We recommend Zillow Inc. (Z-NASDAQ) as a BUY with an initial target price of $120.00. Zillow offers investors a unique opportunity to take a stake in an early-stage online residential real estate marketplace company that is disrupting the $75 billion realtor-centric machine through its greater purpose to “lead a revolution in online real estate to empower consumers”. In less than a decade, Zillow has created a thriving ecosystem with significant scale and influence by generating Positive Social Capital (i.e. shared value and positive externalities) for its community of 800-plus employees, over 70 million unique visitors, 650,000 real estate agents, four leading media distribution partners, and the U.S. government.
Zillow will be able to sustain its competitive advantage through its following four generative economic moats:
- Low Cost Producer: Visitors to Zillow’s listings provide it with an extremely low-cost and highly scalable source of raw material (i.e. home impressions).
- Intangible Assets: Zillow is creating the “long tail” of the Real Estate Marketplace by democratizing the tools of production and distribution and connecting supply with demand by facilitating trust and reducing search costs for consumers.
- High Switching Costs: Zillow’s freemium aspects and social value creation opportunities of advocacy, learning, and collaboration create stickiness.
- Network Effect: Zillow’s structural asset appreciates in value as a result of the network effect.
Zillow is poised to start capitalizing on its structural asset base (database on 115 million homes, 650,000 Real Estate Agent Professional Profiles, 37 million pieces of user-generated content). Although Zillow appears unthreatening with nascent business lines producing under $200 million in revenue, the revolutionary power of its radical consumer-centric model makes it a ubiquitous disruptive force to the traditional realtor-centric machine.
Unlike most advertising-dependent social networking plays, Zillow’s path to monetization is through client acquisition for its subscriber base of Platinum Premier Agents. We forecast its revenue will grow at 30% CAGR over the next decade, from $130 million last year to $1.5 billion by 2022 through increasing its Platinum Premier Agent subscriber base (from 40,000 to 180,000) and its average revenue per agent (from $3,650 to $8,000). Our $1.5 billion forecast is conservative as it implies a 19% share of the $7.8 billion spent on advertising and under 3% of the $75 billion generated in commissions.
The attractiveness of Zillow’s unique business model is its client acquisition platform. Zillow has significant pricing power given the price elasticity of demand for Platinum Premier Agents is the ROI. Even more exciting is the long-term potential for Zillow to improve its economics by shifting from advertising to a market-based dynamic pricing model. This creates significant opportunity for value creation given Zillow’s high valuation sensitivity (every 1% increase in our pricing assumption adds $5 per share in value to our discounted cash flow valuation).
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