Zillow’s Acquisition of Trulia: Case Report
Team Creighton
Shradha Shrestha
Ravi Shukla
Scott Summers
Creighton University
November 3, 2014
The Economist Which MBA? Case Study Competition

Abstract
Zillow’s proposed acquisition of Trulia presents an analytical challenge. Both companies lack traditional metrics of valuation, like net income, free cash flow, and residual income. In this report, we value the company based on a fundamental valuation model that relies upon pro forma financials for the next ten years. We also use adjusted multiples of a peer group of high growth
Internet companies to derive relative valuation of Trulia, Zillow, as well as the combined entity.
Subsequently, we analyze the valuation and structure of the deal and provide trade recommendations.
2

Introduction
Zillow (Z) announced a plan to acquire Trulia (TRLA) in an all-stock deal on July 28,
2014. Zillow and Trulia are the two largest online real-estate listings platforms. The merger of these two entities will create an online real-estate listings behemoth with massive growth potential. However, there is disagreement on the pricing and efficacy of this merger. In this report, we will value both companies as well as the combined entity using our valuation models.
Subsequently, we will present our research findings and recommendations in relation to this deal.
Company Details
Trulia, Inc. was incorporated in June 2005 and is headquartered in San Francisco, CA. Its stock began trading on the NYSE on September 20, 2012 (Trulia, Inc., 2014). Zillow was also founded in 2005. It is headquartered in Seattle, WA. Zillow began trading on July 20, 2011 on
NASDAQ (Tuman, 2014).
Both, Trulia and Zillow, have several similarities in their product offering. Both companies operate real-estate marketplaces that connect home-buyers, home-sellers, renters, and real-estate agents. They provide a database of homes along with price estimates, house photos, and additional information about the property and its neighborhood. Both companies also have subscription-based offerings for the real estate agents. In addition, both companies also provide advertisement services directed at real estate and associated services. They have web-based as well as mobile platforms.
Both companies also offer certain unique services. For example, Trulia’s database contains local information on school districts and their ratings, crime statistics, neighborhood amenities, historical data on natural disasters, and enhanced map visualizations. Trulia also
3

offers customized software services for real estate professionals through its recent acquisition of
Market Leader, Inc. Zillow’s unique services include the Mortgage Marketplace that connects home buyers and mortgage companies as well as Digs Estimates that caters to the furnishing needs of home owners. Based on our analysis of these unique product-offering associates with each brand, we believe that the cannibalization in unique visitors will be minimal.
Acquisition Details
The acquisition, which was announced on July 28, 2014, is expected to close in 2015.
According to the deal terms, Trulia shareholders will receive 0.444 shares of Zillow class A shares for each share, option, and other equity-linked security of Trulia. Based on Zillow’s closing share price of $160.32 on July 28, deal values Trulia at $71.18 per share. The deal price indicates a premium of 26% to Trulia’s share price of $56.35 as on July 25. Current Trulia shareholders will own approximately 30% of the combined entity, while the current Zillow shareholders will own the rest 70%. The Board of Directors of both companies have approved this transaction (Trulia, Inc., 2014).
Zillow and Trulia will continue to operate as two separate brands under the merged entity. The Board of the combined company will include eight members of Zillow and two members of the Trulia Board of Directors. In case the deal falls through, Zillow would be required to pay Trulia a termination fee of $150 million.
Relative valuation
To begin the relative valuation process, we searched for comparable companies for
Zillow and Trulia. We picked companies from the Internet Software and Services sector that
4

exhibited high growth in revenues. We also aimed for companies with similar capital structure to that of Zillow and Trulia. We determined that Twitter, Facebook, LinkedIn, and Yelp were the appropriate peers for relative valuation analysis. Most of the companies in this space lack positive net income or free cash flows. Therefore, we focused our analysis on Price to Sales and
Enterprise Value to EBITDA ratios. We also considered revenue growth and user growth.
Exhibit I contains the table of ratios and multiples that we computed for these companies.
Next, we derived implied values for the combined entity, as well as for Trulia and Zillow on a stand-alone basis. We began with the revenue estimate given by company management for
Zillow and Trulia. We took the midpoint of the respective revenue forecasts to create our forecasted revenue for fiscal year 2014.
Sales
Adjusted EBITDA
Revenue Multiple Value Estimate Value Per Share
$250 million 15.4x $3.85 billion $103.34
$20 million 87.2x $1.73 billion
Trulia Final Estimate Value Per Share = $91.95
$46.41
Table I: Trulia Relative Valuation
For the revenue of the combined entity, we added the revenue forecasts for Trulia and
Zillow. We adjusted the sales number down to account for the estimated 20% overlap in subscribers between the two companies. Sean Aggarwal outlined the overlap estimate on Trulia’s second quarter earnings call that took place on July 31, 2014.
Next, we took that adjusted revenue number and applied the median price to sales multiple from the comp set to derive a value estimate of approximately $8 billion. We then divided that number by the number of shares the combined entity would operate with to get an
5

implied valuation of $141.60. The table below shows the stand-alone value of Zillow based on the relative valuation –
Sales
Revenue Multiple Value Estimate Value Per Share
$321 million 15.4x $4.94 billion $123.22
$124.12 Adjusted EBITDA $53 million 87.2x $4.98 billion
Zillow Final Estimate Value Per Share = $123.40
Table II: Zillow Relative Valuation
Adjusted EBITDA is an important metric that was used by each company due to the lack of positive earnings. We took a consistent approach with how we calculated the price to sales multiple with the EV/EBITDA calculation. We found EBITDA guidance for the remainder of the year and took the midpoint for each company. We then adjusted for the 20% overlap in subscribers to get a combined 2014 EBITDA number of $69 million.
By taking the midpoint of EV/EBITDA, we were able to back into an EV of $6.02 billion. After adjusting for the cash and debt levels, we calculated an equity value of $6.36 billion, which gave us an implied share price of $112.24. Since adjusted EBITDA is a non-
GAAP measure, we assigned a weight of 20% in calculating our final relative valuation. We assigned a higher weight of 80% to the sales based multiples.
Sales
Revenue Multiple Value Estimate Value Per Share
$521 million 15.4x $8.02 billion $141.60
$112.24 Adjusted EBITDA $69 million 87.2x $6.36 billion
Combined Entity Value Per Share = $135.73
Table III: Combined Entity Relative Valuation
For Trulia and Zillow, we utilized the same valuation methods as for the combined entity.
For Trulia, we arrived at an implied per share value of $103.34 and $46.41 based on the P/S and
EV/EBITDA multiples respectively. After assigning the weights, we calculated an intrinsic value
6

of $91.95 for Trulia on a relative valuation. Zillow’s calculations derived an implied share price of $123.22 and $124.12 on a P/S and EV/EBITDA multiple respectively. After assigning the weights, the intrinsic value for Zillow based on our chosen market multiples was $123.40 per share.
Fundamental valuation
The relative valuation analysis looks at the value of Trulia, Zillow, and the combined entity based on market multiples. However, ongoing market sentiment may deviate these relative valuations from the intrinsic value of the stock. As financial analysts, we place greater emphasis on fundamental valuation based on well-researched assumptions and inputs.
Conventional methods of deriving the intrinsic value of the stock include Dividend
Discount Model, Free Cash Flow Model, which reflect the company’s ability to generate cash flows, and Residual Income Model, which reflects the earnings of the company. Neither Zillow nor Trulia pays dividend, has positive cash flows, or has positive earnings. Therefore, we cannot utilize the conventional methods of estimating the intrinsic values of the stocks for these companies. Hence, we developed a two-step valuation model. First, we projected the financials of the companies for the next ten years. Second, we calculated the present value of the free cash flow generated by these companies in the years ahead and used it compute its current intrinsic value. Complete projected financials are included in the appendix as exhibit II to VII. Our model included the following assumptions.
Assumptions
1.
Revenue Growth
7

Trulia has a TTM revenue growth of 111%. Based on this statistic, we assumed that the revenue growth will be 100% in year 1, declining to a 30% in year 5, and further declining to a steady state growth rate of 4% in year 10. In spite of the high average growth rate of approximately 90% over past 3 years, we anticipate significant slowdown in the revenue growth as the company expands in the years ahead.
Based on similar analysis, for Zillow, we assumed revenue growth of 75% in year 1 declining to 55% in year 5, and further declining to a steady state growth rate of 4% in year
10.
For the combined entity, we aimed for an approximate midpoint of the growth rates of
Trulia and Zillow. Thereby, we projected a revenue growth of 90% in year 1 declining to
50% in year 5 and further declining to a steady state growth rate of 4% in year 10 for the combined entity.
2.
EBIT Margin
TTM EBIT margins for Trulia, Zillow, and combined entity were -19%, -8%, and -25%.
Our TTM EBIT margins for the combined entity is lower because we lowered the revenue for the combined entity to account for user cannibalization. However, academic research has shown that the average EBIT margins for online software and service companies are 19% in the long run (Damodaran, 2014). Therefore, we assumed a target EBIT margin of 19% for
Trulia and Zillow in year 10.
The combined entity will benefit from synergies from the merging of the two operations.
Therefore, we projected higher EBIT margins of the combined entity of 21%, a 10% premium above the average of all online software and service companies.
8

3.
Initial WACC
We calculated WACC for all three entities using CAPM. We obtained the beta, debt, and equity info from publicly available sources.
4.
Reinvestment Rate
All three entities are in the growth phase of their life cycle. They will require high capex to support their growth. Therefore, we assumed relatively high sales to capital ratio of 2.0
5.
Tax Rate
In May 2013, The New York Times, in conjunction with S&P Capital IQ, conducted a through analysis of the effective tax rates faced by companies in various sectors. According to this report, IT sector has a median tax rate of 21% (Bostock, Ericson, Leonhardt, & Marsh,
2013). Thereby, we included a tax rate of 21% for the valuation models of all three entities.
Inputs
1.
Revenues
We used the Trailing Twelve Months (TTM) amount as of June 30, 2014, for both Trulia
($208,588) and Zillow ($256,577). As for the combined entity, due to the 20% overlap in the subscribers, we took 80% of Trulia revenues and added the amount to the total Zillow revenues to derive $423,447.70.
2.
EBIT
Like revenue, we took the TTM amount for the EBIT for both the companies. We added the
EBITs of the companies for the valuation of the combined entity.
3.
Book Values of Equity and Debt
9

The book values of equity and debt were taken from the balance sheets as of June 30, 2014 for the companies.
4. Number of shares and options outstanding
The number of shares and options for the individual companies were as of June 30, 2014.
The deal is structured such that the Trulia shareholders will receive 0.444 shares of Zillow for each share of Trulia. Therefore, we added 0.444 times the number of shares of Trulia (37,255.9) to the number of shares of Zillow (40120.8) to derive the number of shares outstanding for the combined entity (56,662). The same logic and calculation was used to derive the number of options outstanding for the combined entity (6584.60).
Valuation Summary
We have placed 70% of the weightage on the fundamental analysis and 30% on the relative analysis. Based on the analyses, we estimate that the stock prices of Trulia, Zillow, and the combined company are $54.34, $102.83, and $125.33 respectively. The table below summarizes the valuations:
Company
Trulia
Zillow
Combined
Relative
Valuation (30%)
$91.95
$123.40
$135.73
Fundamental
Valuation (70%)
$38.22
$94.01
$120.87
Final
Valuation
$54.34
$102.83
$125.33
Table IV: Fundamental Valuation Summary
Deal Analysis
According to our analysis, Trulia shareholders are getting a marginally better deal. Our derived value for each Trulia stock is $54.34. Their stake in the combined entity is worth $55.65
10

per share. Thus, based on our derived valuations, Trulia shareholders will have a small gain through this deal.
On the contrary, Zillow shareholders stand to lose a lot of value. Our derived value for
Zillow on a standalone basis is $102.83. However, their stake in the combined entity will only be worth $69.68, representing a massive 32% downside.
Our deal analysis is supported by academic research. Shleifer and Vishny (2003) observed that when a relatively overvalued firm acquires a relatively undervalued firm in an allstock deal, the stock of acquirer firm loses value and tends to underperform in the post merger phase. In the case of Trulia and Zillow, Trulia is undervalued and Zillow is overvalued on a relative basis. Therefore, our finding of the loss of shareholder for Zillow is in accordance with the academic consensus on this issue.
Deal structure
Prima facie, the deal structure is desirable for both firms. Trulia shareholders get to buy into the combined entity at close to its fair value based on the given exchange ratio. They do not experience any loss of value through this deal.
Zillow stock is overvalued compared to Trulia based on several multiples and user metrics we have considered in the relative valuation analysis. In theory, buying an undervalued stock using an overvalued stock should be gainful for the overvalued acquirer. Thus, Zillow shareholders should stand to gain from the current deal structure.
However, academic research has shown that such deal structure do not create any value for the acquirer shareholders. For example, Fu, Lin, and Officer (2009) have found that the acquirer companies tend to pay significant premium in pursuit of their acquisition, thereby
11

negating the potential gains from a valuation arbitrage. Based on these academic studies, we believe that the deal structure will not be conducive to Zillow shareholders in the long run.
Future of Companies on Standalone Basis
Currently, a wide majority of real estate sales and advertisements occur through offline mediums. We believe the real estate market is ripe for a transition to the online medium over the coming decade. Thus, the market for online real estate listings has tremendous growth potential.
Given the potential growth of the market, both Trulia and Zillow should continue to thrive on a standalone basis. Each company provides certain unique services that the other does not. This gives an economic moat to each company. In addition, these two firms do not have any major competitors in the real estate market. If a new entrant enters this market, they will need several years to build the brand and operational capabilities of these two firms.
Currently, profitability is a concern for both these firms. But, we have seen other Internet based firms transition towards profitability after building a critical mass of customers. We believe Trulia and Zillow will make this transition successfully.
Investment in the Combined Entity
We valued the combined entity at $125.33. This valuation was premised upon the following key assumptions:
• EBIT margins of 21% in year 10 from -24% in the current year. 21% margins are 10% above the long run average for the Internet Software & Services sector of 19%.
• A 9% drop in revenue of the combined entity in year 0 to account for the possible cannibalization effects on the website users from the merger.
12

• Revenue growth rate of 90% in year 1, declining to 50% in year 5, and further declining to a steady state growth rate of 4% in year 10.
We recommend a buy on the stock of combined entity below $125.
Recommended Trades
Based on our valuation analysis, we believe that Trulia is undervalued below $54.34 and
Zillow is overvalued above $102.83. After adding a 10% cushion for potential valuation errors, we recommend the following trades: long Trulia below $48.90 and short Zillow above $113.10.
We also recommend a collar trade for Zillow, structured around the possibility of the deal falling through. It involves selling the $150.00 calls and buying $125.00 puts. On July 29, a day after the deal announcement, Zillow was trading at $150. However, according to our analysis, the fair value of the post merger Zillow stock should be $125. Through this deal, we are selling the upside above $150 and buying downside protection below $125.
We have used the strike prices based on the deal announcement dates to structure the trade. However, a similar collar trade can be entered at a later date based on ongoing stock price and our valuation analysis output.
13

Bostock, M., Ericson, M., Leonhardt, D., & Marsh, B. (2013, May 25). Across U.S. Companies,
Tax Rates Vary Greatly.
Retrieved November 3, 2014, from The New York Times: http://www.nytimes.com/interactive/2013/05/25/sunday-review/corporate-taxes.html?_r=0
Damodaran, A. (2014, January). Margins by Sector.
Retrieved November 3, 2014, from
Damodaran Online: http://pages.stern.nyu.edu/~adamodar/
Fu, F., Lin, L., & Officer, M. S. (2013). Acquisitions Driven by Stock Overvaluation: Are They
Good Deals? Journal of Financial Economics (109), 24-39.
Shleifer, A., & Vishny, R. W. (2003). Stock Market Driven Acquisitions. Journal of Financial
Economics (70), 295-311.
Trulia, Inc. (2014). About Us.
Retrieved November 3, 2014, from Trulia.com: http://www.trulia.com/about
Trulia, Inc. (2014, July 28). ZILLOW ANNOUNCES ACQUISITION OF TRULIA FOR $3.5
BILLION IN STOCK.
Retrieved November 3, 2014, from Trulia.com: http://info.trulia.com/zillow-announces-acquisition-of-trulia
Tuman, D. (2014). What is Zillow?
Retrieved November 3, 2014, from Zillow.com:
http://www.zillow.com/corp/About.htm
14