Chit Chat Stocks - Zillow (Ticker: Z) Not So Deep Dive

Episode Date: October 11, 2022

Zillow is more than just the most visited real estate website in the United States. The company operates through three segments: Homes; Internet, Media & Technology; and Mortgages. At the end of the month, we will publish an Arch Capital episode (only available to CCM+ subscribers) that will cover the company: Consorcio ARA. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Zillow. Enjoy the show! Is this episode locked? Access our “Not So Deep Dive” episodes by signing up for CCM+. Sign-up directly through Spotify or Apple Podcasts. If you listen on another podcast player, use this link and create a private RSS feed: https://anchor.fm/chitchatmoney/subscribe Need more information? Check-out our launch newsletter: https://chitchatmoney.substack.com/p/welcome-to-chit-chat-money-plus  Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:40) Industry | (12:40) Management & Ownership | (16:25) Valuation | (19:24) Earnings | (21:10) Balance Sheet | (24:49) Our Analysis | (27:06) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Deep episode on Chitchat Money that is only available to CCM Plus subscribers. So if you're listening to this, thank you for subscribing for $5 a month.

One side note, if you are listening to this and you do not get the associated emails with the show notes and the charts that go along with each podcast episode, please email us at chitchatmoneypodcast at gmail.com. The link is in the show notes. This is especially true if you're listening on Apple Podcasts, but if you're listening on any other platform and signed up through Anchor or Spotify, you may not have given us your email by accident. If you're not getting them, we'll sign you up. It's a great way to digest all the information from the show because when we talk about numbers, we understand in audio format, it can be a lot tougher. But most of those numbers we have in the charts and the notes to help you out. All right. Today,

we have Brad Freeman joining us. And we're talking Zillow as a part of our housing theme. So, Brad, I know you wanted to mix it up because all the home builders can be kind of the same business model. But why do you want to choose Zillow over, I don't know, any other company? Yeah. So breaking news to all of our listeners, housing is cyclical. So if you didn't know that, housing is extremely cyclical. And right now, I mean, we've got rent inflation through the roof. We've got 30-year fixed mortgage rates setting new generational highs seemingly every single week. So the back exogenous backdrop is about as bad as it can get for these companies right now. So, but that makes it very interesting for us long-term oriented investors. So it's kind of sifting through the players, the open doors, the Redfin,

the Zillows to see who is capable of taking market share. Who's, who's like the, who's, who's the cliche cream of the crop in that group to, to see when assuming that macro doesn't remain just absolutely putrid for the, for these companies forever to see who can kind of come out the other side and look a lot better than they did during the last upturn. So Zillow, to me, is the strongest candidate, just taking a very quick look at all these companies' P&Ls. But obviously, we're going to have to dig a lot deeper in this episode to kind of see if that's actually the case.

All right. That's a perfect intro. Ryan, why don't you introduce them? And yes, Zillow did kind of pique all of our interest because the stock has totally gotten bombed out in 2022. Yeah, I'm looking at all three of kind of just the headline tech slash housing companies. I put Zillow, Redfin, and Opendoor in. Last year, Zillow's down 67%. Redfin's down 86%. Opendoor's down 89%. Redfin and Opendoor.

Wow. I did not. Everyone's struggling. All right. You can throw Upstart into that bucket. You can throw Affirm into that bucket. And all these credit cards. I own Upstart, so I'm not trying to rip at anything.

But credit and real estate and consumer discretionary, just these extremely cyclical industries that got such a large sugar high. And now we're seeing the hangover, but sorry to interrupt again. Go ahead. Exactly. Uh, no, that makes total sense. Ryan introduced the company on how they make money. All right. So I think everyone's probably had an experience with Zillow, but I'll try to lay the groundwork. Anyway, Zillow is the most visited real estate website in the United States. They have a number of brands under their sort of umbrella. And those include Trulia, Street Easy, hot pads out east is another one um they actually have even they have some other businesses that aren't really consumer facing that are more business facing that are like software applications

but uh the consumer facing ones are the ones i just listed and then of course zillow itself and across all of those they attract 234 million unique users a month so um clearly they've reached scale a lot of people interface with at least one of their products and in order to get the data that makes up Zillow's platform. Zillow has partnerships with tons of local multiple listing services, which are kind of just the regional trackers, I guess, of listings, house listings in the area. They also have access to county records. And then there's now that they've reached kind of this threshold of scale, users and agents manually enter a lot of data as well. So it's kind of this aggregate of different data suppliers that are building

Zillow's platform for them. In terms of generating revenue, there's basically two reporting segments today. It's actually, it was three. It's going to move to two, I believe this quarter as they close out their home buying segment. So the two that are still important are internet media and technology. So that's IMT. That's the bulk of their business. And then there's mortgages. So I'm going to talk about IMT first. IMT includes premier agent rentals and then there's a bunch of different real estate like business to business kind of advertising and um just kind of software applications that are really small and kind of trivial to the business um those include like dot loop display showing time which is going to

be start to be included here soon um and i think brett's going to be talking about that in a sec but premier agent is really i mean this is the the bulk of their business and so premier agent This is Zillow basically sells, sorry about that. Zillow basically sells advertising space to agents who are trying to generate leads to sell homes. So, and I'm going to talk about this in the history segment, but they were thinking, they were trying to think of ways to monetize the platform when this really started growing in terms of users.

And they thought, all right, well, we can either be a brokerage ourselves, or we can try to be sort of a distribution platform for agents. And so they went with the agent route. This used to be on a CPM basis. So Zillow would kind of auction off advertising slots to different agents, but they're now pivoting to what they call a flex model. Flex, basically, it changes the payment structure from if you're a real estate agent, instead of paying an upfront cost for that advertising slot, that kind of ad inventory, you're now sharing a commission or a percentage of your transaction revenue with Zillow if there's a transaction that goes through Zillow's platform. And estimates show that it's about 30% to 35% of that transaction volume gets kicked back. I think listeners understand this, but that's of the mortgage fee, not obviously of the entire home value. No, yeah, not the whole value.

And it's not the mortgage fee, but the agent's commission. Okay, so even a smaller subset. The agent's commission of the transaction, they're paying 30% to 35% kicking it back to Zillow in this new Flex model. There's still the old advertising model as well. I believe you can offer your services that way. Marketplace promotion, kind of. Yeah, they're still kind of in the process of pivoting to Flex. But that really is almost their entire business.

And then they also have rentals that's included in the IMT segment that generates revenue through cost-per-click ads. So if you're a property manager, you want to rent out your space, you can basically advertise it through Zillow's various distribution platforms, either Zillow Rentals or I believe Trulia as well. And it's not just cost-per-click that makes up the most of it, but they basically have a bunch of different advertising packages you can choose from if you're a property manager and cost-per-click tends to be the biggest one. ultimately you're just using Zillow for distribution. The second revenue line item that they report is mortgages. So it's pretty much exactly what it sounds like. If it sounds like if you're looking for a home loan, you can go to Zillow home loans, receive a mortgage origination. Most of the time, Zillow just takes that. They originate the loan, they take the mortgage, sell it in the secondary market. So they're not really taking a balance sheet risk

themselves. If you listen to the NBR episode last week, it's the same exact thing, except Zillow's doing it for the second, like they're not doing it. They're doing it for the homes that kind of there's that are getting sold on their marketplace. Yeah. And I think you can even go out and get one, even if your home's not being like, you could just use it as a home loan alternative. But I imagine most of it is people that have transacted through there and then see the offer for a home loan product within the platform. As for the history, Zillow.com was actually founded in 2004 by Rich Barton and Lloyd Frank. They were two former Expedia executives and the They gathered kind of a small team.

They had already had some prior success, as I mentioned. So they launched Zillow.com in 2006 with that small team. In a 2016 interview, Rich Barton said, it was pretty much a logical extension of what we did when we built Expedia. With Expedia, we are giving power to the people, giving travelers the power to plan their own trips, to make decisions for themselves, to see all the prices and all the choices and be able to take the time they wanted in planning something that was so important to them, a trip.

But Expedia was bought in 2003 by Barry Diller's IAC. And then apparently Rich Barton and Lloyd Frank had nothing to do and were just trying to find a new startup idea. I think Rich even said part of the inspiration for building a business was that their wives wanted them out of the house. And so they needed something to do during the day. I don't know if that's a joke. Maybe it was true.

And so they were kind of looking for new ideas. And they were, at the time, both buying homes. And they said, why don't we just build a similar marketplace or data aggregation platform for home buying? There really isn't anything for consumers to browse that's like that. And so that was kind of the inception of the idea. once they launched, like I said, they explored a couple of different revenue models. They wanted or they considered being the brokers themselves, but they realized that apparently real estate agents provide a lot of value that Zillow wasn't very good at providing. And so they opted to go with that advertising model, as I said. Sounds like I'm going to tease the next part you're about to say. Sounds like they forgot that in 2018. Yeah. Well, I guess there's a difference between brokerage and iBuying, but yeah. And they've still kind of, even after choosing the

advertising model, they've been exploring tons of different ways to monetize their platform. And a lot of this is through acquiring other small businesses. And if you go to their Wikipedia page, they've acquired more than 10 companies in the last decade. A lot of them don't really show up in the financials anymore. Maybe they've been integrated into the business, but they've explored all these other routes. And one of those routes most notoriously is iBuying. And so to kind of give some historical context, they entered the iBuying business in 2018. In the following three years, they bought thousands of homes, amassed a $1.5 billion deficit, then exited the business and laid off 25% of their workforce in November of 2021. Since then housing, they

actually, that might've been a $3 billion deficit if they continued through this year. So yeah, they actually exited the business sort of at a housing peak, I guess. I mean, it's still affordability is still at a peak or the prices at least. Yeah. But since then a lot of these iBuyers have really been struggling. Opendoor in particular, you'll look at sort of their August and September results. They're not looking very good. They're selling a lot of their homes at losses. And so Zillow's exit ended up kind of being great timing on their part. Now, some people probably think they should have had the foresight to see that it was a tough business to begin with, but they're out of it now. And they're still just, you're going to hear us talk through the

financials, they're still selling through. I think they're about to finish selling through their entire home inventory that they had acquired. So their cashflow looks a little higher than it should because they had all that inventory. They're selling through it. They're not acquiring any more homes. So they're collecting cash on those. Yeah. All right. I'll hit industry competition. Pretty simple. And I mean, Zillow operates at a unique position in the housing market, but it's still a piece of the housing market and that's how they're going to make money. But just because they're not doing the buying and selling of homes anymore, they're not building homes, it's hard to estimate their total addressable market. But luckily, management shared,

I think they've been sharing, this is kind of the stat they like to highlight over the last couple of years, or at least the last year or so, is that they only monetize approximately 3% of real estate transactions that they potentially could monetize. So assuming all of these revenue opportunities have the same gross margins, that is a $58 billion gross profit opportunity. I'm gross profit just because the revenue stuff got wonky uh with the eye buying if we look at the historical results and that is basically just taking 2021 oh i said revenue here but i may let me no yeah use gross profit i said revenue in the notes but it is gross profit i will fix that um yeah so it's just taking their 2021 gross profit and dividing it by three percent

now that tells me that clearly there's just a huge opportunity even if it's just in the united states or north america there's a giant opportunity in the real estate brokerage and transaction market. It is huge. Now, competitors, they specifically outline in the 10K, there are iBuyers that are competitors like Opendoor, but as we'll talk about later, they're kind of a frenemy now. There are other real estate marketplaces like Redfin. I guess Compass is a little bit different, but there's also something like Apartments.com that dominates the rentals market. And then there are legacy players in the brokerage space, including institutional buyers that really essentially what you're looking at is Zillow

competing to win all these fees that come along with a real estate transaction. And there are a lot of these legacy systems that people still like to use. And there's all these different revenue streams that they're trying to win market share from. And after leaving iBuying, it really includes everything except the transaction itself. It's hard because they are, quote, exploring constantly. It seems like they're constantly exploring new revenue opportunities to pinpoint exactly how their business model works. Like Ryan was saying, There's just a lot of different stuff. But it's, I guess, the market is, like I said, just going after all those ancillary fees. All right, Brad, want to hit management? Oh, Brian, one follow-up.

I don't know if it was super clear how they make money on the Flex model. So I just want to provide a little bit of clarity there. So when you're the agent, agents get basically tagged into various properties that are on Zillow. And typically, these are agent teams. So they're part of a bigger organization. Those agents take a percentage. They help the home buyer close on the deal, right? So, and there's obviously different services, closing services that are involved in that process. They take, it ranges depending on the agent, a commission on that housing transaction,

the price tag of that home. And let's say it's 3%. Zillow is taking 30 to 35% of the agent's commission. So in that case, it would be roughly 1% of the overall home transaction volume. Now, those are rough numbers. They don't break them out exclusively in the 10K. I've seen kind of various disparate sources that refer to that. But that's kind of how the economics work on Zillow's side. So they aren't collecting revenue up front for that advertising space. They're doing it at closing. Yeah. And then there's all these other things that they like to talk about of how they're trying to expand just beyond this, this premier agent stuff. And I guess what we should just mention that they said there's five growth pillars. There's financing, touring, selling solutions, integration, and partner network. Yeah, those are very buzzwordy. So we'll see what actually materializes, but I guess we'll talk about it in future growth opportunities. Let's move to the next section. And that is Brad with management ownership. What'd you find for Zillow? Yeah. And correct me if I'm wrong, but I think this was, it was a SPAC, right? When it initially went public. No, you're thinking of, you're thinking of, uh, open door. Uh, no, I think

it was a SPAC like before it became cool to be like, I think it was, but look that up and don't, don't like, don't quote me on that, but, um, management ownership, it's a bit of a weird share structure. So in 2015, uh, they split their, uh, class a common voting stock into a class A class c and so each holder of class a and class b got two shares of the new class c stock for every one share they own a class a or b um and then class b like we see with countless other technology firms is really how the executives and the founders maintain their voting control um 10 votes per share for class b versus class a um and then quickly running through the leadership team so the ceo is rich barden um he's been he's been the ceo since 2019 he was also the ceo from 2004 2010.

looked like he took a little bit of a break, but I mean, his resume is sparkling. He's a, he's a Netflix board member, co-founder of Glassdoor, founder of Expedia, a co-founder, I should say, because one of the other co-founders of Zillow that I'm about to talk about was another founder there and a GM at Microsoft. So quite the resume. The CFO is Alan Parker. Since 2018, he was the, for 13 years, he was a VP of finance at Amazon in various departments, a director at General Electric, former CFO of American Standard. And then I think I'm going to go back down to voting power now instead of just reading off all the executives, because I mean, newsletter, if you're interested in reading more, just go there. But the largest stockholder,

the CEO, the co-founder, Richard Barton, I spelled it wrong in the notes, but I fortunately said it wrong or correctly in the episode, but he's got 31% of the voting power. The other co-founder, president, current chairman, Lloyd Frank. He was a senior vice president at Expedia with Richard Barton. He's got 20% of the voting power. All executives and directors together have 52%. Caledonia Private Investments is the largest institution at 13%. Vanguard's got 7%. But I mean, they own a piece of everything at this point. And yeah, that's as of the latest proxy statement. So April 2022, it's probably a bit different now, but it's probably pretty accurate still this was just just to be clear this was an ipo i mean it went public in 2011 so it was a long

time ago but the the zillow ceo or the old ceo raskoff i think his name was yeah spencer raskoff has uh launched a couple specs like private blank check companies and so he he he said zillow should have gone public via spec but they they were well he's just talking his book and it's interesting to look at the voting power, how they're slightly over 50%. I wonder if the buybacks they've been doing recently is to keep that above 50% because just where the stock's going, we'll see. I don't know. All right, let's move to valuation. Pretty easy one. And let me get the numbers up. We got a margin cap of $7 billion. And if we take out the cash equivalents and debt, we actually get down to an enterprise value quite lower of $5.2 billion.

However, they are buying back stock. So we'll see. I mean, that kind of will even out. There's a lot of fluidity to that because as they sold off all their iBuying stuff, they had a lot of cash and they started returning to shareholders through repurchases. But the two metrics I want to look at here for, and when going through all the charts and the metrics that I thought kind of were maybe the most important ones to follow from a valuation perspective would be enterprise value to gross profit.

And this weird one I came up with, which is enterprise value to IMT operating income, subtracting out corporate expenses. And now that might seem a bit wonky, but the reason I wanted to do IMT is to basically that that's the majority of this business. And that's the one that's really profitable. I mean, mortgages makes things a little bit worse. And then the iBank stuff can muddy the waters because it's going to go away. Now I subtracted out the corporate expenses because they have increased that a lot.

And I think it is important because they talk about segment profitability, and that can make the numbers look a lot higher when they have over $100 million in corporate expenses. Now, if we look at those two numbers, EV to gross profit, it is 2.97, so basically three, which I think is not very expensive at all. And then we look at the EV to IMT operating income, subtracting out the corporate expenses, 12.8. Um, so I kind of think that, that last one is if they, it's probably the best proxy of how much cashflow they could generate if things were, um, evened out from the iBuying and they, they were stopping investing for growth and, and all that good stuff. Um, and that's really it on the valuation. So let's move to earnings, Ryan.

Yeah. So just in terms of the last 12 months, their revenue is going to be pretty inflated. So it, it shows $11 billion in revenue, which is up. Square and Bitcoin. I remember that. Sorry, go ahead. They had, they had, they had, they did what? It was like square when, when they were.

Oh yeah. Reporting volume instead of, I mean, it's not like it was their choice, but yeah, they're reporting the housing, the, every house sale as revenue, even though the margins on that are really slim. So it shows $11 billion in revenue for the last 12 months, which was like triple digits, But really, their revenue basis is probably going to be, I'm guessing, what, $2 billion to $3 billion this year?

Something around there. Yeah. I mean, excluding iBuying. Yeah. So it's a much smaller business without the iBuying segment. And then for the last 12 months, they had $1.2 billion in operating cash flow. However, as I mentioned, they're selling through all the homes that were on their balance sheet. So cash flow looks elevated right now. As for the most recent quarter, I'm going to report their numbers without the iBuying segment. So $504 million in quarterly revenue. Most of that, almost 90% of it, was from IMT, which was flat year over year. And then $29 million of it, so a tiny amount, was from the mortgage revenue, which they are trying to grow. So however, it was down sizably from last year because a lot of that mortgage segment was tied to the iBuying business.

They're still trying to grow volumes outside of the mortgages that were tied to iBuying. So expect that to grow. And they're also plowing a lot of money into it. So they are losing, I think it's like minus 100% operating margins or EBITDA margins on that business. However, the IMT segment is pretty profitable. So earnings before taxes in total was $31 million. Adjusted EBITDA on that $504 million in revenue was $165 million.

So they can be, I think Brett has put some of the metrics down here before, on that IMT segment, their operating margin is around 30%. However, they spend a ton on stock-based compensation. So, that adjusted EBITDA number, I would almost just avoid it. You really want to look at the EBIT number. And also, that deficit that they amassed, they have a lot of tax credits. So, the earnings before taxes measure should be fairly close to the earnings they're actually going to generate, at least for the next couple of years, if I'm thinking about that correctly. um all in all you're basically buying this for the imt operating income that's what's hopefully going to translate to free cash flow and so in 2021 their operating income was 550 million dollars roughly so i would just base it off that well i should track that corporate corporate and i i made it for for anyone uh and the newsletter i will have because i know it's hard especially with

Zillow because these earnings are so muddy. I made some good charts I think people would be interested in like IMT operating income minus corporate expenses going back to 2017. IMT operating margin, gross profit per share growth, dilutive securities as a percentage of shares, outstanding, a lot of that stuff. So I know the numbers can be hard to understand in the audio format. Make sure to read the newsletter if you want to look at some of those charts. But let's move on. Last informational section until we get to the fun stuff, Brad. What about their balance sheet. Again, not the simplest one. Zillow likes to make things complicated. Yeah. And it's changed a lot over the last 12 months. I mean, or I guess since the exit of

the iBuying and started just liquidating homes and cleaning up their balance sheet. I mean, they really did. And I included a graphic from their most recent quarterly filing of the June 30th, 2022 balance sheet and total debt versus December 31st, 2021. And it is starkly different. And you can see it for yourself if you look in there. But for now, highlights in high level stuff. So it's got $2.2 billion in cash and equivalents versus $2.6 billion year over year. But now it's got $1.4 billion in short-term investments, which is an increase in $900 billion year over year. So that's a large portion or more than the entire use of cash there. And then just now, today, it has just $55 million borrowed under credit facilities.

It does have $1.7 billion remaining in convertible senior nodes. That's really the only debt vehicle on the balance sheet at this point in time. With rates, again, it's convertible. So there are some really nice equity rights for these holders, which is why the rates are low. But the rates are just 0.75%, 2%. Again, that's why. When you look at current shares authorized versus outstanding, there's about 4% equity dilution available to the company if it wants it. it looks like, and then no, it doesn't look like. It settled $1.1 billion in long-term debt earlier in the year and in 2021, part of unwinding the Zillow offers, iBuying business. And again, the image I think is really valuable to include here. It just shows you how many credit

facilities, how many debt facilities they had outstanding six months ago, or I guess nine months ago now, and how much cleaner they look from a liquidity and capital perspective. Yeah, it makes sense. And to harp on the equity dilution part, they have been talking about the repurchases and large dollar amounts going into repurchases, but it's a bit of a tug of war because of their heavy granting pays for RSUs and stock options. So the dollar amounts might seem high, but when you look at their actual shares outstanding chart, it's not going down maybe as much as you'd like. However, given where the stock price is last quarter, they maybe could have taken out a huge chunk uh but let's move on fun stuff anecdotal evidence brad i know we all

got it uh for zilla but any thoughts anecdotally yeah um in undergrad at michigan and go blue i have to say that every time i i mentioned michigan because did i really even go there if i don't uh but so for for like greek life and in hindsight it was stupid but i did it while i was there um i was the housing chair for our like for our fraternity and i was tasked with going to find housing and negotiate content. It was actually really fun. Like I enjoyed it, like talking to realtors and negotiating and the largest, I mean, or not the largest, but like the core piece of that process was going on Zillow and looking through Zillow and Trulia, which I didn't know Zillow owned, but, um, but yeah, it's a, it's a great site. Um, I don't, I haven't gone on

Opendoor and Redfin to see how great of a site it is, or if it's more of a, um, I mean, not, not commodity because this is this is not a commoditized space yet but um in in terms of just e-commerce um shopping for homes it seemed like it was it was really easy to use and i liked using it yeah redfin's okay i mean but i go on zillow i think i'll probably explain that too but ryan talk about yours yeah i think everyone's had like the occasional browse on zillow just to see like what crazy homes there are out there um i've i've done that as well i've never transacted through there i've found properties and i guess this is where they are trying to bridge the gap and kind of be that glue between window shopping and transactions um if i were if i were looking

for a home and i found one on there i don't think i'd go through every transaction step on zillow but i'd certainly reach out to the agent via whatever that whoever's listed on the The premier agent stuff does seem very durable. So it's like to me, yeah, I think that, I think that's a really good way to go. Even though it might hurt them in the short term, I think the commission-based is also a great way to go. I think there's a lot of advantages to it or that flex model as they call it.

So, and it's more fair for the people. I love the platform. I mean, the platform is incredible. Yeah. From a user perspective, like you can't say anything more positive as phenomenal brand awareness. I should probably say it's similar to even Airbnb, maybe even better than Airbnb. Probably similar, just from a brand awareness perspective, from people saying, I'm going to, whatever, go on Zillow, or I was on Zillow. They could have been on Redfin, but they always say Zillow because everyone knows that. The only thing I'll add here anecdotally is I think people should consider whether that 3% number they throw out there is a positive or a negative. Because if it's only 3% today, why hasn't it been higher from all the work they've done the last 10 years?

So maybe there's just a lot of friction here. But on the flip side, on a positive note, that means there's still just a giant opportunity for them. All right. Future. Oh, Brian, one more. Something else I will add. Anecdotally, a lot of people that are in the real estate business, whether they're agents, brokers, whatever, kind of have this animosity towards Zillow. They don't want to give them a lot of credit.

And I think part of that has been that it will threaten and feel threatened. That would feel threatened. Yeah, you feel threatened. And there's never been like this symbiotic relationship between the two. I think a commission based or a transaction based model like they have with a flex kind of helps that relationship. And without any eye buying, because eye buying, I feel like you're not competing with your customers. Exactly. Exactly.

Yeah, that's what I was thinking. To me, Opendoor is the ultimate real estate agent threat with how much they're leaning into that. But it's interesting. I mean, I don't know enough to comment on the relationship between realtors and Zillow, but what you're saying does make sense. Yeah. And we're going to talk about Opendoor with Ryan's future growth opportunity. But let's move into that section. Brad, what do you have for us? uh yeah so future growth opportunities mine's a little bit of a cop-out but um to me we were talking about this at the very beginning of the episode cyclical industry right now um the tide is out you can see whoever's naked i mean the warren buffett quote and and all that good stuff but it's not gonna i mean macro in the world is not going to suck for these companies forever i don't know when it's not going to suck anymore but i know it's not going to just be permanently terrible in perpetuity for real estate forever and ever. So macro, I hesitate to say this

because it could always get worse. But it's hard to envision 30 year fixed mortgage rates just continuing to race to new highs rapidly every single week. I don't I mean, I don't think it's a controversial opinion to think that that doesn't just last forever. And when it doesn't, and these companies, when affordability of what they're actually selling becomes a bit more favorable as mortgage rates come down um to me i just view zillow as kind of best in breed among the three with their balance sheet with their their track record um with their leadership team to be able to um just just take that larger piece of the pie like we see from other standouts and other industries um like for me maybe the trade desk would be a great example over the last few quarters

yeah and i agree with that the one not even like the most important thing is stability because people get kind of skittish if things are going crazy like oh wait a few months and that's really we've seen that show up in zillow's financials but people might be listening to this and then saying oh well hasn't zillow made a ton of mistakes what i think brad is referencing is the execution on the imt revenue which in 2017 was only uh one billion dollars and probably in 2023 it will close in over two billion dollars um but yeah brad do you have anything to follow up on i did for a second but then it kind of escaped me so it probably wasn't that important All right. Yep. That happens to us more than we'd like to admit as well. All right, Ryan,

what do you have for us? Their partnership with Opendoor. This was announced in August of this year. So two months ago now, if you're looking to sell your home on the Zillow platform, you can now receive an instant offer from Opendoor. And so if there's a sale that basically is orchestrated through the Zillow platform, Zillow gets a referral fee from Opendoor. This means they are collecting referral revenue without taking any balance sheet risk. This seems like a no-brainer for me, and it seems like a total loss for Opendoor. Yeah, I mean, this shows Zillow's superiority within the industry, for sure. There's even – here, one second, Brad.

There's even – this was announced in August, and then in August, data came out that open door lost money on 42 percent of the homes that they bought so that's before any expenses that's literally them just like they bought the home and then 42 percent of the time they sold it for a lower price um so the majority of the time they made money yeah good point but zillow literally just zillow is just the arbiter here i mean they literally they took like the capital the less capital intensive route and they collect the easy money on this it feels like a great thing for them to do yeah gives the gives the customer flexibility gives open door what they want surprisingly

um so i mean just feels like a win-win here yeah brad you had something i was just so kind of remembering what i was going to say before it's just uh like we're talking about cyclicality and and tides and lifting and lowering boats and essentially especially for zillow when you're trying to ship off all your balance sheet risk to these capital market partners i mean you need you need that funding supply to be there and and it could just grow more timid and all those things but I'm kind of going off on a random tangent because it was a point from earlier that I got really excited that I remembered. And then I just said it at a random time.

No, it's all right. It makes sense. It makes sense. If you want to let your partners or I guess you'd call them partners out. If you want to let these companies take the risk, like there's nothing to lose for Zillow here. Yeah. Well here's, yeah, here's, they might just be not as big of an opportunity because if Opendoor collapses which honestly could happen i think it's like that i don't know how high of a risk it is but it's there uh they also got six million warrants uh to acquire open door shares uh which

could be worth i mean it's totally meaningless right now like what's that gonna be worth six million dollars here here in the near future uh but either way like even if it works out it's great if it doesn't like zillow's not any you know they left eye buying and it even shows how they're much more smart with that. All right, I'll hit mine. And that is the showing time acquisition. So I wanted to highlight this one because they spent a lot of money on this. It was made for $512 million about a year ago, if I remember correctly, almost exactly a year ago. So hefty price, and it's supposed to be a strategic purchase. It's hard, like all of Zillow's products that it's hard to kind of wrap your head around how they exactly make money,

but the service helps people manage walkthroughs and tours of real estate properties. As CEO Rich spartan said they want to make showing time the quote open table for real estate if you don't know what open table is it's kind of the reservations for restaurants and managing that which i think makes sense uh and they want they want to integrate that within the zillow app which again makes perfect sense reservations and stuff that can connect your users um that may not be ever interacting with you uh it just gets them interacting more with on the zillow app and maybe more revenue potential there i think i think it makes sense it's early within that process and we'll see how material this can be but i think there is some promise there brad you had a follow

up is this like a uh like an ar matterport 3d no it's more of just uh time management so like basically you integrate this with an agent whoever's i don't know what person shows the homes but whoever's showing a home it's probably tough to manage all the people that want to come in and this is kind of like you know a restaurant has to manage all the reservations i think open table does that although i've never used open table um showing time is trying to be the same thing i think that works perfectly within the zillow app but people are already doing their browsing on their um scheduling a tour is the next step um so yeah all right highlights and lowlights brad what'd you like and dislike here yeah i was about to steal yours again i'm glad i

i'm glad i scrolled down a little bit more it's the brad and the brad always always throws me But so these are mine, not yours, I promise. So the leadership team, I mean, they've been around forever. Both founders are still very intimately involved. involved. I know some people will point to the iBuying and say, tsk, tsk, they should have not entered that business at such a high point in the cycle. But they did show leadership and nimbleness and flexibility when they were willing to be the player to back out when at that point in time, they were sort of being made fun of it for doing so instead of, duh, that's the right decision and everyone should be doing that. But aside from that, Brett alluded to this, And I'll just kind of follow this up. The asset light model and approach that they've taken to this industry, I do find extremely compelling. It makes any kind of niche or any kind of moat that they can actually build within this industry, which asset light does make moats more difficult to build.

But if they can, it makes it just extremely lucrative, especially in a massive industry like this, where they're at less than 5% penetration. Again, Brett rightly pointed out that maybe that's a little worrisome, but maybe it's also an opportunity. And again, I don't know enough about the situation to comment for sure, but for low lights. So, I mean, I hate to keep hitting the same topic, but the business is wildly cyclical. And again, they're not taking balance sheet risk, but this reminds me of an upstart and how they rely on capital market funding and funding supply in order to originate this credit or in order to transact on their platform. And as that credit becomes less and less willing to fund and more and more timid, it may not go away for Zillow.

It's more likely to go away for an upstart than it is for Zillow, but it will get more expensive and it will weigh on margins. And that process likely is playing out right now. So just their reliance on capital markets and how fickle and volatile capital markets are is something that I don't really prefer in an investment. Yeah, they're relying on dollar volumes. That is true. Housing is probably the best cyclical industry to be in just because it's one of the priorities of everyone's life. They need a place to live. However, it's not as great as...

SaaS. I don't know. yeah sass or i'm trying to think of like a cpg or a popular cpt or whatever selling water yeah uh ryan what do you what do you like and dislike here but i think it just being the leading real estate marketplace kind of gives them a lot of shots on goal a lot of chances to mess up which they have messed up many times but they get the chance to keep doing it because they're leading marketplace um it's like they've failed failed upwards to that imd imt segment just it's like impossible to mess up yeah and that's i guess my second highlight is the imt operations feel

durable especially the premier agent business and even zillow rentals they both feel durable and they're profitable at least it appears um zillow rentals get a lot of opportunity if they can steal from apartments.com and all those other ones because i'd rather go to one spot anecdotally yeah and then the last one is and i'm not an expert when it comes to this but apparently they have 1.7 billion dollars in net operating loss carry forwards which should help offset taxes for a couple of years so they they i guess got that asset through hemorrhaging money in the eye buying business yeah through a mistake but yeah so i mean that that's an asset for the business no doubt um yeah nice cherry on top low lights they uh they're kind of implementing

this new commission-based model right at a time when i think housing transactions kind of look poised to implode where you've got either we're not you're on the same point i mean we're seeing the data the last few months yeah i mean there's there is less transactions going on right now You've got rates having gone from like 3% to 7% and there's just affordability has never been as bad as it is today. That just doesn't feel really, that doesn't feel like a good setup for transactions. Yeah, it doesn't give you a good feeling in your stomach. And so right as they're pivoting to kind of a transaction-based revenue model, it could

be just sort of unfortunate timing, although I think it was the right move long-term. And then the last low light for me is they just constantly find ways to lose money. They're losing a lot of money in this mortgage segment right now. It feels like they just, could they not just spit off cash? Would it be so damn hard to just let your business run and grow it organically? Yeah. And now they did some layoffs, but let me give the employee count here. 2017, 3,000 employees.

At the end of 2021, 8,000. uh so that you know these experiments they've been running and here's another part they brag about it they brag like i was listening to interviews with the ceo with rich barton you're not you're not bezos dude go on they're like talk about like give the thesis for uh for zillow in a bottle and he's like well we're the biggest real estate marketplace we have 2 000 employees when you lead with how many employees you have that doesn't make me excited as an outside shareholder that is that is correct pride yourself on the size of your employee base like how does that help you're not spitting off cash yeah i agree i agree all right i'll hit mine or

brad something no i was saying it's the opposite of spitting off cash if you're if you're pounding your chest about how many employees you can onboard i mean just look at the the best companies in the world freezing hiring and and slowing hiring and but yeah so i'm just long i agree Ryan. Yeah. And Zillow is doing layoffs. So we'll see what it looks like. Um, I probably could have gotten one updated on the 2022, uh, numbers, but we'll see what it looks like. Cause I are talking about right-sizing and with iBuying, uh, they obviously had to do that as well. Cause I just shuttered that business. Uh, but it is very, very important, especially with how expensive software engineers can be and the amount of SBC they do, which as a side note,

they repriced down. Uh, so they said there's going to be an extra 2% dilution, uh, and that the buybacks are really just going to offset that. But okay. My highlights, brand awareness, we already talked about that, but it's really no surprise to see MAUs and site visits growing year after year. If we look at 2021, they had more than 10.2 billion site visits, which is just, I mean, no one comes close in that market, I don't think. Second one, the internet opportunity, quote unquote, internet opportunity within real estate is still large. On the flip side, we already talked about that. If it's still so large, why hasn't it been captured yet? But I I mean, if they can execute their opportunity here, it's phenomenal.

They talked about $5 billion in revenue by 2025. And then I think 40% EBITDA margins, which maybe that's 30% true cash flow margin. I mean, that opportunity is really, really strong with high margins. You got to love that. C, I have, or third, is hitting goals they set five years ago. So if you look at an earnings release from 2018, which I'll link in the newsletter, management set out to do, they had some goals in the IMT segment when Rich Barton came back as the CEO. iBuying obviously did not hit their execution there, but they did pretty much hit their IMT

segment execution or their, I mean, it hasn't been five years yet though. They had a five-year goal. They're on track to hit that pretty closely. And maybe if housing market collapses, they might not hit exactly there, but they're pretty darn close, which I like because they just did these new goals. And I was kind of skeptical saying, wow, $5 billion in revenue. I don't know if they could do that. But these last three to five-year goals worked out. Now, lowlights, capital allocation. I mean, I think it's been very poor since they went public. The $1.57 billion iBuying, quote, experiment, which is the cumulative operating loss from that. And then second, the acquisition strategy from a product perspective is pretty unclear to me.

I think it's tough to, there's a difference between a company that acquires separate products to have them just run on their own or separate companies to have them run on their own versus a company that's trying to take a bunch of software products and mash them together into the quote super app they're trying to build.

That just is so, I mean, we've seen that with kind of, I mean, you see it, there's just plenty of examples across the software industry where it's really, really tough. I mean, that's probably one of the biggest lowlights or a company you follow well uh brad paypal of that they've had a tough time integrating some of those acquisitions over the years so to sum things up they made a ton of acquisitions i mean truly a 3.5 billion dollars showing time five 512 million dollars street easy 50 million dollars

some of them have been pretty small but my question is how have any of these been worth it and should we trust management that's just kind of the big yeah hold up i have they've bought 16 companies since 2011 and spent pretty much the equivalent of their entire current enterprise value on these acquisitions. And I don't think any of them are a meaningful part of this. Now, as we move into the last part, I want to have one more data point here, and that is to highlight this, maybe capital allocation misfires. Zillow's stock price since his IPO is only up 146% since going public in 2011, right outside the GFC, so underperforming the market significantly the market cap over that time period is up 863 oh god so it's just tough like but i

mean that that's just hard to look at like i'm telling you this it feels like it's run for their employees it might be now let's move to bull case because let's see with the optimistic side here brad what do you think has to go right here i mean is the bull case they've managed capital so poorly and they're still in this dominant market position i mean that's true yeah it's feels like but um so you guys covered it pretty well above so i'll keep hammering home um sean sean emory is a good twitter account post he loves zillow and posts a lot of data on it showing that they they continue to take market share and search share and volume share during this entire cycle so um the bull case is that most likely again the world is not going to suck for zillow

forever. When it doesn't, this is best positioned out of the three that I'm sure we're all familiar with at this point to take share and to continue doing well in that IMT business. That's the bull case. It's hard to believe that results won't look good for the next few quarters. It's going to take a while for this pain to cycle through. The thing to focus on is market share because industry volumes will pick up again. It's whoever took the most market share is going to benefit the most. And it seems like Zillow is sort of kind of doing that. The bear case, I mean, when you have all these purchases and failed experiments and losses bloating for several speculative projects, it just not only, so I won't pick on management because I think we've

done enough of that already, but it just makes me worried that this is a one-trick pony and that um, when IMT, um, reaches maturity and, and when that isn't capable of, um, or when that's reaching the end of its runway, kind of what's next. And I know it is kind of a nice runway. Um, but it's just concerning how many times they've tried to branch out, um, and how little success or how low their batting average has been when doing so. Yeah. I'll say my bear case. That's the exact same for me. Uh, but Ryan, what is your bull case? Well, I'm going to try to put some numbers on it. And there's a lot of adjustments in here because it's such a- That's the dangerous game though.

The adjustments are so dangerous, but you have to with them right now. Yeah. So I'm just going to make it kind of round numbers. On the IMT business, they generate just under $2 billion in revenue over the last 12 months. It's 1.9 and it's been $444 million in earnings before taxes. So let's just be really rounding up here, but let's say $500 million in operating income on the whole business, which is optimistic. It's more than it really is. And $2 billion in revenue. Do we think, and the IMT revenue has grown 50% since 2019. So it's been a pretty impressive

business. However, I do worry about a little bit about maturity. So if we say that they're generating $500 million in cash a year at its current enterprise value is what five, I think it was like 5.2 billion. Yeah. I mean, today we're having a really big down day. So it's, it's less than maybe what you did on your notes there, but yeah, it's 5.2 billion. I mean, almost 10% yield. I mean, it's pretty darn, you know, not even that much growth. Right. You basically just have to assume that IMT grows high single digit percentages with steady margins, or even a little lower growth with some margin expansion, and then they don't hemorrhage cash elsewhere. If they can do that, yeah, I think you're going to get pretty good

returns here. Yeah. Plus you have some optionality if they ever execute on something. Maybe that's being too harsh for them because they have a $2 billion revenue business, but I have the same one, really the exact same. I mean, it seems like if the adjustments work out, they could be generating $500 million in cash a year. That's all you really need. All right. Ryan, did you have anything specifically for the bear case well i guess there's the the housing market potentially slowing down in terms of transaction that's a bear case and then also just them destroying cash like yeah if they generate all that cash i mean imt is clearly generating a lot of cash i mean the margins are fantastic on that like can they sell the iac is that can they just sell themselves to

iac so that we can trust that their capital management that's that that i do not mind that idea let's do an lbo with ic at these prices maybe that's why or maybe just the yeah maybe maybe that's why they rich barton and lloyd frank have maintained more than 50 ownership so that doesn't happen so someone doesn't come in that's yeah i mean that is honestly a low light for me uh if we speak on that because they can kind of if they have this high voting power we can't get an activist in there also if they have the power to vote to say yeah we're gonna buy back shares so that they can maintain their voting power uh it's just kind of this yeah it's a negative um i don't know more or less interested i guess do you have anything else i have nothing my

very case was yeah very more or less interested brad i changed my answer middle of the episode so it was more and then it kind of moved to less i will say if i had to pick between redfin open door and zillow it'd be a very easy decision going with zillow um just because um longevity seems like a higher probability event here than for the other two. And also Redfin's smile or CEO's smile just pisses me off for some reason. And I have no-

It's very, it's so intense. He can't possibly be that happy. I don't think- Down 89%. Yeah, smiling through the 90% drawdown. Yeah, but less interested. Maybe a leadership shakeup would make me more interested at this point.

Usually I love founders leading the company, but a lot of missteps that we've cited here. And honestly, I joked about ISE buying them, but that would make this a lot more attractive of an asset base than it is today, in my opinion. Yeah. Ryan? God, I've been more interested for like five years.

This is the time. It's just management's the holdup, right? It's just constantly been this like, they could generate cash if things go right. And then they just like lose it elsewhere. So yeah, I guess management's the holdup. I mean, I am more interested. i'd like to see like a year of clean results but by then maybe it's too late yeah i'm gonna say

less i i think it's pretty like we all came to the conclusion that this business is great but management i can't trust them i i think the big thing is that i mean they were smart buying right to end it but when barton came back i kind of thought all right maybe he's going to write the ship here that you know the trulia thing was probably pretty dumb but some of the acquisition stuff was very very dumb and then they stopped buy buying um and he came out right when they already were starting that so like it wasn't that bad but then they do the showing time acquisition for 500 million dollars and all i'm thinking is can you not build this yourself are we serious it's a year's worth of like in an optimistic scenario that's a year's

worth of cash flow that's what i'm talking about like they're just like not even like even like for saying i sorry to interrupt but not even build it yourself but go find and ideally build it yourself but even don't go like go find a 20 million dollar company that has bones in place that you can build on top of don't don't spend have a billion dollars yeah you have the you have the crazy good network effect use it to your advantage you could crush showing time into oblivion with your network effect i mean it's not that that was maybe the last straw for me and i don't think i can touch management if they were gone i would be very very interested in this company if they got a management team that had a capital allocator's mindset i mean

this is a this is really oh i mean i can't i don't think i think we're all in agreement here a great business yeah but i just don't like it all right stock for next week gonna be ryan and i uh dream finders home small cap home builder and this is an update brad this is brad's last uh not so deep dive we're hoping to uh you know we're still friends here uh but we're going to be doing the maybe some power hours maybe some stuff associated with the show but uh for any of the listeners i know there's only a small amount on the subscription but stock market nerd free newsletter right got stuff coming out every week and then some deep dive write-ups that are very thorough on some companies so brad thank you for joining us uh anything else before we sign off

i mean it's pretty ugly breakup so no no i'm not yeah i mean i'm gonna i'm gonna continue uh doing episodes with you guys as frequently as I can. We're cross-promoting on the newsletter. So just excited to keep kind of building hand in hand and respect your work very deeply and excited and consider you two good friends. So I'm excited to keep working together. Same as well. All right. Thank you, Brad. That's going to do is remember we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital. Brian and I are general partners at Arch Capital and clients mail securities discussed in this podcast. Again, thank you for listening and subscribing.

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