2023-11-09 09:14:04 ET
Summary
- ZG has positioned itself well for future growth, with strong performance in its current business segments and the recent acquisition of Follow Up Boss.
- ZG outperformed the industry in terms of revenue and reported high double-digit growth rates in Rentals Marketplace, the mortgage space, and the home loan segment.
- The acquisition of Follow Up Boss will strengthen ZG's position and financials, as the company has been growing at an impressive rate and its products are integrated with ZG's.
Summary
Following my coverage of Zillow Group ( ZG ), which I recommended a buy rating given that the company is still consolidating market share in the current operating environment thanks to strong execution. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for ZG, as I believe the company has positioned itself well to capture future growth. The recent acquisition of Follow Up Boss is an excellent strategic decision that I believe will boost ZG’s future growth because the business has been growing at high double-digit rates. Apart from acquisitions, ZG’s current business segments are all reporting strong numbers, with Rentals Marketplace, mortgage space, and the home loan segment all reporting high double-digit growth rates.
Investment thesis
When compared to the industry, ZG demonstrated a strong relative outperformance. It reported better-than-expected third quarter 2023 revenue of $496 million, up 3% from the previous year. With $362 million in revenue from residential properties, ZG outperformed the industry by 11% as the overall market declined by 14% while it declined by 3%. The third quarter has meaningfully outperformed the industry for the fourth consecutive quarter. Its continuous attempts to enhance its customer funnel, capture more demand, and link more of that demand to its network of partners continue to be beneficial to its performance.
During the quarter, its Rentals Marketplace exceptional performance also contributed to it outperforming the market for this quarter. ZG reported $99 million in revenue in rentals in the third quarter, up 34% year over year, driven by increased traffic and listing growth in both multi-family and single-family properties. ZG is also doing very well in the mortgage space. Despite the fact that mortgage rates have reached 20-year highs, the company has grown its purchase mortgage originations business by 88% year over year. Due to its strong brand, ZG's core business continues to show strong top-of-funnel demand. With an average monthly unique user base of $224 million in the third quarter, its overall leading traffic is double that of its closest competitor.
Anyone that has been following the news would know that securing financing is another source of pain for most of the customers who are looking to buy a home. Mortgage financing accounts for about 80% of all home purchases, as management mentioned during the earnings call. About 40% of all homebuyers begin their mortgage search prior to selecting an agent to deal with. The fact that nearly all of these individuals looking for a mortgage use ZG puts them in a great position to develop a sizable first-party direct-to-consumer mortgage origination business that is seamlessly integrated with its wide network of premier agent partners. In the past few quarters, ZG’s mortgage business has started to gain significant momentum. In the third quarter, ZG Home Loans reported an 88% year-over-year increase in the volume of purchase loan originations, despite a historically terrible mortgage origination market. I believe ZG’s penetration into the home loan segment was a good strategic move, as it provides them with an alternative avenue for future growth. With its rapid growth, it also serves as a catalyst for ZG's future growth.
On November 1, 2023, ZG announced that it was acquiring Follow Up Boss . Follow-Up Boss is the industry-leading customer relationship management system for real estate professionals. For a long time, Follow-Up Boss has been an important integration partner for ZG. As a result of ZG agents’ familiarity with the system, many of them formed a strong bond with Follow-Up Boss. For the past four years, Follow Up Boss's revenue has increased by more than 40% annually on average, mostly through word-of-mouth marketing without any substantial outbound sales efforts. In any market, this kind of growth is impressive, but it's even more so in the housing market, which has dropped by almost 20% since 2019. In addition, the company has been making money and expanding for the past 11 years, and in 2023, it is expected to grow by more than 20%. Like ZG's acquisition of ShowingTime in 2021, Follow Up Boss provides agents in the business with a technologically advanced solution that lets them concentrate on what they do best, which is to provide amazing customer experiences. I believe ZG’s decision to acquire Follow-Up Boss is a good move. Firstly, it allows ZG to have control over Follow Up Boss products, which are heavily integrated into ZG. This will allow ZG to fine-tune its software to create an even better experience, which in turn might lead to more users. Secondly, and the most important factor, Follow Up Boss’s revenue growth is impressive, and adding such a company to ZG’s portfolio will definitely strengthen its position and financials even deeper.
Valuation
My target price for ZG based on management's FY25 target is around $81. My model is based on a forward projection, anchored on management’s revenue target of $5 billion in 2025, and attaching a revenue multiple to derive my price target. Note that this is different from the typical DCF model that relies on projecting cashflow. In this case, I am using a revenue multiple as ZG is not generating meaningful FCF at the moment (ZG is still in growth mode). I believe management's FY25 target is achievable because ZG has consistently outperformed the industry. In the third quarter, it was their fourth consecutive quarter of outperformance. Due to Rentals Marketplace's exceptional performance, ZG has been able to increase its revenue even when the general market is declining. Despite the fact that mortgage rates have reached 20-year highs, the mortgage market is still reporting strong numbers. Another catalyst to drive its 2025 guidance is its strong growth in the home loan segment. In the third quarter, ZG’s home loan grew at a jaw-dropping rate of 88%. Lastly, its acquisition of Follow Up Boss will be another catalyst for future growth, as the company has been growing at 40% annually on average.
Peers include Opendoor Technologies Inc ( OPEN ) and Redfin Corp ( RDFN ). The peers’ median forward revenue multiple is 1.5x, and ZG is trading well above it. The reason for that is that ZG’s gross and EBITDA margins exceed peers' medians by huge margins. ZG’s gross margin is 81%, whereas that of its peers is 12%. In terms of EBITDA margin, ZG is at a positive rate of 7.8%, while the peer’s median is at a negative rate of 5.38%. ZG's being a profitable business here greatly sets them apart from their peers. Lastly, in terms of debt to equity, ZG’s 42x also greatly surpasses the peer’s median of 280x. Overall, ZG is a better-quality company that is profitable and has a much healthier balance sheet. This is especially important in the current high interest rate environment, where many firms are struggling to pay off their interest. Putting these assumptions together, I believe ZG current multiple of 3.8x is sustainable.
Risk
One downside risk to my buy rating is the current challenging macroeconomic landscape. As ZG operates in the housing and mortgage sectors, it is very susceptible to inflation and interest rate movements. If inflation were to rise again, it might deter individuals from buying houses, which would have a direct impact on ZG. In addition, interest rates tend to rise with inflation, and this would have a serious impact on the mortgage rate and ultimately on ZG’s mortgage business. If these were to happen, it would create pressure on ZG’s top-line revenue growth.
Conclusion
In conclusion, I believe ZG is a high-quality business. This conclusion stems from its impressive third quarter result, where its top-line revenue grew. In addition, Rentals Marketplace, mortgage space, and the home loan segment are all reporting high double-digit growth rates that are not showing any signs of deceleration. The recent announcement that ZG will acquire Follow Up Boss is great news for investors and shareholders, as Follow Up Boss is also a high-quality business that has been growing at double-digit rates. In addition, its products are also heavily integrated with ZG’s, making this acquisition even more compelling as it gives ZG control. When compared to peers, ZG dominated them in terms of both profitability and liquidity. Among its peers, ZG is the only profitable company. On the back of these, I maintain my buy rating for ZG.
For further details see:
Zillow Group: Robust Q3 2023 Results And The Acquisition Of Follow Up Boss