Evaluation of Zillow - Trulia Merger

Transcription

1 Evaluation of Zillow - Trulia Merger Sydney Business School University of Wollongong Participants: Devika Chandramohan Kaustav Chatterjee Sebastian Isbanner

2 Table of Contents 1 Introduction Which company is getting the better deal and why? Structure of the deal Future on a standalone basis Assumptions about future Trade recommendations Conclusion References: Appendix Sydney Business School Page 2

3 1 Introduction = 5, right? The typical rationale representing synergy, as the whole is worth more than the sum of the parts. Online real estate market leader Zillow expects substantial benefits from its $3.5 billion acquisition of its major competitor Trulia. In the past, both companies have invested significantly into R&D in order to differentiate themselves from each other. Now, due to this merger, it is anticipated to address a much larger customer base and nurture from a wide range of benefits while keeping both businesses operating separately. Based on a set of questions and key variables, this report pursues to evaluate Zillow s acquisition of Trulia. At first, it will be examined which company is getting the better deal and why. Secondly, the structure of the deal and its impact on both shareholders and customers are analysed. In case the deal fails due to a FTC investigation, a potential future outlook for each company on a standalone basis is provided in the next section. Based on the companies present combined market valuations, assumptions about their future to buy stock in the combined company are given. Ultimately, this report ends with examining if any trades can be recommended around this transaction. Sydney Business School Page 3

4 2 Which company is getting the better deal and why? On 28 July 2014, Zillow announced a $3.5 billion deal to acquire Trulia (67% of shares belonging to Zillow; 33% to Trulia) 1, with the merger representing 61% of the online real estate advertising market, and laid the foundation for a strong competitive advantage for Zillow. After a history of several acquisitions, this $3.5 billion deal represents by far the biggest acquisition by Zillow. The deal is expected to accelerate innovation, broaden distribution, enhance value and ROI for advertisers, provide greater access to Free Real Estate Market Data, and provide annual corporate cost savings of around $100 million from 2016 (Securities and Exchange Commission 2014a, 2014b). As both company s financials suggest, intense R&D investments in the past in order to differentiate itself from each other will lead to strong synergetic effects. Thus, both companies should be able to capitalize from the fact that these differentiation efforts are now combined under the umbrella of one company. Especially, the combined expertise gained from these differentiation efforts can create a long-term competitive advantage as innovation efforts could be accelerated. However, it is difficult to assess which company is better off since different scenarios as well as the future outlook of the industry needs to be taken into account. On the one hand, the deal itself could be considered to be in favour of Zillow, as it has acquired its major competitor, gained a larger market share and received the majority of shares and therefore, owns Trulia. Zillow can exert influence on Trulia s entire business and only two Trulia directors (including Trulia s CEO) will be assigned to the board of directors. Also, Zillow can take advantage from the recently acquired software provider Market Leader by Trulia, which adds another feature to their portfolio and 1 Although Trulia currently retains its business model, and trades separately from Zillow Sydney Business School Page 4

5 strengthens its competitive advantage. From Trulia s perspective, Trulia has given up its challenger position in the market, its market share and ultimately, its autonomy. Its expertise and gained competitive advantages from the past have become transparent to Zillow. Notwithstanding, on the other hand, this deal could also represent a do-or-die deal for Trulia and that it is better off to merge with Zillow. Trulia has generated increasing negative operating income from 2010 to 2013 and its Market Leader acquisition in 2013 has enlarged its long-term debt significantly. Resulting from that, a negative net operating cash flow in 2013 was posted. Given these circumstances, Trulia might be better off to merge with Zillow as this means to ultimately survive in the marketplace. This assumption may be corroborated by the recent News Corp. acquisition of Move, Inc. that will amplify the competition in the market. Although the deal itself is not necessarily in favour of Trulia and Trulia had to give up its autonomy, one may conclude that yet, Trulia is better off. In summary, it is difficult to predict which company is better off with the deal as the future remains uncertain. Both companies should be able to take advantage from their similar business models, their larger customer base and synergetic effects, especially in terms of innovation to remain competitive in the long run. However, it is with both companies in how far and when these synergies will turn out into positive effects as an acquisition poses high administrative and structural challenges. In particular, merging both companies cultures and creating cohesiveness among former competitors will be key to its success. Sydney Business School Page 5

6 3 Structure of the deal According to Securities and Exchange Commission (2014a, p. 2), Trulia s shareholders receive shares of Zillow s Class A Common Stock and the value of the deal denotes a premium of 25% to Trulia s closing price on July 25, Current Class A and Class B Common Stock holders of Zillow receives one comparable share of the combined company at closing. Trulia would own approximately 33% and Zillow would own approximately 67%, of the combined company (Securities and Exchange Commission 2014a, p. 2). The deal also includes Zillow having the option of pulling out by paying a termination fee if the FTC proposes certain constraints on their business such as a divestment of assets. Should this deal come to pass, the structure of the deal does make sense for each company if the expected benefits can be realised. In the following section the impact of the deal from the perspective of shareholders and customers is examined. Table 1 summarizes the analysis: Stakeholder Perspective Zillow (Acquiring Entity) Trulia (Target Entity) Shareholder Dilution of ownership Long term benefits Combined debt obligation 25% premium Customer Negotiating power Lack of choice Benefit from synergy Negotiating power Lack of choice Benefit from synergy Table 1: Impact on Shareholders and Customers Sydney Business School Page 6

7 When there is a stock-for-stock acquisition, the parent company s equity is affected in proportion to the shares issued (Balasubramaniam 2014). As a consequence of the stock-only deal and issuing share in exchange of acquiring Trulia, the dilution of ownership represents a negative impact on Zillow s shareholders as the value of shares may decline. This can be accompanied by a diluted EPS. Also, as Zillow is paying a premium of 25% to acquire Trulia, this could result in increased dilution of its share value (The Motley Fool 2006). On the other hand, Zillow s shareholders could benefit in the long term due to the expected cost savings and larger market share, the combined company is expecting to achieve. Trulia s shareholders would benefit from the annualized cost savings, which are expected to be realized from the combined expertise of Zillow and Trulia. Since Trulia has been experiencing a significant long-term debt after their acquisition of Market Leader, this deal would make them better off (cf. Appendix 1). Apart from the synergistic advantages, Trulia would benefit all the more from the deal, since the deal comprises a 25% premium on Trulia s share (Securities and Exchange Commission 2014a, p. 2). As to be seen Figure 1 Trulia is currently experiencing an increase in their share price, and eventually market capitalization (cf. Appendix 2). From the perspective of customers (primarily real estate agents), the deal could result in reduction of negotiating power on the advertising price (Bushery 2014). Since the consolidation of Zillow and Trulia is expected to enlarge and strengthen their leadership position in the online real estate market, due to which customers might have to face an increased pricing power from the combined entity (Levy 2014). Furthermore, due to the combination of two major players in the market, customers might experience a lack of choice. For example, if a real estate agent was highly in favour of Trulia s business model and particularly chose to not do business with Zillow, might be alienated by their merger. As a result, this customer might feel the urge to walk away from the combined company. Sydney Business School Page 7

8 Consumers, such as vendors and purchasers might have both positive and negative effects from the deal. On the one hand, they are expected to benefit from the combined company through broadened access to real estate market data and more accurate forecasts (Securities and Exchange Commission 2014a, p. 2). On the other hand, the merger might negatively affect the consumers since the real estate agents could compensate their increased fees by passing them on to the buyers (Davidson 2014a). Sydney Business School Page 8

9 4 Future on a standalone basis There is a likelihood of the Zillow-Trulia merger deal to fail on account of Federal Trade Commission s (FTC) anti-trust laws (Kosman 2014). In other words, FTC could terminate the deal if they feel that the deal reduces competition in the marketplace thus exposing customers to risks of higher prices or reduced choices. Zillow is primarily responsible to obtain clearances required to close the deal (Solomon 2014). There is a high probability of the Zillow-Trulia deal to get the clearance from FTC because FTC views online real-estate advertisements not in isolation but as part of the entire suite of advertising media. The combined revenues of Zillow and Trulia in 2013 was $340.7 million which is around 4% of the estimated $12 billion spent in average on real-estate advertising in the USA every year (Zillow 2014c). If the transactions fail to close, Trulia could lose market share and lose its position as the primary competitor in the market. This is because, even if the deal fails to close, the conditions mentioned in the deal would be in effect till January 28, 2016, which is a fairly long time range for online-based businesses. In that time frame, Trulia is limited in its business operations by what it can do without Zillow s approval. For instance, Trulia can make no acquisitions, no capital expenditures or borrow money (Securities and Exchange Commission 2014c, p. 37). Trulia also cannot employ anyone by paying a salary of over $275,000, except to fill an empty position. These restrictions could severely limit Trulia s ability to maintain its competitive advantage and if it has to comeback as an independent company after 18 months, it could find it very hard to recover and regain its market position. Sydney Business School Page 9

10 For Zillow, failure to close the deal would mean a direct payment of $150 million of termination fee to Trulia (Securities and Exchange Commission 2014c, p. 54). Failure to close the merger deal would also mean that the investments made by Zillow to integrate the Trulia into itself will have to be written off as sunk costs. The other financial impact could be that Zillow s shareholders who have already paid a premium to acquire Trulia with a 25% premium on share prices would feel that their wealth has been depleted. Apart from the financial impacts, if the merger fails, Zillow might struggle to compete with Move Inc., another company operating in the online real estate domain. This is because Move Inc. has recently been acquired by News Corp of Australia (Davidson 2014b), an acquisition that promises to strengthen Move s position in the coming future. Move s USP is its agreement with over 800 MLS s (Multiple Listings Services) resulting in more accurate listings than either Zillow or Trulia (Davidson 2014b). A strong financial backbone and focus on data accuracy could make Move dethrone Zillow from the pinnacle position in online real estate. Sydney Business School Page 10

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12 5 Assumptions about future Based on the combined market value of approximately $5.9 billion, as of 24 October 2014 (NASDAQ 2014a), the following key factors have to be taken into consideration in order to buy stock in the combined company: micro- and macro environment, market and industry. Due to the limited framework of this report, please find a detailed report on this in Appendix 4. Microeconomically, the combined companies are subject to a wide range of risks that can have significant impact on their business, operating results and financial health resulting in the fact that prospects can be materially and adversely affected (Trulia 2014; Zillow 2014a). As the nature of both businesses is equal, the combined company risk profile is the same. This means, that these companies, due to their horizontal integration (Peirson et al. 2012) are not able to mitigate and offset each other s risk exposure. Macroeconomically, based on the PWC report, the real estate industry seems to have a positive outlook for 2015 and Executive compensation schemes and a history of acquisitions by Zillow may lead to volatile share price movements. Thus, based on the given key factors and assumptions, the combined company could face a positive and solid future. Based on the combined market value, it may be possible that the market is still adjusting to the deal as the share price of both companies show similar incremental decreasing patterns. As to be seen in Figure 2, the post-announcement share price development resulted in a steady but smooth decline for Trulia, whereas Zillow s price adjustment takes a steeper drop. Sydney Business School Page 12

13 As stated in Zillow s quarterly report (Zillow 2014b) the two companies combined revenue currently represents less than 4 percent of the estimated $12 billion that real estate professionals spend on marketing their services to consumers each year. Following from that, a strong growth potential exists for market participants. Both Zillow and Trulia have implemented director s share-based compensation schemes. Under Zillow, this compensation plan is called 2011 Plan and among others, includes equity awards and incentive stock options to employees, directors et cetera (Zillow 2014b). Assuming that the overall corporate objective is shareholder wealth maximisation, the combined company s stakeholders such as directors, the executive management and other employees could be encouraged to undertake certain actions to influence the stock price. In this respect, these actions might not be in alignment with the long-term strategy and opposed to that, focus short-term earnings (Windsor et al. 2010). Thus, a compensation scheme that attempts to encourage certain employee behaviour according to stock incentives can result in share price volatility, as provision and bonus payments are dependent on the extent of a potential deviation. Sydney Business School Page 13

14 6 Trade recommendations In order to recommend trades around this transaction, some scenarios have been analysed. An example of successful merger in the real estate industry was the acquisition of ZipRealty by Realogy. Details on this acquisition are in Appendix 5. If Zillow-Trulia merger follows a similar trend, shareholders would be better off by buying or holding on to Zillow s shares. An example of a failed merger is the merger between America Online and Time Warner in 2000 (Arango 2010). Details on this merger are in Appendix 5. There are similarities between this deal and the Zillow-Trulia deal. These are: The management of the new company would have more members from Zillow. The new Board has only 2 members from Trulia. Zillow would own two-thirds of the combined company. Lack of synergy could be a concern. Possible structural and cultural integration issues. If the Zillow-Trulia deal does not work out due to some unforeseen circumstances, the shareholders could lose heavily. In that case, it would be advised to sell Zillow s shares. The analyses of Zillow s past mergers (cf. Figure 3) show that, since 2011, Zillow has acquired several companies. All these acquisitions show a common trend. Immediately after the acquisition, there is a temporary drop in Zillow s share price. However, in the long term, Zillow s share prices picked up and Zillow shareholders could make profits over the long run (Yahoo Finance 2014g). Based on this scenario, it can be suggested that the shareholders should hold on to their shares. Sydney Business School Page 14

15 Figure 3: Source: Adapted from Yahoo Finance 2014a In order to consider other factors, horizontal mergers often do not result in higher revenues for the merged entity. On the contrary, sometimes the revenue of the new entity is less than the sum of individual firms revenue before merger. In the classic Cournot merger paradox (Salant, Switzer & Reynolds 1983) the merging parties are often worse off after the merger while outsiders (competitors/rivals) are better off. There are two main reasons for which the Zillow-Trulia merger could actually reduce revenue and increase risks. First of all, the merger could reduce the differentiation capabilities of the individual firms. Customers who liked some feature of Trulia over Zillow may walk away now that Zillow and Trulia have merged. Secondly, since both the companies operate in the same macroeconomic environment, they are exposed to same risks. Sydney Business School Page 15

16 So, if political or economic change reduces Zillow s revenues, chances are that Trulia s revenue would also reduce since they operate in the same environment. None of the companies compensate for each other s limitations in the macro-environment. A closer look at Zillow s executives and manager s actions with Zillow s shares show an unusual trend. According to data provided by Thomson Financial, these insiders have sold nearly 1.15 million shares over the past six months. For example, Zillow s CEO Spencer Rascoff, sold 10,000 shares for $1 million on October 14 (Nichols 2014). This sell of shares by Rascoff and other executives could suggest that Zillow s insiders feel that the share price is be too high. This trend suggests that the price of Zillow s shares could be uncertain in future and shareholders should sell the shares and book profits as soon as they can. To conclude, it can be said that it is too early and too uncertain to suggest any trades around the Zillow-Trulia merger. The examples of past mergers show that it would be prudent to wait for at least a year before making any trades around this transaction. The selling of shares by Zillow s executives suggest that the ordinary shareholders should follow suite but analysis of Zillow s previous mergers suggest that Zillow s share prices increase over the long run after a merger. Sydney Business School Page 16

17 7 Conclusion The purpose of this paper was to review and analyse Zillow s acquisition of Trulia. The analysis undertaken was based on a set of questions and key variables. Although Zillow s merger history demonstrates a positive share price development the main results identified are that it might still be too early and too uncertain to suggest any trades around the Zillow-Trulia merger. Executive share-based incentives and a history of acquisitions by Zillow may lead to further volatile share price movements. Also, in addition to the online real estate market s fast-moving nature there is still a growing concern of a real estate bubble. However, the real estate industry itself seems to have a positive outlook for 2015 and 2016 as both labour force growth and GDP are expected to increase. Due to the stock-only deal a dilution of ownership represents a negative impact on Zillow s shareholders as the value of shares could decline. As a result, this can be accompanied by a diluted EPS. If the merger deal fails to close, Trulia could lose market share and lose its position as the primary competitor in the market as it has given up its competitive advantage and expertise to its major competitor. Apart from the financial impacts such as the termination fee and the 25% premium paid, Zillow will face Move, Inc. as a serious competitor on a standalone basis. The combined company should be able to capitalize from its larger customer base and synergetic effects, especially in terms of innovation to remain competitive in the long run. However, it is with both companies in how far and when these synergies will turn out into positive effects. Merging both companies cultures and creating cohesiveness will be key to its success. Sydney Business School Page 17

18 8 References: Agarwal, A & Jaffe JF 2000, The post-merger performance puzzle, JAI Series: Advances in Mergers and Acquisitions, vol. 1, pp Agarwal, A, Jaffe, JF & Mandelker, GN 1992, The Post-merger performance of acquiring firms: A reexamination of an anomaly, Journal of Finance, vol. 47, pp Arango, T 2010, How the AOL-Time Warner Merger Went So Wrong, The New York Times Company, viewed 28 October 2014, < Balasubramaniam, K 2014, In M&A how does an all-stock or all-cash deal affect the equity of the buying company?, Investopedia US, viewed 29 October 2014, < Bushery, M 2014, The Zillow-Trulia Merger: How It Impacts Real Estate Agents and Brokers, Placester, Inc., viewed 26 October 2014, < Chowdhry, A 2014, Zillow Is Acquiring Trulia For $3.5 Billion, Forbes.com LLC, viewed 25 October 2014, < Davidson, J 2014a, What a Zillow/Trulia Merger Might Mean For Consumers, Time Inc., viewed 26 October 2014, < Davidson, J 2014b, Rupert Murdoch Wants to Sell You Your Next Home, Time Inc., viewed 25 October 2014, < Kosman, J 2014, Realtors want FTC to block Zillow-Trulia merger, New York Post, viewed 23 October 2014, < Sydney Business School Page 18

19 Lahey, KE & Conn, RL 1990, Sensitivity Of Acquiring Firm s Returns To Alternative Model Specifications And Disaggregation, Journal of Business & Accounting, vol. 17, no. 3, pp Levy, J 2014, Zillow and Trulia Merge to Disrupt the Real Estate Industry, Business 2 Community, viewed 26 October 2014, < Madison, NJ & Emeryville, C 2014, ZipRealty Inc., viewed 30 October 31, 2014, < Munarriz, R 2014, 3 Reasons Zillow Inc. Stock Could Rise, The Motley Fool, viewed 25 October 2014, < NASDAQ 2014a, Zillow, Inc. Stock Quote & Summary Data, NASDAQ.com, viewed 24 October 2014, < NASDAQ 2014b, TRLA Company Financials, NASDAQ.com, viewed 25 October 2014, < Nichols, B 2014, Should Investors Follow Zillow Inc. Insiders and Cash Out?, The Motley Fool, viewed 28 October 2014, < Peirson, G, Brown, R, Easton, S, Howard, P & Pinder, S 2012, Business Finance, 11 th Ed., McGraw-Hill Australia, NSW. PricewaterhouseCoopers (PWC) 2014, Emerging Trends in Real Estate, PricewaterhouseCoopers LLP, viewed 30 October 2014, < S&P Dow Jones 2014, S&P/Case-Shiller Home Price Indices, S&P Dow Jones Indices LLC, viewed 25 October 2014, < Sydney Business School Page 19

20 Salant, SW, Switzer, S & Reynolds, RJ 1983, Losses from Horizontal Merger: The Effects of an Exogenous Change in Industry Structure on Cournot-Nash Equilibrium, The quarterly journal of economics, vol. 98, no. 2, pp Securities and Exchange Commission 2014a, Zillow Inc., Form 8-K, Securities and Exchange Commission, viewed 25 October 2014, < 6AA1JU/ x0xS / /filing.pdf>. Securities and Exchange Commission 2014b, Transcript of Spencer Rascoff s October 1, 2014 appearance on CNBC, Securities and Exchange Commission, viewed 26 October 2014, < Securities and Exchange Commission 2014c, Agreement and plan of merger among Zillow, Inc, Zebra Holdco, Inc. and Trulia, Inc., Securities and Exchange Commission, viewed 26 October 2014, < Solomon, SD 2014, In Real Estate Listings Deal With Zillow, Trulia Bears Most of the Risk, The New York Times, 25 October 2014, < The Motley Fool 2006, Foolish Fundamentals: Stock Dilution, The Motley Fool, viewed 29 October 2014, < Trulia 2014, Trulia Inc., Annual Report on Form 10-K, Trulia Inc., viewed 24 October 2014, < Wagner, D 2014, Politics and Real Estate in the U.S., Huffington Post, viewed 25 October 2014, < Sydney Business School Page 20

21 Windsor, D, Autrey, LS & Jones, JH 2010, Shareholder Wealth Maximization, in Boathright, JR 2010 Finance Ethics, Critical Issues in Theory and Practice, John Wiley & Sons, Inc., Hoboken, New Jersey. Yahoo Finance 2014a, Historical Prices, Yahoo! 7 Pty Limited, viewed 26 October 2014, < =66&y=66>. Yahoo Finance 2014b, Historical Prices, Yahoo! 7 Pty Limited, viewed 26 October 2014, < d&z=66&y=462>. Yahoo Finance 2014c, Historical Prices, Yahoo! 7 Pty Limited, viewed 26 October 2014, < d&z=66&y=0>. Yahoo Finance 2014d, Historical Prices, Yahoo! 7 Pty Limited, viewed 26 October 2014, < >. Yahoo Finance 2014e, ZipRealty, Yahoo! 7 Pty Limited, viewed 30 October 2014, < Yahoo Finance 2014f, Realogy, Yahoo! 7 Pty Limited, viewed 30 October 2014, < d&z=66&y=0>. Yahoo Finance 2014g, Zillow, Yahoo! 7 Pty Limited, viewed 29 October 2014, < 6&y=66>. Zillow 2014a, Zillow Inc., Form 10-K, Annual Report, Zillow Inc., viewed 24 October 2014, < 6AA1JU/ x0xS %2D14%2D56800/ /filing.pdf>. Sydney Business School Page 21

22 Zillow 2014b, Zillow Inc., Form 8-K, Zillow Inc., viewed 24 October 2014, < 6AA1JU/ x0xS %2D14%2D281415/ /filing.pdf>. Zillow 2014c, Zillow Announces Acquisition of Trulia for $3.5 Billion in Stock, Zillow Inc., viewed 26 October 2014, < Sydney Business School Page 22

23 9 Appendix Appendix 1: Trulia balance sheet for four quarters Quarter: 2nd 1st 4th 3rd Quarter Ending: 6/30/2014 3/31/ /31/2013 9/30/2013 Current Assets Cash and Cash Equivalents $214,909 $220,755 $225,597 $43,417 Short-Term Investments $0 $0 $0 $0 Net Receivables $14,541 $11,230 $11,697 $13,679 Inventory $0 $0 $0 $0 Other Current Assets $9,238 $8,190 $12,272 $5,853 Total Current Assets $238,688 $240,175 $249,566 $62,949 Long-Term Assets Long-Term Investments $0 $0 $0 $0 Fixed Assets $30,155 $25,999 $22,289 $12,524 Goodwill $255,904 $255,904 $255,904 $255,904 Intangible Assets $110,221 $114,073 $117,888 $121,699 Other Assets $14,639 $14,842 $9,762 $2,507 Deferred Asset Charges $0 $0 $0 $0 Total Assets $649,607 $650,993 $655,409 $455,583 Current Liabilities Accounts Payable $25,704 $21,431 $25,142 $22,016 Short-Term Debt / Current Portion of Long-Term Debt $21 $28 $51 $3,748 Other Current Liabilities $11,117 $11,886 $11,037 $12,690 Total Current Liabilities $36,842 $33,345 $36,230 $38,454 Long-Term Debt $230,075 $230,080 $230,084 $4,269 Other Liabilities $3,900 $3,439 $3,268 $1,551 Deferred Liability Charges $5,752 $5,125 $4,751 $0 Misc. Stocks $0 $0 $0 $0 Minority Interest $0 $0 $0 $0 Total Liabilities $276,569 $271,989 $274,333 $44,274 Stock Holders Equity Common Stocks $0 $0 $0 $0 Capital Surplus $470,936 $459,039 $445,960 $465,047 Retained Earnings ($97,898) ($80,035) ($64,884) ($53,738) Treasury Stock $0 $0 $0 $0 Other Equity $0 $0 $0 $0 Total Equity $373,038 $379,004 $381,076 $411,309 Total Liabilities & Equity $649,607 $650,993 $655,409 $455,583 Table 2: Source: NASDAQ 2014b Sydney Business School Page 23

24 Appendix 2: Trulia - Share price movements Figure 1: Source: Adapted from Yahoo Finance 2014b Sydney Business School Page 24

25 7/14/14 7/21/14 7/28/14 8/4/14 8/11/14 8/18/14 8/25/14 9/1/14 9/8/14 9/15/14 9/22/14 9/29/14 10/6/14 10/13/14 10/20/14 7/14/14 7/21/14 7/28/14 8/4/14 8/11/14 8/18/14 8/25/14 9/1/14 9/8/14 9/15/14 9/22/14 9/29/14 10/6/14 10/13/14 10/20/14 Appendix 3: The stock price patterns of Realogy & ZipRealty Stock price patterns of Realogy Figure 4: Source: Adapted from Yahoo Finance 2014c Stock price patterns of ZipRealty Figure 5: Source: Adapted from Yahoo Finance 2014d Sydney Business School Page 25

26 Appendix 4: Detailed analysis of future assumptions Based on the combined market value of approximately $5.9 billion, as of 24 October 2014 (NASDAQ 2014a), the following key factors have to be taken into consideration in order to buy stock in the combined company: micro- and macro environment, market and industry. Microeconomically, the combined companies are subject to a wide range of risks that can have significant impact on their business, operating results and financial health resulting in the fact that prospects can be materially and adversely affected (Trulia 2014; Zillow 2014a). As the nature of both businesses is equal, the combined company risk profile is the same. Consequently, due to this prevailing condition, one has to take into account that in case of uncertain events happening, either positive or negative, both company s share prices move into the same direction (cf. Figure 2). This means, that these companies, due to their horizontal integration (Peirson et al. 2012) are not able to mitigate and offset each other s risk exposure. Also, share price volatility patterns are paramount when making assumptions about the future market value of both companies and buying stock, particularly prior and post-merger. As to be seen in Figure 2, there is a strong resemblance in both company s share price development. Even though Zillow could realize a stronger share price growth since the end of year 2012, both companies significantly increased their share price prior to the announcement. The decline in the months from May to beginning of June is depicted in the Case-Shiller index as home prices decreased roughly at 0.3% (Munarriz 2014). Indicative of insider trading, one week before the merger announcement rumours about the potential became public and the share price began to rise (Chowdhry 2014). This increase in share price has amplified after the official merger announcement on 28 July 2014 and a salient spike can be observed. Sydney Business School Page 26

27 Share price development comparison Zillow Trulia $170 $160 $150 $140 $130 $120 $110 $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $- Figure 2: Source: Adapted from NASDAQ 2014a In order to make assumptions about the future stock price, studies about long-term post-merger performance of combined companies have to be considered. For example, Agarwal et al. (1992) have examined that combined companies face a statistically significant loss of approximately 10% in a five-year post-merger period. Likewise, Lahey and Conn (1990) investigate that after three years of a merger, the cumulative abnormal results decrease to -10.2%. This is corroborated by a study of Agarwal and Jaffe (2000), concluding that long-term post-merger stock performance is significantly negative. Macroeconomically, as the Price-Waterhouse-Coopers (PWC) report on emerging real estate trends for 2015 demonstrates, there is still a growing concern of a real estate bubble (PWC 2014). They argue, that the positive industry outlook and optimism can result in excessive optimism, which could lead to reckless behaviour. However, PWC (2014) claims that the real estate industry seems to have adapted some self-regulation and self-correction. The 2015 industry outlook is positive, considering the once-burned, twice-shy experience. As the Blue Chip Economist forecast ascertains, the positive industry outlook is strengthened by a above-trend gross domestic product (GDP) growth in Sydney Business School Page 27

28 late 2014 and through 2015 (PWC 2014). Moreover, prospected labour force growth in the next three years, a drop in the unemployment rate to 5.5 % and Consumer Price Index (CPI) prediction above 2% demonstrate a positive future industry outlook. The market potential is contributing to making assumptions about the future of the combined company. As stated in Zillow s quarterly report (Zillow 2014b) the two companies combined revenue currently represents less than 4 percent of the estimated $12 billion that real estate professionals spend on marketing their services to consumers each year. Following from that, a strong growth potential exists for market participants. This can be underpinned by the fact that the Case-Shiller index has shown a steady upward trend from 2012, apart from a dip between May and June 2014 (S&P Dow Jones Indices 2014). Both Zillow and Trulia have implemented director s share-based compensation schemes. Under Zillow, this compensation plan is called 2011 Plan and among others, includes equity awards and incentive stock options to employees, directors et cetera (Zillow 2014b). Assuming that the overall corporate objective is shareholder wealth maximisation, the combined company s stakeholders such as directors, the executive management and other employees could be encouraged to undertake certain actions to influence the stock price. In this respect, these actions might not be in alignment with the long-term strategy and opposed to that, focus short-term earnings (Windsor et al. 2010). Thus, a compensation scheme that attempts to encourage certain employee behaviour according to stock incentives can result in share price volatility, as provision and bonus payments are dependent on the extent of a potential deviation. Sydney Business School Page 28

29 Appendix 5: Merger and Acquisition Scenarios 1. Realogy acquisition of ZipRealty The acquisition was announced on July 15, 2004 (Madison & Emeryville 2014). On the day of the announcement, Realogy s share price was $ A year later, Realogy shares were worth around $40.76 (Yahoo Finance 2014f). More spectacular was the rise in ZipRealty s stock prices. While ZipRealty s shares were priced at $3.02 on July 15, 2004, their prices had more than doubled a year later. They were priced $6.74 on date of deal completion (Yahoo Finance 2014e). The stock price patterns are shown in Appendix Merger between America Online (AOL) and Time Warner The merger was similar to the Zillow-Trulia merger because it was an attempt to consolidate the market (media and internet). It was also a stock-only deal in which AOL acquired Time Warner s shares and their debt. The value of the deal was $350 billion. According to the deal, AOL paid $183 billion in stock and acquired $17 in debt of Time Warner. AOL was to own 55% of the company. However, the deal was unsuccessful over the long run because lack of synergy between the two organizations, structure of management team that was heavily tilted in favour of AOL and lack of trust. The AOL-Time Warner deal was broken in Time Warner s stock price, which was close to $250 in January 2000, was around $25 in May AOL was valued at $161 billion in January 2000 but was valued at $4 billion in Sydney Business School Page 29