FLUCTUATING TIDES
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Tickers mentioned in this show: Z, ZG
Tidal River Investments positions the day after the first show airing:
Long: NFLX, ETSY, SPY, TDOC, U, Z, ZG
Collected Z/ZG data spreadsheet
Photography from Tidal River Investments can be purchased at https://tidalriverinvestments.com/
Welcome to Fluctuating Tides, the Podcast, Episode 4. I’m your host, SomeCodingGuy, and let’s get right to it!
This week I’m going to be covering Zillow Group Incorporated, ticker Z and also ZG, an online real estate company that’s completely changing the nature of how we handle housing transactions. Prior to the creation of Zillow, just doing something as simple as figuring out a home’s value was a difficult process, and talking to real estate agents made casual browsing hard. CEO and founder Rich Barton, a Microsoft veteran, and founder of Expedia and Glassdoor, has a history simplifying high friction industries. When he realized how much work it was to buy and sell a home, he decided to do something about it.
For this week’s knowledge segment, I want to talk about share classes, something that can be a little bit confusing.
What is a stock? At its core, stock represents partial ownership of a company, and the founders initially decide how many parts (or shares) they want to split their company into. If the company goes public, those shares can be easily traded on public exchanges - when you want to buy or sell shares of a company, you give your brokerage instructions on what to do, and through a market maker match you up with someone on the other side of the trade, before settling the shares in your name. Ok, it’s a little more complicated than that, and the broker usually just holds the shares in their name on your behalf, also called “street name”, which simplifies a lot of the steps, but the principle is basically the same, since in the end, you still control the shares.
For most public companies, those private shares can be subdivided, reissued, renamed, resized, and all manner of craziness, before the company goes public, but by the time the company goes public, they typically represent the full stock of the company. In the common case, there’s one class of shares, and each share gives you one vote in the company, and shareholders typically have the right to vote their shares on various topics presented at the company’s annual meeting. Now these days, votes are normally done electronically, and don’t require the shareholder to be present at the meeting, but you get the idea.
All shares don’t need to be exactly the same, however. Based on various financing deals, companies may create a special class of stock, different from the ordinary shares, for various accounting or executive reasons. These days among tech companies are super voting shares, or shares that carry more voting power than one vote per share of stock; these super voting shares may have some multiple, such as 10 votes per share instead of one, which is often used so that the founders can sell off a bunch of their stock, while still retaining majority control of the company. Since regular shareholders may not agree to this sort of thing after the company is public, this sort of thing often happens while the company is still private.
Zillow uses both of these techniques, having three classes of shares: the Class A shares, which trade as ticker ZG, have one vote per share. On the other hand, Class C shares, which trade as ticker Z, have no voting rights, even though they still represent partial ownership of the company. The Class B shares, the smallest class, can be converted to Class A shares, but since they’re not commonly traded and aren’t a large share of the company, I’ll just ignore them for now, more detail is available in the company’s filings.
Voting, non-voting, and super voting shares do show up occasionally, and they normally trade using different ticker symbols if they’re available on the market. Most of the time, the voting shares are worth a little more than non-voting shares, giving value to being able to vote, but that entirely depends on the normal laws of supply and demand. In the case of Zillow, earlier today, ZG, the voting shares, were trading for about 50 cents less than the non-voting Z shares, so if I were to buy it right then, I would probably take ZG before taking Z.
Whenever a company has multiple classes of stocks, be careful to read about them in the company’s filings - you always want to make sure that you know what you’re buying, and it’s easy to mix these things up.
Okay, with that out of the way, let’s dive in on the analysis.
Zillow organizes its business into three major revenue segments: Homes and Zillow Offers, which represents their home buying and selling activities, IMT which includes the premier and rentals category, mainly aimed at real estate professionals, and Mortgages, a nice follow-on business if you’re involved with buying and selling homes. As for Mortgages, Zillow acts more like a mortgage broker, originating the loan with the consumer, and then later selling it to a company that’ll service the mortgage throughout its life.
In one sense, Zillow is an advertising service, interested in listing all of the homes that are for sale, in an easy to search form on both its mobile and web apps. Zillow helps accomplish this by connecting consumers with the homes that they would be most interested in. Real Estate agents can pay for advertising other services that can include prominent placement, VR walkthroughs, motion photography, and a growing suite of services. They can also list rentals with Zillow, and Zillow provides related services to help renters and landlords. That part of the business has been growing steadily from about $217m a quarter to $334m a quarter over the last 2 years.
Mortgages represent a much smaller part of the business, and over the same period went from around $27m to $67m per quarter. The growth in Mortgages is even more steady than the other segments, but it is a relatively small part of the business, and it’s very competitive. I think they just view it as a companion product when they’re involved in the actual purchase and sale, not as a standalone product line.
The part of the stock that I find most interesting is the Homes segment, which includes Zillow Offers. After a number of years disrupting the industry with their “Zestimate”, a Big Data multidimensional estimate of what a house is worth, and a word that often draws the ire of the Real Estate industry, Zillow has recently moved further up the chain. In select markets, when the home meets certain criteria, Zillow will offer to buy the house as-is, with no work, creating a completely painless process for a home seller. Zillow can then apply its considerable scale of staff and talent, to turning the house around for resale, and then selling it through their service and other channels. The business line is only a few years old, it’s not available everywhere, but in the last quarter alone, the company derived more than $700m in revenue from just this segment, making it the largest part of the business in the most recent quarter.
Since this business involves Zillow entering the Real Estate market directly, this segment’s revenue is at the whims of the real estate market, the numbers fluctuate wildly from quarter to quarter, with the typical seasonality of the real estate, but it also offers some of the most promising future growth as Zillow continues to expand. The key to doing this well, at scale, has been doubling down on technology, something that management has indicated they have an appetite for after their recent pandemic related hiring freeze.
When I was going over the filings, I was a little confused when I didn’t see the houses show up on the “Property, Plant, and Equipment” line, a common accounting entry used for buildings related to the company’s operations; instead, houses show up as inventory, which makes sense when you realize Zillow treats these homes as the product it puts on its shelves, and they do break out homes depending on if they’re in a “finished” or “work-in-progress” state, later on in their reports. You do have to keep an eye on the inventory though, since homes can swing a lot in value, so there is extra risk associated with this number.
How does the company acquire this inventory? Real Estate takes a lot of money, and Zillow has a few tricks up their sleeve to access this capital cheaply. In the past, they have issued convertible bonds, which resembles a regular loan, except that both Zillow and the company issuing the loan have the option to convert the amount owed into shares of Zillow stock. While this is a cheap source of working capital for the company, it does have the net effect of issuing more shares of the stock, which can drag the share price down a bit. Over the period I looked at, I didn’t see anything major, but I’m always a little wary of any company that issues extra shares of its stock, so I carefully noted how many shares of Zillow were around for every quarter reviewed in the spreadsheet linked from the show notes.
Interest rates also happen to be at record lows at the moment, and most of these homes are mortgageable, so Zillow has access to classic Bank financing as well, if needs be. They also have a credit line that’s tied to LIBOR that they can access quickly, which acts like a credit card with a multi-million dollar limit. LIBOR occasionally introduces its own issues, so it’s also worth keeping an eye on.
The mobile and web apps have been growing in popularity, as measured by usage, at a fairly steady rate. In the last filing, a quarter of a billion unique users accessed the app in one month, up from 190 million unique users two years ago. Apps are not easy to maintain, so Zillow has been careful to be investing continuously in keeping a dominant position among real estate apps, and I found it easy to use. Management has mentioned significant technical and marketing investments in building Zillow 2.0, a larger set of services that cover more aspects of the home buying and data analysis business, and with the proven track record of the CEO and management, that’s probably money well spent.
Zillow stock has also dropped quite a lot so far this year - from reading some of the news, this appears to be related to inventory issues in the real estate market, as detailed by competitor Opendoor. The year-over-year comparison against the pandemic also makes the comparisons a bit strange, given the frenzied moving activity this started, but again, even going into the quieter part of the real estate year, Zillow still has almost $4b in cash on the balance sheet, even if things are a little bumpy. It’s worth repeating that this stock does have a lot of exposure to the Real Estate market, so some of this has little to do with what the company does either way. Just the past 6 months of price movement volatility alone makes this a risky company to own.
Depite all of this, Tidal River is going to take a position in Zillow this week. Whether it’s going to be in Ticker Z, or Ticker ZG, will largely depend on the spread between the two at the time of the trade, other than a slight preference for the voting shares, the choice will likely go to the cheaper option. Either way, I’m going to put my money where my mouth is.
If you like the podcast and want to see more content like this get created feel free to subscribe on your favorite podcast app, or buy a photo from https://tidalriverinvestments.com - money earned on the photos gets deposited in the investment account. As always Tidal River Investments and I are not financial advisors, market analysts, or otherwise in any way offering advice for or against any of the securities discussed - meet with a financial advisor for that information. Stocks and funds may not be good investments for you, depending on your financial situation.
We’re here for learning, not advice, and I wish you the best on your financial journey, and remember, tides fluctuate!
2021-09-08 00:00:00 +0000 UTC
