puts downwards pressure on margins, which compresses EBITDA and free cash flow.
The second, however smaller one, would be the increasingly difficult nature to collect data on real estate transactions. This seems to be the case as CoStar's rivals have attempted to previously steal information from the company. While CoStar has been successful in previous lawsuits and has researchers and staff making about 50,000 calls a month to collect information as well as through other means, this is still a risk that should be monitored by investors.
Conclusion
In summary, CoStar is playing the long game. It's building marketplace platforms to replicate the success it's having in the commercial real estate space and taking that to bigger markets to build leading marketplaces where the TAM opportunity is exceptionally large. CoStar outshines its competitors by investing heavily into marketing and finds ways to monetize its platforms to support profitable growth. With consistent 80%+ growth margins, the company has been consistently growing revenues in the commercial real estate segment for 50 consecutive quarters and hopes to replicate that success in the larger residential housing market. We're already starting to see promising signs where CoStar is now overtaking its rivals in terms of total monthly unique visitors, with a gap that's widening over time. With a business model that isn't fully appreciated by the market, and valuation multiples that don't tell the whole story, shares of CoStar aren't as expensive as they might appear. For these reasons, I'm buying shares of CoStar today.
For further details see:
CoStar: Playing The Long Game