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Zillow Stock: Priced At 17x Free Cash Flow (NASDAQ:Z)


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Investment Thesis

Zillow (Z) has been through a roller coaster ride. Its shares are down 70% and investors want to exit this position at all costs and forget that they were ever involved with the stock in the first place.

Management tried to expand its operations but failed. Management is now dusting itself off, and plowing ahead into its advertising opportunity, broadening its core operations, rather than moving into a different business model.

Zillow’s core business is its IMT (Internet, Media, and Technology) segment, which is an advertising business. This side of the business is a high-margin business, that actually generates solid cash flows.

Without any heroics, Zillow is priced at 14x EBITDA, which is more than attractively priced, if we consider that this doesn’t even factor in its 2025 financial targets.

Investor Sentiment Near All-Time Low For Zillow

Zillow share price
Data by YCharts

Including the 10% pop on Friday, on the back of Zillow’s Q4 2021 results, the stock is down slightly more than 70% in the past 12 months. Anyone that has invested in Zillow in the past year is now holding onto a loss.

This implies that shareholders are disgruntled and impatient to ”breakeven” and call it a day on this ”dog”. What’s more, this implies that as the share price starts to appreciate, there will be a meaningful amount of selling to take place, as shareholders will look to exit their positions and break even on their holding.

What this further implies is that Zillow’s shares will be very volatile, seemingly, without clear direction. Even if the underlying business has now turned a corner and started to grow intrinsic value once again.

Zillow’s Revenue Growth Rates Are Misleading

Zillow revenue growth rates

Zillow revenue growth rates

Further complicating the investment thesis, as you can see above, Zillow’s revenue growth rates are misleadingly strong. Yet, as you know, that’s mostly being driven by Zillow Homes, better known as iBuying. However, as you undoubtedly already read, Zillow is exiting its iBuying segment.

So, what we have to come to terms with now is what will Zillow look like going forward without iBuying.

Zillow Q1 2022 outlook

Zillow’s Q1 2022 outlook

Above we see the guidance for Zillow to go into Q1 2022. This is a reasonable representation of what the business will look like on a go-forward basis.

Zillow still has 2 more quarters of iBuying left on its books before it fully exits that venture, but for all intents and purposes, this is what we have to think about here.

Zillow’s Cash Flow Potential is Strong

Zillow highlights to investors that its underlying IMT segment is a high-margin business.

Zillow IMT segment revenue

Zillow Q4 2021 investor presentation

As you can see above, Zillow’s IMT segment alone ended 2021 with 45% EBITDA margins.

Thus, when Zillow makes the case that looking out to 2025, it’s capable of generating 45% of EBITDA margins, including ancillary products, such as its Mortgages segment, this is fairly easy to believe.

Zillow adjusted EBITDA margin

Zillow Q4 2021 investor presentation

What is more difficult to believe is Zillow’s $5 billion revenue target, where Zillow makes the case that its top line will grow by 24% CAGR into 2025.

Zillow Revenue 2025 target

Zillow Q4 2021 investor presentation

Here’s a reminder, from 2018 to 2021, Zillow’s IMT revenues increased 57%.

Zillow IMT segment revenue trend

Zillow Q4 2021 investor presentation

Thus, we are talking about a segment that has historically grown at approximately 12% CAGR and that now, all of a sudden it will grow at 24% CAGR? Needless to say, this looks odd. So, let’s put aside those heroic estimates, and focus instead on what looks more realistic:

Zillow adjusted EBITDA

Zillow 2021 10-K

As you can see above, if we exclude Zillow’s Homes segment, Zillow’s IMT segment brought in approximately $853 million of EBITDA in 2021, an increase of 53% compared with the same period a year ago.

Thus, if we presume that this segment grows by just 10% CAGR over the next twelve months and that its margins remain high, it’s very likely that Zillow’s IMT segment could reach approximately $940 million of EBITDA.

Z Stock Valuation – Cheaply Valued to Free Cash Flow

Next, looking through Zillow’s SEC filings, the overall business’ capex requirements appear to be around $100 million. Obviously, a meaningful portion of that would have been associated with building out its Homes segment.

Nevertheless, using this same figure would imply that Zillow’s free cash flow in 2022 could be around $840 million for the year. This would put the stock priced at 17x this year’s free cash flow.

In my previous article on Zillow, I estimated that Zillow could grow by 15% CAGR in 2022. Meanwhile, management declares that the business could grow by 24% CAGR over the next several years. While at the same guiding to grow in Q1 2022 by just 9% into Q1 2022.

With all this in mind, I believe that my revised target of 10% CAGR is perhaps a more reasonable estimate.

Altogether, I believe that paying 17x FCF for a high-quality advertising business that’s likely to grow at double-digits is attractive.

The Bottom Line

Zillow has been through a lot of turmoil this past twelve months. With the stock down 70% from its former highs, this implies that the stock has gone essentially nowhere in the past 3 years.

I estimate that Zillow’s free cash flow in 2022 could be approximately $840 million. This puts the stock priced at approximately 17x this year’s free cash flows.

Note, I’ve afforded no meaningful consideration to Zillow’s Mortgages segment, with this segment coming for free, and it would start to be worth substantially more if it ever starts to turn a profit. Whatever you decide, good luck and happy investing.



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