The Economist MBA Case Competition 2014 Muddy Waters Investment Competition Analysis on the Zillow Trulia Merger Authors Michael Jonas, Juan Guillermo Rintha, Philipp Soechtig Full-Time MBA Class of 2015 WHU Otto Beisheim School of Management Submitted November 3, 2014
Table of Contents 1. Introduction to online real estate market... 4 2. Case Questions... 5 a) Which company is getting the better deal and why?... 5 b) Does the structure of the deal make sense for each company?... 8 c) What will the futures likely be for each company on a standalone basis if the transaction fails to close?... 8 d) Based on the companies present combined market valuations, what assumptions about their future would you have to make in order to buy stock in the combined company?... 12 e) What trades, if any, would you recommend around this transaction and why?... 16 3. Wrap-up... 19 WHU Otto Beisheim School of Management, www.whu.edu Page 2
Table of Exhibits Exhibit 1: Share of visitors... 5 Exhibit 2: Future revenues/ebitda vs. market capitalization... 6 Exhibit 3: Adj. EBITDA and synergies 2016... 7 Exhibit 4: M&A deals capped to certain market share... 11 Exhibit 5: Market position highly correlated with level of profitability... 13 Exhibit 6: Share prices mainly influenced by three major drivers... 14 Exhibit 7: Significan premiums at technology M&As... 17 Exhibit 8: Benefit from online trend... 18 WHU Otto Beisheim School of Management, www.whu.edu Page 3
1. Introduction to online real estate market The fundamental structure of the American real estate market has not radically changed in last decade, even after the housing bubble that took place around seven years ago (CNN, Money & Main St., 2009). The traditional and largely fragmented way has always facilitated interactions between the agents, who personally show the properties, and the final residents, aiming to acquire a new home. However, new virtual mechanisms prior to those interactions are now widely used and appreciated by the last mentioned (CNN, Zillow buys Trulia for $3.5 billion, 2014). The online platforms in this market now store properties from diverse parts of the country that are uploaded by the real estate agents, and display them to thousands of people that rate them with their computers and mobile devices. The largest ones are Zillow and Trulia, followed by others like Realtor.com, Yahoo! Homes, Homes.com, Redfin, among others. They provide not only information about houses to buy and to rent, but also complementary services such as housing valuation, moving-in advice, mortgage options, interior designer lists, and the like. The business model of the platforms mostly relies on few streams. For example, Trulia s revenue largely depends on the mortgages that are traded online, the advertisement on its site and the number of properties it shows. The listings of properties are uploaded by the agents who pay the platform to publish their information on its website and mobile apps. WHU Otto Beisheim School of Management, www.whu.edu Page 4
However, these payments towards Zillow and Trulia represent less than 4% of the total advertisement expenditure that the real estate market invest (CNN, Zillow buys Trulia for $3.5 billion, 2014). On the other hand, the platforms have relatively low fixed costs, making the marginal variable ones (mostly the development of the platform) almost negligible (Refkin). 2. Case Questions a) Which company is getting the better deal and why? The merger of Zillow and Trulia seems to be the best that opportunity in the online real estate market. It can be seen as the beginning of market consolidation and will create the biggest player by far in the market with market share of visitors of 24% (inman, 2014) or 3.5 times the second largest player (see Exhibit 1). This gives market power to the combined player and will help to negotiate higher fees with agents. On the cost side, 1. significant cost avoidance can This be deal reached creates due to a economies strong market of scale. leader Share of visitors Opportunity analysis December 2013 Market consolidation starts now First mover advantage is important Rumors about Trulia trying to acquire Move (Realtor.com) Zebra will be by far the biggest player Dominate the market Avoid competition with larger ones Other M&A opportunities were even less attractive Highest synergy potential between Zillow and Trulia Acceptable range of visitors overlap Source: http://www.inman.com, Team analysis Exhibit 1 WHU Otto Beisheim School of Management, www.whu.edu Slide WHU Otto Beisheim School of Management, www.whu.edu Page 5
To find out who gets more of the deal, the contributions of each company stand alone were analyzed and compared to the share of ownership in the combined company. The data were taken from the management forecast on stand alone basis in the SEC form S-4 (SEC, 2014), published by Zebra HoldCo. In Exhibit 2 it can be seen that Zillow contributes roughly 60% of revenues and 64% of EBITDA from 2014 till 2017 and Trulia earns 40% 1. revenues Future or respectively revenues/ebitda 36% of EBITDA vs. market in the capitalization same time horizon. Zillow Trulia Revenue ($m) 2014 328 2015 516 2016 738 2017 971 266 365 485 634 Adjusted EBITDA ($m) 2014 53 2015 121 2016 208 2017 296 29 72 121 190 Market capitalization ($m) 6,400 Enterprise value ($m) 6,858 2,773 2,758 Visitors (m) 81.1 Attention on Google (index) 100.0 Number Average of agents (000) Unweighted revenue average per user ($) 320.0 56.8 62% 38% 51.6 26.0 73.9 206.0 Ownership 67% 33% Sources: Zebra Holdco SEC form S-4, Team analysis WHU Otto Beisheim School of Management, www.whu.edu Exhibit 2 Slide 8 Looking at the market capitalization at the last day before the merger was announced Zillow contributes 70% of the combined market capitalization. The share of enterprise value of Zillow was at 71%, due to higher cash and lower debt than Trulia. The unweighted average shows that Zillow only contributes 62% but gets 67% of ownership. Nevertheless, a valid argument would be that the capital market takes the market consensus of the forecast into account and values Zillow higher and implicitly values WHU Otto Beisheim School of Management, www.whu.edu Page 6
the risk of Trulia s future revenues and profits higher. Therefore, only based on this analysis it cannot be said who made the better deal. Furthermore, it has been analyzed how the forecasted operating synergies were distributed among the shareholder of the combined company. The data is based on the synergies of 2016, the first year with a significant synergy effect. The total EBITDA consists of the contribution of both companies stand alone and the synergies. It will be distributed to 67% to former Zillow shares and 33% to former Trulia shares. Assumed that the base of the distribution is the stand alone EBITDA, the difference to the share of 67% respectively 33% is the part of the synergy allocated to each former company. It can be seen that Zillow get 71% of the synergies compared to a share of ownership of 67%. Trulia gets 29% of synergies distributed to a 33% share of ownership. Exhibit 3 shows that Zillow gets 1. 4%-pt. Zillow more ownership gets slightly than higher synergies. share of synergies Adj. EBITDA and synergies 2016 $m, according to management forecast 649 320 214 33% 93 121 29% of synergies 121 329 227 71% of synergies 435 67% 208 208 Zillow Trulia 1+1=2 Operating Synergies 1+1=3 Ownership Zillow s synergy share Trulia s synergy share Sources: Zebra Holdco SEC form S-4, Team analysis WHU Otto Beisheim School of Management, www.whu.edu Exhibit 3 Slide 9 WHU Otto Beisheim School of Management, www.whu.edu Page 7
Taking that into account it seems that Zillow gets a slightly better deal than Trulia. b) Does the structure of the deal make sense for each company? The deal was structured as a 100% share deal. Trulia s shareholder will get 0.444 shares of the combined company for each share. No further cash premium will be paid. Based on the share prices of the last day before the public announcement of the merger agreement Trulia s shareholder will receive a premium of 25%. The volume of the total deal amounts to $3.5bn. The debt of Trulia will not be repaid. Looking at the structure of the deal, it stands out that there is no cash involved and the combined company is not levered any further. Looking ahead that seems to be reasonable for two reasons. Firstly, cash is needed to facilitate the organic growth of each company. In particular, building stronger brands, develop the US online real estate market in terms of better service to agents and buyer/renters as well as realizing the operating synergies and do successful post merger integration. The second reason is the ongoing market consolidation. The combined company will need to take an active part in that and needs firepower to execute M&A deals quickly. The process of issuing new shares can be too long to succeed in acquiring companies, which are interesting to more than one player of the market, especially when cash premiums come into play after the first offer and another capital raise is needed. WHU Otto Beisheim School of Management, www.whu.edu Page 8
Both companies will operate under a holding company called Zebra Holdco Inc. Both trademarks will remain in the market. That makes sense to not lose the visitors visiting both sites. Nevertheless, it is likely that certain departments will be shared to realize the estimated cost synergies. Especially in the IT development and maintenance economies of scale can be gained. The back-end of both platforms can be joined. Furthermore, all administrative functions like HR or Investors Relations can be merged. Looking it marketing costs, it can be argued, that both trademarks will remain and there are no advantages of the merger. However, due to the fact that the biggest competitor is gone, there is less need to advertise against each other. Zillow and Trulia will focus und slightly different market segments and thereby use their resources more efficient. Considering the no cash deal and the organizational structure of both companies, the overall deal structure makes sense and fits to the strategy of the combined company. c) What will the futures likely be for each company on a standalone basis if the transaction fails to close? Both companies, Zillow and Trulia have already entered into an Agreement and Plan of Merger ( Merger Agreement ) (Zillow, 2014) and thereby committed to pursue the merger of both companies. Considering the termination regulations of this Merger Agreement, there is still the possibility that the planned merger will fail to close. WHU Otto Beisheim School of Management, www.whu.edu Page 9
Analyzing all termination options in the Merger Agreement, such as mutual written consent ( ), if the Initial Effective Time shall not have occurred ( ), the case of the other s companies Board Recommendation Change ( ), the main risks can be seen in external influences. There are chances that Trulia s stakeholders do not approve the deal and that an US Governmental Authority classifies this merger as illegal. While the risk of a lack in Trulia s stakeholder approval can be assumed to be low due to the win-win situation both companies get as a result of this merger, there is a realistic probability that the deal will fail as antitrust authorities may state objections. Under Zebra Holdco, Inc. both platforms are supposed to operate as independent brands because two brand appeal to a larger audience, as Spencer Rascoff, CEO of Zillow states. Fewer than half of Trulia s audience visits Zillow and two third of Zillow s visitors visit Trulia (NBR, 2014). This supports the decision to keep the brands separated. However, both players already are the biggest companies on the online real estate market and Zebra Holdco would then cover 24% (inman, 2014) of all US real estate website visitors as a sum of both independent platforms as shown in Exhibit 4. WHU Otto Beisheim School of Management, www.whu.edu Page 10
3. Antitrust issues would impact the overall market M&A deals capped to certain market share Living apart together December 2013 Antitrust issues on Zillow and Trulia Merger limit share of visits at ca. 20% Oligopoly with 3-5 large players Organic growth more important than market consolidation Economies of scale limited Adverse effect on Zillow s and Trulia s market valuation Less operating synergies Remaining big players KPIs: Monetization of revenues due to brand and service quality and management of cost basis Source: http://www.inman.com, Team analysis Exhibit 4 WHU Otto Beisheim School of Management, www.whu.edu Slide In case antitrust authorities evaluate this market share as too large, such a decision would impact the overall market, as M&A deals would be capped to a market share at around 20%, which is in between Zillow s current share of 16% and the targeted Zebra Holdco share. Moreover, Trulia would have much more negative effects if the deal does not close because it is not allowed to acquire other companies or any debt to itself as long as the Merger Agreement is still valid (NY Times, 2014). In the end, it all would leave both companies on a stand-alone basis, leaving the market as an oligopoly to be shared with the remaining largest players. The stand-alone basis also takes its toll on the operative synergies that the deal attempts to realize. The disappearance of the massive size of the combined company would erase any major bargaining power that Zebra Holdco would have, and also cost reductions achieved by economies of scale on its value chain. It would also lower at some extent the relevance WHU Otto Beisheim School of Management, www.whu.edu Page 11
of further acquisitions that both companies may pursue and will leave them with organic growth as the best alternative to increase their own market share. A further consequence of this scenario would be the necessity from the companies to rely on the past perceptions the customers and agents already had about them. This means that their brands and quality of service would be the first most influential assets they will rely on after the merge attempt to keep as the largest players in the market. Overall, a deal failure would have adverse effect on Zillow s and Trulia s market valuation. d) Based on the companies present combined market valuations, what assumptions about their future would you have to make in order to buy stock in the combined company? The combined market valuation of Zebra Holdco adds up to 9,173 m$ and can is estimated by combining both the market capitalization of Zillow (6,400 m$) and Trulia (2,773 m$). In order to buy stock in the combined company, an increase in the share price must be expected. While there is the argument that Zillow s market capitalization alone with a price-toshare ratio of 20 is already significantly higher compared to other internet companies such as LinkedIn with a price-to-share ratio of 12, TripAdvisor (12) and Yelp (16) (Barron's, 2014), there is the possibility of Zebra Holdco s share price increase under the following assumptions: WHU Otto Beisheim School of Management, www.whu.edu Page 12
Assumption 1: An increase in market size of the combined company will lead to an increased EBITDA margin compared to Zillow and Trulia on a standalone basis. With the combined visitor share of 24%, Zillow and Trulia are 3.5 times bigger than the then second largest competitor Realtor.com. Considering the correlation between market position and the level of profitability of other internet firms there is a high probability that Zebra Holdco s share price will positively influenced by an increased EBITDA margin as shown 4. in Exhibit Market 5. position highly correlated with level of profitability EBITDA margins up to 70% 100 50-70 leboncoin.fr blocket rightmove.uk EBITDA margin (%) 30-50 5-30 Auto Trader seloger.com REA Immobilien Group Scout 24 Zebra Auto Scout 24 seek Jobindex FINN bytbil.com carsales.com.au monster.com Trulia Zillow 1x 3-5x 8-10x Size versus second player Real estate platforms Sources: capital IQ, company information, ZU analysis, Bertelsmann SE WHU Otto Beisheim School of Management, www.whu.edu Exhibit 5 Slide 12 WHU Otto Beisheim School of Management, www.whu.edu Page 13
The higher profitability is a likely result of higher synergies of scale and operating synergies of 320 m$ as introduced above. It gives the combined companies further growth potential, which potentially leads to investors phantasies about the optimistic future development of Zebra Holdco. Assumption 2: Three major drivers mainly influence share prices: Revenue, numbers of visitors, number of agents registered Exhibit 6 shows that both Zillow s and Trulia s share price development was highly correlated to financial and operational figures from the respective past quarters: Revenue Number of visitors 4. Online and mobile trend will help Zebra to realize synergies Number of agents registered Share prices mainly influenced by three major drivers (correlations in %) 180 Zillow Trulia 80 120 98% Revenue (m$) 78% 60 98% Visitors (m) 90% 40 0 01.10.12% Q3/12 01.10.13% Q3/13 Q3/14 01.10.14% 97% Agents (000) 73% 0 01.10.12 Q3/12 01.10.13 Q3/13 Q3/14 01.10.14 Exhibit 6 It can be assumed that due to a stronger market position of both companies all three parameters will increase leading to an increased stock price. This Sources: Zillow, Trulia, Bloomberg, Morgan Stanley, UBS WHU Otto Beisheim School of Management, www.whu.edu development is supported, as both platform brands are to operate Slide 13 WHU Otto Beisheim School of Management, www.whu.edu Page 14
separately which reduces the risk of agent/visitor overlap elimination. Furthermore, both platforms can introduce volume discounts for agents, which motivate to place real estate listings on both platforms. This again raises revenues. As further visitors are attracted by more comprehensive real estate databases, this figure will most probably increase as well and also drive revenues from third party advertisements on the Zillow s and Trulia s websites. Assumption 3: There is a significant growth potential in the online real estate market, from which Zebra Holco s share price will very likely benefit. 90% of US Americans begin their home searches online. In addition to this, Zillow and Trulia currently cover only 4% of all US American real estate agencies marketing spend, which is estimated at 12 bn$ per year (CNN, Zillow buys Trulia for $3.5 billion, 2014). The real estate market can be described as stable and the clear trend towards online and mobile real estate search gives rise to further growth opportunities for the combined company. In this context, Zebra Holdco s growth is strongly supported by the synergy advantages, e.g. when it comes to the joint development of new smartphone apps and the marketing of both platforms. This cost optimized approach in a growing market will most likely result in a favorable stock price development. WHU Otto Beisheim School of Management, www.whu.edu Page 15
e) What trades, if any, would you recommend around this transaction and why? The merger transaction of Zillow and Trulia can be seen as the starting point in the US American online real estate market consolidation. In order to further exist on a competitive level, other real estate platforms are forced to grow. As such a growth is organically not possible at the high speed required, it can be assumed that other players will merge as well in order to gain size from acquisitions. Trading recommendation 1: Buy shares of Move, Inc. The real estate website Realtor.com will become the second largest platform visitor-wise in case the Zillow/Trulia merger succeeds. A clear buying recommendation for the shares of Move, Inc., the operator of Realtor.com can be formulated, as two scenarios seem likely: (1) Zebra Holdco or another participant in the online real estate market, such as Yahoo! Homes, acquires Move. In this case Move s share prices potentially increase due to a premium paid on the share price by the acquiring company. Exhibit 7 shows premiums, which have been paid on 638 technology M&A transactions with a deal volume of >100 m$ and change of control considered since 2004. WHU Otto Beisheim School of Management, www.whu.edu Page 16
5. Trading recommendation around the Zillow and Trulia Merger Significant premiums at technology M&As Benefit from online trend 638 transactions since 2004 Home search Core business Starting point for customer Close the deal Act as mortgage broker Offer insurance for new home Move to new home Remover agency service Offer craftsmen platform Deal volume >$100m and change of control transactions considered Home search Home improvement Interior design Online furniture shop Trading recommendation: Move, Inc. Trading recommendation: Wayfair LLC. Source: Zebra Holdco SEC form S-4, Team analysis WHU Otto Beisheim School of Management, www.whu.edu Exhibit 7 Slide 1 (2) Move acquires another market participant. In this case, Move s share prices are likely to increase because of the company s growth potential with regards to increased revenues, visitors and agents registered analogue to the correlations discussed above. Trading recommendation 2: Buy shares of Wayfair LLC. There are companies that might benefit from the online trend for real estate searches. Exhibit 8 shows potential real estate buyers/renters needs along the process chain. While Zillow and Trulia already cover the home search process and act as a broker for mortgages, both can furthermore direct customers to insurance companies and remover agencies or craftsmen platforms, which are related to the process steps close the deal and move to new home. These companies have the opportunity to advertise WHU Otto Beisheim School of Management, www.whu.edu Page 17
5. on online real estate platforms and benefit from an increased marketing coverage, as their target group, the home buyers/renters, can increasingly be addressed on the real estate websites. This at the end might positively influence revenues and growth of the third parties and lead to a share price Trading recommendation increase. around the Zillow and Trulia Merger Significant premiums at technology M&As Benefit from online trend 638 transactions since 2004 Home search Core business Starting point for customer Close the deal Act as mortgage broker Offer insurance for new home Move to new home Remover agency service Offer craftsmen platform Deal volume >$100m and change of control transactions considered Make it your home Home improvement Interior design Online furniture shop Trading recommendation: Move, Inc. Trading recommendation: Wayfair LLC. rce: Zebra Holdco SEC form S-4, Team analysis HU Otto Beisheim School of Management, www.whu.edu Exhibit 8 Slide 14 Wayfair LLC. covers a wide range of services in the process step make it your home. The website Wayfair.com offers home improvement advices and suggests interior designs. Furniture can be purchased online on this website. Besides advertising on Zillow and Trulia, Wayfair LLC. could enter into a cooperation with Zebra Holdco and e.g. offer a 5% welcome discount to customers who contacted the real estate agent via Zillow or Trulia. By doing so, Wayfair LLC. would also benefit from increased growth potential and consequently rising share prices as discussed above. WHU Otto Beisheim School of Management, www.whu.edu Page 18
3. Wrap-up Recapitulatory, the merger of Zillow and Trulia will change the online real estate market quite a lot. The strong combined company will use its bargaining power and exploit economies of scales. Further consolidation is likely will affect other companies significantly. 1. Which company is getting the better deal and why? Zillow gets a slightly better deal based on market capitalization and share of synergies. 2. Does the structure of the deal make sense for each company? The structure makes sense because it facilitates further organic and inorganic growth for both. 3. What will the futures likely be for each company on a standalone basis if the transaction fails to close? Antitrust issues may cause a failure and will lead to a living apart together scenario with lower valuations. 4. What assumptions about their future would you have to make in order to buy stock in the combined company? Online and mobile trends remain strong and monetize; operating synergies will be exploited as planed. WHU Otto Beisheim School of Management, www.whu.edu Page 19
5. What trades, if any, would you recommend around this transaction and why? Participate in further M&A deals and benefit from online trend in real estate and related markets. WHU Otto Beisheim School of Management, www.whu.edu Page 20
List of References Barron's. (August 09, 2014). Zillow Shares Could Fall By Half. Retrieved October 28, 2014, from http://online.barrons.com/articles/sb50001424053111904329504580071503076700616 CNN. (January 29, 2009). Money & Main St. Retrieved October 26, 2014, from How a 'perfect storm' led to the economic crisis: http://www.cnn.com/2009/us/01/29/economic.crisis.explainer/index.html?_s=pm:us CNN. (July 28, 2014). Zillow buys Trulia for $3.5 billion. Retrieved October 27, 2014, from http://money.cnn.com/2014/07/28/real_estate/zillow-buys-trulia-for-3-5-billion/ CNN. (July 28, 2014). Zillow CEO: Why Trulia is worth it. Retrieved October 28, 2014, from http://money.cnn.com/video/news/2014/07/28/zillow-ceo-trulia-deal.cnnmoney/ inman. (February 04, 2014). Visits to real estate websites surge 25 percent from December to January. Retrieved October 21, 2014, from http://www.inman.com/2014/02/04/visits-to-realestate-websites-surge-25-percent-from-december-to-january/ NBR. (July 28, 2014). Why Trulia deal won t fix Zillow s stock for long. Retrieved October 29, 2014, from http://nbr.com/2014/07/28/why-trulia-deal-wont-fix-zillows-stock-for-long/ NY Times. (July 31, 2014). Deal Book. Retrieved October 26, 2014, from http://dealbook.nytimes.com/2014/07/31/in-deal-for-real-estate-listing-trulia-zillow-comesout-on-top/?_r=0 Refkin, J. The zero marginal cost society. Zillow, I. (July 28, 2014). Form 8-K. Retrieved October 21, 2014, from http://investors.zillow.com/secfiling.cfm?filingid=1193125-14-284607&cik=1334814 WHU Otto Beisheim School of Management, www.whu.edu Page 21