Muddy Waters Investment Competition
MBA Case Competition 2014
ZILLOW ACQUISITION OVER TRULIA ANALYSIS
FULL PAPER
William Vidal
Adriana Martins
Raquel Clara
W.A.R. Consultancy Team
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Introduction
This report aims to provide information about the recently announced USD 3,5 billion
acquisition of Trulia by Zillow, two online real estate advertising companies. While the deal still
awaits on the FTC decision, there are interesting and unique points on this acquisition that
certainly require further analysis.
1.
Deal Structure
The argument that Zillow and Trulia are media companies performing on the online Real Estate
advertising segment is extremely advantageous to the deal, as one can sustain that the majority of
the advertising expenditure is not currently made online, and both companies together will own
around 4% of the total market. This dialectic characterizes the structure of the deal and is a
strong support against the HSR Act1.
The conduct of business pending the merger is a crucial point on the deal structure, since Trulia
is restrained on the business they may conduct. Apart from the obligations both Zillow and
Trulia share, Trulia will not be able to borrow money, participate on mergers, hire top
management executives whose compensation exceeds $275,000 annually,
make capital
expenditures in excess, or commence Intellectual Property rights exceeding $500,000. The deal,
in this sense, prevents Trulia from increasing costs or debts while the merger is pending, in a
way to assure the acquisition continues viable and possibly profitable for Zillow.
1
HSR Act: set of amendments to the antitrust laws of the United States. Parties must no complete certain
mergers until they have made a detailed filing with the US Federal Trade Commission.
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From the strategic point of view, the combined company will still perform with two different
brands. Having two different brands is consistent, since the companies have a limited
overlapping in terms of customer’s profile and business strategy. Combining those companies,
therefore, provides them with competitive advantage, transforming them in the online solution
for real estate information, a concept that is much broader than advertising. Due to the
acquisition, Zillow and Trulia will be able to share real estate data and the forecasts on housing
trends, which will possibly improve accuracy of the Zestimates – one of the challenges Zillow
faces today. This is an optimal solution to minimize the MLS2 power over Zillow’s Zestimates,
increasing their awareness on the pricing dynamics for the real estate industry, preparing for the
attraction of a larger mass of consumers who value reliable data, and decreasing the power of the
real estate realtors on the Zillow-Trulia new business. On the long term, more people will be
willing to access their portals, leveraging their advertising force.
Apart from that, combining resources for innovation will contribute to the delivery of faster and
more creative solutions, especially considering the development of more consumer friendly
mobile apps.
In addition, there are cost savings expected to come from synergies. This is better described
further in this report.
2
MLS: Multiple Listing Service is a suite of services that enables real estate brokers to establish
contractual offers of compensation (among brokers), facilitates cooperation with other broker participants,
accumulates and disseminates information to enable appraisals, and is a facility for the orderly correlation
and dissemination of listing information to better serve broker's clients, customers and the public (source:
Wikipedia).
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2.
Scenarios in case the deal fails to close
Some possible scenarios can be evaluated if the acquisition fails to take place.
The Outside Date for the agreement is Jan 28 th, 2016. In case the FTC does not reach a
consensus by then or there is any impediment constraining the acquisition to take place, the
agreement is cancelled including all the correlated measures. Expenses taken until then are due
to each part. In this sense, both Zillow and Trulia have a lot to lose.
However, the situation of Trulia would be worse, for the reasons mentioned on the Structure
Deal Chapter: the merger is pending until FTC approval, and Trulia could not proceed with any
merger or acquisition, capital expenditures or borrow money. Apart from that, Trulia cannot
protocol any intellectual property rights. Considering how fast changes happen for online
companies, Trulia may lose all its innovative competence, and therefore lose their good position
in the market. For Zillow, the situation is not that dramatic, as they can acquire companies, make
organizational changes and borrow money to the top of USD 250 million.
Assuming the FTC asks for an impactant change on the agreement, leading to a material adverse
effect, Zillow can cancel the agreement and acquisition, owing a fine to Trulia of USD 150
million. This fine might not be enough to cover Trulia’s expenses, apart from having a direct
impact on Zillow’s cash flow.
Considering Trulia withdraws from the acquisition, they would need to pay a fine of USD 69.8
million, which might be less than sufficient to cover Zillow’s expenses with the merger and also
have a negative impact on Trulia’s cash flow as well.
In this sense, the future for each company on a standalone basis is likely to be very complicated.
Other than all the effort and money placed from both companies on the acquisition, added to the
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possible fines they might have to pay, and the period of up to 18 months they will lose, there is
still a problem with information shared between both companies. Not to mention that Trulia’s
cost increase will make it more difficult for them to keep a sustainable growth (see exhibit 5 for
2014 projection cost increase).
After sharing vital information with each other, they will need to reinvent themselves, which will
be particularly difficult.
Apart from that, since competitors were able to visualize the possible synergies this kind of
merger could have, they may also inclined to promote similar mergers and threaten Zillow and
Trulia position. (see exhibit 1 to analyze how possible different mergers could threaten Zillow
and Trulia).
As a result, Zillow could still have more chances to continue growth and innovation in the event
they can fastly understand FTC demands and make a decision as to how far they would wait for
an agreement with them. The fastest a decision is given, the more likely they are to succeed. If it
fails, Zillow may possibly restructure their strategy and even acquire other smaller companies on
the same field in an easier manner.
For Trulia, the situation might be more complicated and timing is crucial. The longer it takes for
an FTC decision, the more devastating it could be for Trulia’s future.
3.
Assumptions for investing in the new company
This report does not cover the application of conventional valuation methods, such as DCF or
available comparable methods. DCF approach is well grounded in theory, simple to use and
works well for stable industries3, which is not the case for internet companies. In addition,
3
Damodaran, 2001b
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comparable methods are not recommended either, because multiples for internet companies in
the same segment are hard to find.
As covered in the previous sections, Zillow and Trulia’s merger is a strategic action. This section
will cover the analysis on how this merger will make sense for the investors.
The analysis includes how the Benefits of the Synergies will enable cost reductions, and include
the Growth of Revenues provided by the merger and the market growth for this segment.
3.1 Growth of Revenues
Total spent with advertising in the Real Estate industry is $27.3 billion4, whereas $15 billion is
spent online. The assumption made on this report is that the market potential for Real Estate
websites is 55% if the total advertising spent, whilst the remaining will be directed to different
channels other than online advertising . Zillow and Trulia combined reached total revenues of
$341 million in 2013 (4.1% of market potential). Proper marketing strategy, including pricing
and value creation, proliferation of mobile devices for consumers and real estate agents, and the
value created on the improved accuracy of the Zestimates are enough to assume that ZillowTrulia will achieve 10-12% share of the potential market in a 5-10 years’ time.
Moreover, Real Estate online advertising has grown 16,9% in 2013, growing at a pace of 2 digits
for the last 15 years. According to Borrell Associates, after a certain point, the market growth
will decline, so a growth of 10% has been considered for 2014, and the following 5 years after
the merger. From that point on, the growth estimated is 7%.
In addition, Zillow and Trulia revenues growth have surpassed 50% in the latest years, and a
reduced growth percentage has been considered for the following years.
4
Borrell Associates Real Estate Advertising 2013 Outlook
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Consequently, the estimated growth of revenues can be analyzed in the chart below and in
Exhibit 4.
3.2 Benefit of synergies
Synergies will bring cost reduction in some areas. The following chart shows the cost breakdown
for both companies in 2013:
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The synergies on the year following to the acquisition (2015), has not been considered, once both
companies will be executing the restructuring plan. Thus, 2015 costs and expenses will be an
average percentage of total revenues based on 2014 projection estimates. The result of 20132015 results can be seen in Exhibit 5.
For 2016, the following synergies have been considered:
Cost of Revenues will have a cost reduction of 10% based on operational headcount reduction
and data centers optimization.
G&A departments such as legal, accounting and HR represents good potential on savings. Lease
on real estate has also potential cost reduction considering that both companies will operate in
the same location. For this, the estimated cost reduction is 25% for 2016.
Technology and Development is the main competitive advantage for Zillow, Trulia and the
online environment. Considering this, not recommend much efforts in savings in this area are
recommended. With this in mind and optimizing the overlapping of some resources, it is possible
to estimate 5% of cost reduction for T&D.
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Sales and Marketing have the major potential on savings, representing major part of the costs,
accounting for 58,3% of the total revenues. The combination of efforts will represent a cost
reduction of 10%.
Considering the assumptions above, the total cost and expenses savings reaches around $ 100
million5, which is consistent with Zillow-Trulia expectations. In addition, as cost growth over the
years, it will be considered a factor of 90% of revenues growth, from 2016 onwards.
3.3 Growth of Revenues and Synergies Combination
The following table summarizes growth and potential savings for the combined company.
Considering the synergies, the results and growth on profit seems to be sustainable for the
combined company. Earnings per share will then increase (Exhibit 5), motivating investors to
buy stocks of the combined company with an attractive return on the stock price valuation.
It is important to note not only the synergies, but mostly the high growth potential of revenues
the new company has, since this elevated growth potential is boosted by the combination of an
above average growth of the market, surpassed by a two-digit growth of the online market for
real estate advertising, and,more specifically, by the strong force the new company will have to
grow in such a prosperous market.
5
Conference call on Zillow Acquisiton of Trulia - July 28, 2014
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4.
Trades
Considering a successful merger, the conglomerate of new companies, with its broad portfolio of
brands, will enable trade opportunities by increasing its offerings. The new technologies have
changed buying behavior worldwide and since then, digital platforms have been the protagonist
in providing communication and information. Those softwares are used not only for transactions
but also by providing organizational content and information, empowering the market.
Information is no longer in hands of a restricted group, becoming more widely accessible.
For the brand portfolio of Zillow-Trulia, many strategies could be in the center of their next
move. Uniting this powerful amount of data and being able to organize, segment and use it
wisely, allow many monetization opportunities such as:
1.
Profitable data: Information as primary source of competitive advantage
Usage of combined data to create new services by tracking and gathering IP, geolocation and
searches, providing useful data that impact other industries such as gardening, furniture,
refurbishment, safety, pets, baby & child, etc.
Knowledge about demand is crucial for all businesses in any sector and the type of information a
real estate website collect is of a great use to many sectors. This creates value to the new
company and ultimately to its shareholders as well as focusing on the expansion of its business
model by diversification.
2. Expand the business to new markets: Brazil
Zillow-Trulia new company could expand and replicate their business to other countries such as
Brazil as their model is not widely spread, leading to a great opportunity in emerging markets.
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The sector is growing primarily in metropolis such as Sao Paulo and Rio de Janeiro and there is a
gap in the market as the services offered by the local competitors are not comparable to ZillowTrulia in criteria as information, estimation, and ancillary service as well as in providing
reasonable ROI to sellers.
3.
New technologies platform ZITPAD
New product development: a specialized tablet device for agents powered by an enhanced
Agentfolio platform, aiming to streamlines the home buying process and transforms a usually
complicated experience into an efficient way to organize their search. That leads communication
between customers and agents enhanced. ZITPAD could ease the use the combination of data,
filter and search. In addition, the following functionalities could be provided for each property of
the realtor’s portfolio:
·
Organizing the appointments with interested customers
·
Enabling visit´s history
·
Sales process workflow
·
Rate the level of relationship
·
Online Sales assistance chat (real time)
The objective would be monetizing with a monthly fee, providing brokers with a proper product
developed specially for their needs. It would mean expansion in business model for Z-T
conglomerate as well as provide a management tool to brokers. A personalized relationship
between agents and company is crucial and would be another source of profit.
4. Enhancement of Omni channel presence
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Searching and purchasing have changed completely and the experience has moved to multi
device: a search may start on its mobile, double check the price and conditions in their PCs and
finishes the purchase on tablets, for example.
Technological companies have already launched innovative products such as Apple Watch and
Google Glass. Although adoption has not spread yet, being able to adapt portals to those types of
screens and facilitate the use of their customers is key to sustainable growth in the online
business.
5. Real Estate Asset Bank Security product
In order to add more services to the portals, Zillow-Trulia could make an agreement with an
Investment Bank to sell shares of houses for investors looking after a Closed End Fund.
Foreclosure fillings is declining over the last months (Exhibit 3), but America has almost 3
million houses in shadow inventory (Exhibit 2) since the subprime crisis has begun.
New software application would be developed to offer online shares of houses, in a dedicated
section in the portals, segmented to investors. A partnership with a leading bank that has a
portfolio of foreclosure houses could use Zillow-Trulia as a marketplace to offer shares of those
houses.
In that scenario the bank splits the total value of the house in shares and sell each of them as an
Asset Bank Security. With the house price appreciation and the bank being able to sell the house,
investors and the bank will share the gains of the transaction. It is a win-win situation where
banks and investors are benefited.
This is a strategic move that leads to portfolio extension, another source of revenue and create a
new demand for the portals. With such a powerful online tool the company could explore the
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advantage of attracting real time investors. Banks would find offer another tools to attract
investors that would be able to finish the deal with real time and easing the online tools provide.
5.
Both sides of the acquisition
Although the acquisition on Zillow over Trulia can be seen as a win-win one, Zillow will get the
best part of the deal for the following reasons:
-
Acquiring Trulia, Zillow becomes stronger and with additional competitive advantages,
considering that both companies have similar development and innovation strategies
-
Zillow will avoid the threat that Trulia would merge with a different company (Eg.
Realtor.com) and become as big as they are
-
And finally, Zillow will enjoy the appreciation of their shares, considering the growth of
revenues and synergies mentioned previously on this report
-
Zillow will increase the market share, reaching visitors that are currently at Trulia
-
With the merger Zillow will also increase the distance to the second place (Realtor.com)
on number of visitors.
-
The governance will stay at Zillow’s side, as Trulia’s CEO will report to Zillow’s CEO.
Apart from that it is important to note that Trulia will also have benefits, being more efficient on
managing costs and expenses. Exhibit 5 shows that Trulia is expected to increase 76% on costs
expenses versus 51% increase of Zillow in 2014. Trulia will also be part of the biggest company
of the market, enjoying all correlated benefits of this with more resources to invest, innovate,
minimize risks, and stills enjoy the gains.
Stills, from the strategic point of view and long term returns, Zillow gets the best part of
the deal.
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ATTACHMENTS
Exhibit 1 - Top 10 Desktop Real Estate Websites
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Exhibit 2 - Shadow inventory in the U.S.
Exhibit 3 - Foreclosure filings in the U.S. - Source: ReallyTrac
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Exhibit 4 - Growth of Revenues and Market Scenario - 10 years after the Merger
Values in $ thousands, except percentages.
* 2014 estimates from Q1 and Q2 results
** Market potential calculated as 55% of Online Market Available
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Exhibit 5 - Growth of Revenues and Market Scenario - 10 years after the Merger
Exhibit 6 - Earnings per Share (EPS) estimates
EPS calculated based on the assumption of 70,000,000 outstanding shares after the merger with no dillution or accretion.
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